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Chapter 7:The Labor Market in advanced economies
In the U.S. labor market Wages account for two-thirds of per capita
GDP.
Average wages have grown at 2 percentper year for the last century.
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The employment-population ratio The fraction of the civilian population over the
age of 16 that is working
This ratio:
Has been increasing over time in large part
due to the entry of women into the workforce. Decreases in times of a recession.
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The unemployment rate The fraction of the labor force that is
unemployed
A person is unemployed if the followingconditions hold:
She does not have a job that pays a wage orsalary.
She actively looked for a job during the four
weeks before measuring the unemploymentrate.
She is available to work.
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The Dynamics of the Labor
Marketthe example of Australia
Job creation and job destruction in the
United States Occur each month
Are part of normal changes in the economy
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For most people, periods of
unemployment are relatively short. People who are unemployed for long
periods account for most of the total
weeks of lost work. Many countries have developed social
safety nets.
Unemployment
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Australia: Long-term unemployed as a proportion of thelabour force
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7.3 Supply and Demand
The labour market is an example of a factor market
Supply of labour those people seeking employment(employees)
Demand for labour from employers
Supply and demand for labour services determine the wage
The labor demand curveslopes downward because of
diminishing marginal product of labor (MPL). The labor supply curveslopes upward because the price of
leisure is higher when wages are higher.
The intersection of labor supply and demand determines thelevel of employment and the wage rate.
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Downward flexible wages and
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A Derived Demand not wanted for its own sake but for what itcan contribute to production
Demand for labour related to productivity of labour and the level ofdemand for the product
Elasticity of demand for labour related to the elasticity of demand forthe product
Employers make hiring decisions taking into account costand benefit of an extra workers.
Higher wages means higher costs: At higher wage ratesthe demand for labour will be less than at lower wage rates
Higher productivity means higher benefits
Demand for labour from employers
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Labour productivity
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A critical Assumption: Law of Diminishing
Returns
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Main assumptions: price/wage takingbehaviour
The wage rate employers must pay isgiven to them by the market;
From the viewpoint of the single firm,
the supply of labour is horizontal; at themarket wage there is no labourshortage;
Firms can instantaneously adjust theirlabour input (and costs) as marketconditions change.
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A production function: q=F(K ! A"
K=capital stoc#$!=la%our inputs
A=technology
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&enefit of hiring an additional wor#er = cost of hiring an additional wor#er
'='& from hiring )=*+'**
if the firm ta#es ) and * as gi,en (perfectly competiti,e mar#ets"
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The firms hiring decision
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-he 'R* cur,e is the firm.s la%our demand cur,e/
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A Change in Labor Demand
Suppose the government createsregulations making it harder to fire
workers. Firms will demand fewer workers.
Labor demand shifts left, causing wages and
employment to fall. The unemployment rate rises initially and
recovers as discouraged workers drop out of
the labor force.
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A Change in Labor Supply
If the government collects a tax on a
workers wage: The labor supply curve shifts left.
A worker receives less money and suppliesless laborthis applies to anywage.
In order to be in equilibrium, firms mustraise wages.
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age !igidity
Wage rigidity Wages fail to adjust after a shock to labor
demand or supply.
What happens if wages do not fall in theabove demand shock example?
The labor market will not clear and thisresults in a larger fall in employment.
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Different "inds of Unemployment
The natural rate of unemployment
Rate that would prevail if the economywere in neither a boom nor a bust
Cyclical unemployment
The difference between the actual rate andthe natural rate
Associated with short-run fluctuations in
output
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The natural rate of unemployment includestwo components:
Frictional unemployment
workers being between jobs in the dynamiceconomy
Structural unemployment labor market failing to match up workers
and firms in the market
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Actual unemployment is the sum offrictional, structural, and cyclicalunemployment.
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Two equations:
employment unemployment
size of
labor force
change inunemployment
job separation
rate
job finding
rate
Sol ing the model
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Solving the model:
Set the change in unemployment to zero
Solve the equation for U
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The unemployment rate is defined asthe fraction of the labor force that isunemployed. Therefore:
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Insights of the model: Only way to alter the natural rate of
unemployment is:
change the job finding rate.
change the job separation rate.
Policies along these lines can haveunintended consequences.
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7.5 Labor Markets around theWorld
Some facts about international labormarkets since 1980:
Unemployment in Europe Substantially above Americas rate
Unemployment in Japan
Historically below the United States.
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European unemployment has increaseddramatically because of:
Adverse shocks and high oil prices. Inefficient labor market institutions in the form of
higher unemployment and welfare benefits.
1990s hours worked in Europe much lowerthan 1970s levels.
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7.6 How Much Is Your HumanCapital Worth?
The present discounted value of your lifetime income islikely greater than $1 million.
Present discounted value
The value of money you would need to put in the banktoday to equal a given future value.
Tells how much a future payment or a future flow ofpayments is worth today.
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Equation for present discounted value
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To calculate the value of a stream of equal
payments over a given number of years: Arrange the sum of each periods present
discounted values into a geometric series.
Use the formula for a sum of a geometricseries to calculate the present discountedvalue of the stream of payments.
If ais some number between 0 and 1, thencalculating a geometric series is:
$
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For example, the series for a $100 initial
payment for twenty years is:
Or:
From previous page: If a= 1/(1 + R), then:
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Letting the interest rate R= .10
What is the pdvon $100 over 20 years? $936.
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7 7 The Rising Return to
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7.7 The Rising Return to
Education
The premium to having a college degree: Has been rising rapidly over the last fortyyears.
Far outweighs the forgone wages and tuitioncosts of going to college.
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Supply of skilled workers and their
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Supply of skilled workers and their
wagesSource: Table 10.1, drawn from Machin (2001)
Share of graduates intotal employment (%)
US UK
Relative wages ofgraduates to non-graduates
US UK
1980 19.3 5.0 1.36 1.48
1990 23.8 10.2 1.55 1.60
2000 27.5 17.2 1.66 1.64
Can supply side factors explain the rising college wagepremium? Empirical evidence
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premium? Empirical evidence
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Explanations for a large shift in demandfor highly educated workers include:
Skill-biased technical change: newtechnologies are more effective at improving
productivity of college-educated workers.
Globalization: increased opening of trade.
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Case Study# ithin)country ,ncome,ne-uality
Rising college premium is one cause ofrising income inequality
Early 1900s
Most inequality associated with capitalincome
Recently
Most inequality associated with salariesand business income
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