©2012 the mcgraw-hill companies, all rights reserved 1 chapter 16: wages and unemployment

©2012 The McGraw-Hill Companies, All Rights Reserved

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Chapter 16: Wages and Unemployment


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Learning Objectives

1. Use a supply-and-demand model to understand the labor market

2. Explain the relationship between the supply of and the demand for labor and real wages and employment

3. Define and calculate the unemployment rate and the participation rate

4. Differentiate among the three types of unemployment and the costs associated with each


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Supply and Demand in The Labor Market

Supply and demand analysis can be used to find the price of labor (real wages) and the quantity (employment) Analysis will consider the number of workers

employed, not work-hours per yearLabor market is an input market

Firms buy labor to produce goods and services

Macroeconomics look at aggregate levels of employment and real wages Microeconomics looks at wage

determination for a category of workers


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Wages and Demand for Labor

The demand for labor depends upon: The productivity of workers

Greater productivity increases employment The price of the worker’s output

Higher real prices increases employment

Diminishing returns to labor Assumes non-labor inputs are held constant Adding one worker increases output but by

less than the previous worker addedValue of Marginal Product (VMP) is

extra revenue that an added worker generates


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Manama Computer Company (MCC)

Number of

Workers

Computers per Year

1 25

2 48

3 69

4 88

5 105

6 120

7 133

8 144

Value of Marginal Product

$75,000

69,000

63,000

57,000

51,000

45,000

39,000

33,000

Marginal Product

25

23

21

19

17

15

13

11

MCC can sell all its computers for $3,000 each


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Demand Curve for Labor

Hire an extra worker if and only if the VMP exceeds the wage paid

If wage is $60,000, MCC will hire 3 workers At $50,000, MCC

hires 5 workersThe lower the wage,

the more workers employed

Employment

Wag

e ($

000s

)Labor

Demand

3

60

50

5


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Shifts in the Demand for Labor

Demand shifts when the value of the marginal product of a worker changes

Two factors determine the demand (VMP) for labor The price of the company’s output

An increase in market demand The productivity of the workers

Greater quantity of non-labor inputs Organizational change Training and education


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Price of Output Increases

Number of

Workers

Computers per Year

1 25

2 48

3 69

4 88

5 105

6 120

7 133

8 144


$125,000

115,000

105,000

95,000

85,000

75,000

65,000

55,000

Marginal Product

25

23

21

19

17

15

13

11

MCC can now sell all its computers for $5,000 each


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Price of Output Increases

When price was $3,000 MCC hired 3 workers

When price is $5,000 MCC will hire 7 workers Demand for labor

increased from 3 to 7 An increase in the

price of workers' outputincreases the demand for labor Employment

Rea

l Wag

e ($

000s

)Labor Demand(P = $3,000)

60

3

50

5 7 8

Labor Demand(P = $5,000)


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Higher Productivity

Number of

Workers

Computers per Year

1 37.5

2 72

3 103.5

4 132

5 157.5

6 180

7 199.5

8 216


$112,500

103,500

94,500

85,500

76,500

67,500

58,500

49,500

Marginal Product

37.5

34.5

31.5

28.5

25.5

22.5

19.5

16.5

Each technician builds 50% more machines


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Higher Productivity

Increases in productivity increase VMP MCC hires 6 instead

of 3 Demand curve shifts

right Employers hire more

workers at any given wage

Employment

Rea

l Wag

e

Labor Demand(before productivity increase)

Labor Demand(after productivityincrease)


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The Supply of Labor

Reservation wage is the lowest wage a worker would accept for a given job

Will you go to the beach or clean your parents’ basement?

Opportunity cost of working is your leisure activity

Work compensates you for lost leisure If working conditions are unpleasant or

dangerous, a premium for that would be included in the wage

Cost – Benefit Principle at work


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Aggregate Labor Supply

People work for many reasons: Personal satisfaction Opportunity to develop skills and talents Chance to socialize with co-workers

Still, for most people, income is one of the principal benefits of working The higher the real wage, the more willing they

are to sacrifice other possible uses of their time The fact that people are more willing to

work when the wage they are offered is higher is captured in the upward slope of the supply curve of labor


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The Supply of Labor

Employment

Re

al W

age

Labor Supply

The labor supply curve slopes up because the higher the real wage, the more people are willing to work


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Shifts in Labor Supply

A shift in labor supply is caused by any change in the number of workers willing to work at each wage Increase in the working-age population

Baby Boom Higher net immigration Increasing age at retirement

Increase in the share of working-age population willing to work

Women's participation in the labor force has increased in the last 50 years


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Explaining The Trends in Real Wages and Employment

We have discussed both the demand for and supply of labor separately

We are ready to apply supply and demand analysis to real-world labor markets

To do so we need to examine supply and demand of labor in the same graph


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Trend 1: Increasing Real Wages

Industrialized countries have had sustained growth in productivity over many decades Increases demand for

labor Both real wages and

employment increased

Productivity increases were due to Technological progress Increases in capital

Employment

Rea

l Wag

e

S

D

W

N

W'

N'

D'


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Trend 2: Increased Wage Inequality

Globalization results in an expansion of many markets to worldwide supply Increasing ease of goods and services

crossing national borders Benefit of globalization is increased

specialization and efficiency Principle of Comparative Advantage

Globalization also means that some goods produced domestically are no longer competitive Some domestic sectors shrink The effects of globalization on the labor

market are mixed


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Employment

Rea

l Wag

e

Employment

ST

DT

W

NT

SS

DS

NS

D'T

W’T

N'T

D'S

W'S

N'S

SoftwareTextiles


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Domestic market starts in equilibrium at wage W NT workers are in the textile industry NS workers are in the software industry

Globalization opens borders and country begins importing textiles and exporting software Demand for domestic textiles decreases

as some textiles are bought overseas This decreases the wage in the textile industry

to W'T and employment decreases to N'T


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Domestic market starts in equilibrium at wage W NT workers are in the textile industry NS workers are in the software industry

Globalization opens borders and country begins exporting textiles and importing software Exports cause an increase in demand,

employment, and wages

The result is a wage differential (W'S – W'T) where none existed before


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When wages in importing industries fall and wages in exporting industries rise, wage inequality increases Low-skill industries face the toughest

international competition Political resistance to free trade grows

Worker mobility is the movement of workers between jobs, firms, and industries Market incentives move workers out of

textiles and into software Transition aid by government can assist

workers to make the change


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Technological change can be a source of increasing wage inequality Occurs if technical change favors higher-skilled

or better-educated workers Some innovation renders old skills less

valuable Addition and the calculator and computer

Skill-biased technological change affects the marginal products of higher skilled workers differently from those of lower-skilled workers Recent changes favor higher skilled workers

Automobile production lines increasingly use robots


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Skill-Biased Technological Change

Employment

Re

al W

age

Unskilled Workers

W'S

N'U

SU

DU

NU

WS

Employment

Skilled Workers

D'S

SS

NS

WS

DS

D'U

N'S

W'S


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Unemployment and the Unemployment Rate

In most countries, a government agency is responsible for conducting a survey of households and the labor force and defining and measuring unemployment

Employed: works full-time or part-time Unemployed: unemployed but is actively

seeking employment Out of the labor force: unemployed and is

not actively seeking employment Full-time students, unpaid homemakers,

retirees, and people unable to work because of disabilities

Discouraged job seekers who have given up searching for employment


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Unemployment and the Unemployment Rate

Measuring Unemployment

Labor force = employed + unemployed Unemployment rate = unemployed /

labor force Participation rate = labor force /

population 16+

Population Age 16Population Age 16++

Employed

Un

emp

loye

d

Out of the

Labor Force


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Unemployment and Labor Force Participation Rates


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Unemployment in Egypt, 1970 – 2008


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Unemployment in Morocco, 1999– 2008


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Unemployment in Tunisia, 1999– 2008


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Costs of Unemployment

Unemployment imposes: Economic costs

Lost wages and production Decreased taxes and increased transfers

Psychological costs Individual self-esteem Family stress of decreased income and increased

uncertainty Social costs

Potential increases in crimes and social problems• Social resources spent to address these

Anger, frustration, and despair may result in social rebellion

• Uprisings in Tunisia, Egypt, Algeria, Bahrain, Libya, Syria, and Yemen


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“True” Unemployment

Discouraged workers would like to have a job but they have not looked for work (during the survey period) Counted as out of the labor force Willing and ready to work Could be counted as unemployed but

they are not Involuntary part-time workers are

people who like to work full-time but cannot find a full-time job Counted as employed


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Types of Unemployment

Short-term unemployment that is associated with the process of matching workers with jobs is called frictional unemployment

Because the labor market is heterogeneous and dynamic, the process of matching jobs with workers often takes time

The costs of frictional unemployment are low and may even be negative; that is, frictional unemployment may be economically beneficial (better match)


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Structural unemployment is long-term, chronic unemployment in a well-functioning economy due to Lack of skills, language barriers, or discrimination Structural shifts in production create a long-term

mismatch between workers and market needs Barriers to employment such as

Minimum wages ■ Unions Unemployment Insurance

Cause high economic, psychological, and social costs


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Structural Barriers to Employment: Minimum Wage

Employment

Rea

l Wag

e

D

S

N

W

AWmin

NA

B

NB

Minimum Wage Laws

Setting a minimum wage (Wmin) above equilibrium (W) creates (NB – NA) unemployment

Workers who find a minimum-wage job get a higher wage Others are

unemployed


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Structural Barriers to Employment: Labor Union

Labor union benefits Reduced worker

exploitation Support progressive

labor legislation Increase

productivity Promote democracy

in the workplace

Labor union costs Introduces

inefficiency into competitive markets

May keep companies from competing globally

Increase labor supply in non-union sector• Decreases wages

for non-union workers


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Structural Barriers to Employment: Unemployment Insurance

Unemployment insurance are government transfers to unemployed workers Helps to reduce the costs of

unemployment May give the unemployed an incentive to

search longer and less intenselyTo work efficiently, unemployment

benefits should be For a limited time Less than the income received when

working


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Cyclical unemployment is the increase in unemployment during economic slow-downs (recessions) Usually short duration Significant economic cost since it is

associated with decline in real GDP


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Other Government Regulations

Health and safety regulations can reduce the demand for labor by Increasing employer costs Reducing productivity

The reduction in demand will increase unemployment and lower wages


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Unemployment in Western Europe, 1980 - 2007


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Why Are Unemployment Rates High in Europe?

Structural rigidities explain persistently high rates Highly regulated labor markets High minimum wages Generous unemployment benefits Powerful labor unions

This lack of flexibility in labor markets—which some observers refer to as Eurosclerosis—causes higher frictional and structural unemployment

©2012 the mcgraw-hill companies, all rights reserved 1 chapter 16: wages and unemployment

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