Chapter 6: The Medium Run

C H A P T E R

6

The Labor Market

Prepared by:

Fernando Quijano and Yvonn Quijano

And Modified by Gabriel Martinez

What’s the point of this chapter?

 The Aggregate Supply curve is a relation between production and the price level .

 Production happens because firms hire workers (among other things).

 The real cost of hiring workers is the real wage.

 Higher price levels reduce the real wage.

 Lower real wages cause firms to hire more workers and increase production.

© 2003 Prentice Hall Business Publishing Macroeconomics, 3/e Olivier Blanchard

What’s the point of this chapter?

Cont.

 Two complications:

– Workers want purchasing power in return for their work.

 Since they sign contracts to work in the future, they care about the future price level.

 Price level expectations may move more slowly than the actual price level.

– Workers’ effort (which is difficult to monitor) and their bargaining power depends on the unemployment rate.

 And on unemployment benefits, etc.


6-1

A Tour of the Labor

Market

 The noninstitutional civilian population are the number of people potentially available for civilian employment.

 The civilian labor force is the sum of those either working or looking for work.

 Those who are neither working nor looking for work are out of the labor force .

 The participation rate is the ratio of the labor force to the noninstitutional civilian population.

 The unemployment rate is the ratio of the unemployed to the labor force.


A Tour of the Labor Market

Population, Labor

Force,

Employment, and

Unemployment in the United States

(in millions), 2000


The Large Flows of Workers

 An unemployment rate may reflect two very different realities:

– A a labor market with many separations and many hires ,

– A labor market, with few separations, few hires, and a stagnant unemployment pool.

 What is worse? To lose your job and get a new one

12 times a year? Or to be unemployed for 6 months?



Average Monthly Flows

Between Employment,

Unemployment, and

Nonparticipation in the United

States, 1994-1999

(1) The flows of workers in and out of employment are large.

(2) The flows in and out of un employment are large in relation to the number of unemployed.

(3) There are also large flows in and out of the labor force, much of them directly to and from employment.



From the CPS data we conclude that:

1.

The flows of workers in and out of employment are large.





Separations consist of:

Quits , or workers leaving their jobs for a better alternative, and

Layoffs , which come from changes in employment levels across firms.

 The Current Population Survey (CPS) produces employment data, including the movements of workers.




2.

The flows in and out of unemployment are large in relation to the number of unemployed.

 The average duration of unemployment is about three months.




3.

There are large flows in and out of the labor force, much of them directly to and from employment.

 Discouraged workers are classified as “out of the labor force,” but they may take a job if they find it.

 The nonemployment rate is the ratio of population minus employment to population.

 Because it includes the discouraged, it might be a better measure of unemployment.


6-2

Movements in

Unemployment

 Fluctuations in the aggregate unemployment rate affect:

– The welfare of individual workers

– Wages

 Higher unemployment affects workers:

 Through a decrease in hires —more difficult to find jobs.

 Through higher layoffs —higher risk of losing their jobs.


Movements in Unemployment

Movements in the

U.S.

Unemployment

Rate, 1948-2000

Since 1948, the average yearly

U.S. unemployment rate has fluctuated between 3 and

10%.



The Unemployment

Rate and the

Proportion of Unemployed

Finding Jobs, 1968-

1999

When unemployment is high, the proportion of unemployed finding jobs is low.

© 2003 Prentice Hall Business Publishing

Note, the scale on the right is an inverse scale.

Macroeconomics, 3/e Olivier Blanchard


The Unemployment

Rate and the

Monthly Separation

Rate from

Employment, 1968-

1999

When unemployment is high, a higher proportion of workers lose their jobs.


6-3

Wage Determination

 Collective bargaining is bargaining between firms and unions.

– The result depends on each side’s bargaining power, which in turn depends on each side’s opportunity cost of not making the deal. For example:

 The skills of the worker compared to the skills required for the job;

 The current and expected unemployment rates;

 Going wages, social norms and laws regarding hiring and firing.

 Etc.


Wage Determination

 Common forces at work in the determination of wages:

– Wages are typically higher than the reservation wage , that is, the wage that make them indifferent between working or becoming unemployed.

 “I won’t work unless you pay me more than $7 an hour.”

– Labor-market conditions.


Bargaining

 How much bargaining power a worker has depends on:

1. How costly it would be for the firm to replace him —the nature of the job.

2. How hard it would be for him to find another job —labor market conditions.

It’s important to realize that, generally speaking, low-income workers have less bargaining power than potential employers.


Efficiency Wages

 Should we pay you as low a wage as you’ll take?

 If we do, we might lose you and we’ll have to train someone else.

– When unemployment is high, a higher proportion of workers lose their jobs.


Efficiency Wages

 Efficiency wage theories are theories that link the productivity or the efficiency of workers to the wage they are paid.

– These theories also suggest that wages depend on both the nature of the job and on labormarket conditions.

– Efficiency wages are typically higher than market-clearing wages: unemployment will result.


Wages, Prices, and

Unemployment

W

 e

( , )



The aggregate nominal wage,

W

, depends on three factors:

1. The expected price level, P e

2. The unemployment rate, u

3. A catchall variable, z, that catches all other variables that may affect the outcome of wage setting.


Wages, Prices, and

Unemployment

1. Both workers and firms care about real wages

( W / P ), not nominal wages ( W ).

Suppose your job is to write a computer program.

To do so, you spend 25,000 calories of energy – i.e., you’ve given real effort to the firm.

You’ll want to be paid back in stuff, in real purchasing power, so that you can at least buy

25,000 calories worth of food.


Wages, Prices, and

Unemployment

Workers also care about what wages they’ll earn in the future, so their expectation of the price level, P e , is key.

Suppose you know that 25,000 calories of energy cost $25 today.

But you are getting paid in 15 days.

In two weeks, 25,000 calories will cost $28. Which price level is relevant here?


Wages, Prices, and

Unemployment

2.

Higher unemployment weakens workers’ bargaining power, forcing them to accept lower wages.

Suppose you are the only available candidate with a bachelor’s degree in aerospace engineering.

Boeing pays you whatever you want.

Suppose, now, that there are seven more people with bachelor’s degrees in aerospace engineering. They are all unemployed. Will you ask for that 15% raise?


Wages, Prices, and

Unemployment

W



P e

F ( u , z )

 If we divide this equation by P, we obtain

W

P



P e

P

F ( u , z )

 This allows us to draw a relation between the real wage W/P and unemployment u .

 This relation has to be downward sloping because higher unemployment makes workers weaker on the negotiating table.


W

P

Wages and Unemployment

Higher unemployment reduces the bargaining power of workers and encourages them to accept lower real wages.

© 2003 Prentice Hall Business Publishing Macroeconomics, 3/e u

Olivier Blanchard

Wages, Prices, and

Unemployment

3. Among other factors that affect wages is unemployment insurance —the payment of unemployment benefits to workers who lose their jobs. Higher unemployment insurance allows workers to hold out for higher wages.

Minimum wages and employment protection are other factors.

Suppose the government pays you $150,000 a year in unemployment insurance. Do you care if you lose your job?


W

P

Wages, Unemployment, and

Unemployment Benefits

Higher unemployment benefits reduces the opportunity cost of unemployment, encouraging workers to ask for higher wages at the given unemployment rate.


Olivier Blanchard

Wages, Prices, and

Unemployment

P e

W



F ( u , z )

P P

4.

It’s obvious that a change in price expectations will change the real wage that workers demand.

Suppose you expected prices to be fairly low. Then, in your nominal wage negotiations with your employer, you’ll make fairly low nominal wage demands.

But now suppose that prices actually turn out to be higher, so P e /P < 1. Then W/P will be relatively low.

P e /P < 1 may happen if an unexpected shock raises prices.


W

P

Wages, Unemployment, and

Unemployment Benefits

If workers expect prices to be fairly low (P e is low), they will demand fairly low nominal wages, W .

But if prices P turn out to be higher, the real wage

W/P will be relatively low.


Olivier Blanchard

6-4

Price Determination

 The production function is the relation between the inputs used in production and the quantity of output produced.

 Assuming that firms produce goods using only labor, the production function can be written as:

Y = output

N = employment

Y



AN

A = labor productivity, or output per worker

 Further, assuming that one worker produces one unit of output —so that A = 1, then, the production function becomes:

Y



N


Price Determination

 If the production function is

Y



N then there are no fixed costs and the only variable cost is the wage rate.

 Then what is the cost of an additional unit of output?

W


Price Determination

 If the cost of an additional unit of output is

W, then W is firms’ marginal cost.

– In perfect competition, P = W.

 If a firm charges more than marginal cost, consumers just go to one of a million competitors.

– In im perfect competition, P > W

 Firms can charge more than marginal cost because there are few other firms selling a product that is similar enough.


Price Determination

 Firms set their price according to:

P



( 1

 m ) W

 The term m is the markup of the price over the cost of production.

– 1+m is the difference between the marginal cost of labor (W) and the price (P).


Price Determination

P



( 1

 m ) W

 1+m is the difference between the marginal cost of labor (W) and the price (P).

 If markets are im perfectly competitive, m > 0, and P > W.

P

P

MR

D

MC

Q

MC

D=MR

Q

 If all markets were perfectly competitive, m = 0, and P = W .


Price Determination

P



( 1

 m ) W

 What determines m ?

– The market power of firms in the product market

(firms may sell differentiated products or they may be oligopolists).


Price Determination

P



( 1

 m ) W

 What determines m ?

– The market power of firms probably increases when the economy is doing well.

 It’s easier to sell and to raise prices (at any given wage) when unemployment is low

 the real wage falls.

– The market power of firms probably decreases when the economy does poorly

 Discounts, price cuts, and “incentives” become larger (at any given wage) when unemployment is high

 the real wage rises.


W

P

1

1+m

Price Determination

P



( 1

 m ) W

W

P



1



1 m

Higher unemployment means lower prices for a given wage (or higher real wages).

Macroeconomics, 3/e u

Olivier Blanchard © 2003 Prentice Hall Business Publishing

6-5

The Natural Rate of Unemployment

 Wage setting and price setting determine the equilibrium rate of unemployment.

 Define the medium run as the period of time when price expectations are fulfilled; or when people have adjusted their expectations to reality.

 Therefore we assume that P e = P , so that this equation becomes this equation.

P P

F ( u , z )

W

P



F ( u , z )


The Wage-Setting Relation

 Earlier, we stated that the nominal wage rate was determined as follows:

W

P



P e

P

F ( u , z )

 Now, since P e = P ,

W



F u z

P

The wage-setting relation:

Workers and firms set real

wages depending on unemployment and other things.


W

P


Higher unemployment reduces the bargaining power of workers and encourages them to accept lower real wages.


Olivier Blanchard

The Price-Setting Relation

 The price-determination equation is:

P



( 1

 m ) W

 If we divide both sides by W , we get:

P



1

 m

W


The Price-Setting Relation

P



1

 m

W

 To state this equation in terms of the wage rate, we invert both sides:

W

P



1



1 m

© 2003 Prentice Hall Business Publishing

The price-setting relation:

Firms set prices (at given nominal wages) depending on their degree of monopoly power.

Macroeconomics, 3/e Olivier Blanchard

W

P

1

1+m

Price Determination

P



( 1

 m ) W

W

P



1



1 m




W

P


PS relation:


Macroeconomics, 3/e

WS relation: Higher unemployment reduces the bargaining power of workers and encourages them to accept lower real wages.

u


W

P


Greater monopoly power allows firms to increase the difference between W and P, at any u, reducing W / P.

PS relation:

High u lowers prices and raises

W/P.

© 2003 Prentice Hall Business Publishing Macroeconomics, 3/e

WS relation: High u weakens workers and lowers real wages.

u

Olivier Blanchard

Price Determination

P



( 1

 m ) W

 For simplicity we’ll assume m > 0.

– Assume m doesn’t depend on unemployment, but that it does depend on structural characteristics such as anti-Trust enforcement.


W

P

1

1+m

Price Determination

P



( 1

 m ) W

W

P



1

1

 m

Unemployment doesn’t affect how firms set prices or wages.


Olivier Blanchard

W

P

Price Determination

W

P



1



1 m

Greater monopoly power increases the difference between W and P, reducing W / P.

1

1+m

1

1+m’



Wage-Setting and Price-Setting

The Wage-Setting Relation, the Price-Setting Relation, and the Natural Rate of

Unemployment

 Real wages are set by workers and firms as a decreasing function of the unemployment rate.

 The real wage implied by firm’s price-setting (given nominal wages) is constant, independent of the unemployment rate.


Equilibrium Real Wages and Unemployment

The Wage-Setting Relation, the

Price-Setting Relation, and the

Natural Rate of Unemployment

The natural rate of unemployment is the unemployment rate such that the real wage chosen in wage setting is equal to the real wage implied by price setting.



 We can solve the Wage-Setting / Price-Setting model for the equilibrium unemployment rate, or natural rate of unemployment, u n

.

 Eliminating W/P from the wage-setting and the price-setting relations:

F ( u , z )



1

1

 m



The equilibrium unemployment rate, or natural rate of unemployment, u n

F ( u n

, z )



1



1 m u n depends on: the shape of the function F ; on unemployment benefits; on the degree of market power of firms…



Unemployment Benefits and the Natural Rate of

Unemployment

An increase in unemployment benefits leads to an increase in the natural rate of unemployment.



Markups and the Natural

Rate of Unemployment

An increase in markups decreases the real wage, and leads to an increase in the natural rate of unemployment.

Monopolists produce less than perfect competitors: then fewer people are hired.


Actual Unemployment versus

Natural Unemployment

 Can the “actual” rate of unemployment be different from the “natural” rate of unemployment?

– This is a medium term model.

– In the short-term, many kinds of inflexibilities will prevent the economy from adjusting.

– Unemployment changes more slowly than most other macroeconomic variables.



Movements in the

U.S.

Unemployment

Rate, 1948-2000

Labor hoarding causes unemployment to rises slowly after the recession begins, and to stay high even after the recession ends.




 When will u be different from u n

?

– When expected prices are higher than actual prices P e > P.

 If people expect high prices, they’ll demand high wages

– At every level of unemployment, workers will demand a high W/P.

– This means that workers will require

W/P > 1/(1+m).

– Because firms will only pay W/P = 1/(1+m), they won’t hire as many workers.




 If P e > P, workers will require high nominal wages, so workers require W/P > 1/(1+m)

– Unemployment will rise because firms don’t hire.

– As workers’ bargaining power weakens, they lower their nominal wage requests, until

W/P = 1/(1+m).

– The actual rate of unemployment will be higher than the natural rate of unemployment, u>u n

.




Expected Prices and the

Actual Rate of

Unemployment

 If expected prices are higher than actual prices P e >

P, nominal wage demands will be too high, leading to a rise in unemployment.

 Then u>u n

.


The Structural Rate of

Unemployment

 Because the equilibrium rate of unemployment reflects the structure of the economy, a better name for the natural rate of unemployment is the structural rate of unemployment .

– I.e., it depends on institutions and behavior:

 Unemployment benefits;

 People’s reactions to being unemployed;

 Industrial organization;

 Other factors.


What next?

 This is all very nice, but what’s the connection with Aggregate Supply?

– Wage-setting and price-setting determine the economy’s actual level of unemployment and the natural level of unemployment.

– The level of unemployment implies the level of employment.

– The level of employment implies output.


From Unemployment to

Employment

 The natural rate of unemployment

 a natural level of employment .

u



U



L

L



N

L

N

L

The unemploymen t rate

 Employment in terms of the labor force and the unemployment rate equals:

N



L ( 1

 u )

The level of employment

 The natural level of employment, N n

, is given by:

N n



L ( 1

 u n

) The natural level of employment


From Employment to Output

 A natural level of employment

 a natural level of output, (and since Y=N , then,)

Y n



N n



L ( 1

 u n

)

Employment

 output

 The natural level of output satisfies the following:

1



Y n

L

 u n

F



1

Y

L n , z



1

1

 m

The structure of the economy



Y n

 In words, the natural level of output is such that, at the associated rate of unemployment, u n

Y n the real wage chosen in wage setting is equal to the real wage implied by price setting.

L

,


Chapter 6: The Medium Run

What’s the point of this chapter?

Cont.

A Tour of the Labor

Market

Movements in

Unemployment

Wage Determination

Wage Determination

The aggregate nominal wage,

, depends on three factors:

Wages, Unemployment, and

Unemployment Benefits

Wages, Unemployment, and

Unemployment Benefits

Price Determination

The Natural Rate of Unemployment

Actual Unemployment versus

Natural Unemployment

Actual Unemployment versus

Natural Unemployment

Actual Unemployment versus

Natural Unemployment

Related documents

Products

Support

Chapter 6: The Medium Run

What’s the point of this chapter?

Cont.

A Tour of the Labor

Market

Movements in

Unemployment

Wage Determination

Wage Determination

The aggregate nominal wage,

, depends on three factors:

Wages, Unemployment, and

Unemployment Benefits

Wages, Unemployment, and

Unemployment Benefits

Price Determination

The Natural Rate of Unemployment

Actual Unemployment versus

Natural Unemployment

Actual Unemployment versus

Natural Unemployment

Actual Unemployment versus

Natural Unemployment

Related documents

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