Unemployment

Large Variations in Labor per Person (www.ggdc.net)

Hours per Worker 2001

0 500 1,000 1,500 2,000 2,500 3,000

EU

USA

Japan

Hong Kong

Singapore

South Korea

Taiwan

Variation in Labor Force Participaton

Employment as a share of Population

38.00%

40.00%

42.00%

44.00%

46.00%

48.00%

50.00%

52.00%

Europe U.S.A Japan Hong Kong Singapore South Korea Taiwan

Labor Demand given by marginal product of labor

WP

WP

LD

L

= (L) = MPL(L)WP

Labor Supply

Wages affect willingness to work. Substitution effect: Each hour of leisure time costs

more in terms of goods when wages go up. This has the effect of increasing willingness to work.

Income/Wealth effect: Higher wages increase the size of your paycheck. Working hard may be less attractive when your wallet is full.

In theory, the effect of wages on labor supply could run either way. Most empirical findings find that labor supply is a weakly positive function of real wages.

Increasing Hours per Population in East Asia (http://www.ggdc.net)

Hours per Population

0

200

400

600

800

1000

1200

1400

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

Ho

urs

Hong Kong Singapore S. Korea Taiwan

Decreasing in Europe, Increasing in USA

Hours per Person

0

200

400

600

800

1000

1200

1959

1961

1963

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

France West Italy U.K. U.S.A

Labor Demand given by marginal product of labor

LD

WP

L

w*

L*

LS

Labor Market

If labor market is competitive, then labor supply equals labor demand.Equilibrium wages and labor are given at the

point where two curves meet. Increases in technology or capital increase

average and marginal product of labor so they shift labor demand curve up. Increase in Q or K, will increase or L in

equilibrium

WP

Labor Demand given by marginal product of labor

LD

WP

L

w*

L*

LSQ↑ or K↑

L**

w**

LD

Unemployment

Labor markets are characterized by sellers (workers) who would be willing to work at given wages but are not able to find work.

Unemployment rate is the ratio of unemployed to the labor force.

Unemployment varies across countries.

Differences in Unemployment Rates (http://www.oecd.org)

Standardized Unemployment Rates

0 1 2 3 4 5 6 7 8 9 10

USA

France

Germany

Italy

Japan

Rising Level of Unemployment in HK

Hong Kong Unemployment Rate

0

1

2

3

4

5

6

7

8

9

10

Oct

-81

Oct

-82

Oct

-83

Oct

-84

Oct

-85

Oct

-86

Oct

-87

Oct

-88

Oct

-89

Oct

-90

Oct

-91

Oct

-92

Oct

-93

Oct

-94

Oct

-95

Oct

-96

Oct

-97

Oct

-98

Oct

-99

Oct

-00

Oct

-01

Oct

-02

Oct

-03

Oct

-04

Efficiency Wages

In standard model, we think of the cost of hiring workers as only the wage costs.

Efficiency wage theory assumes that costs are a function of turnover costs and costs of monitoring workers.

Real costs of hiring workers includes, ct, representing management costs.

t

t t t tt

WLABOR COST L c LP

Efficiency Wages

At the wage offered by firms, there is greater labor supply than demand.

Labor market competition does not bid down the wages to clear the market because firms know that if wages fall, their management costs will rise

Wage Bar

LD

WP

L

w*

L*

LS

Efficiency Wage

Unemployment

Labor Management Costs as a function of wages Management costs are a function of the

wage paid to workers. If real wages are high, there will be relatively

little turnover. If real wages are high, workers will avoid

shirking their jobs so as to keep their jobs. Management costs relative to wage costs

are highest when wages are low.

( )tt

t

Wc c P

What determines wages Firms don’t take market wages as given but

select market wages to minimize labor costs including turnover costs.

Marginal cost of increasing wages is Lt. Marginal benefit of increasing wages is marginal

reduction of management costs

Wages minimize labor costs when marginal benefit equals marginal costs

t

cL

WP

1cWP

Efficiency Wage

MC1

MB

WPwE

Example

Cost function

Per Worker Marginal Benefit of Reducing Wages

Efficiency wages that minimize total costs.

22 2( ) ( )t t

t tt t

t t

E cW Wc EP PW WP P

2 2( )t

tt

t

c WE PWP

2 2( ) 1E EE w w E

Efficiency Wage

Wages offered by firms are set to minimize the per unit labor costs.

Principal determinant of the wage level are those things, E, which determine how sensitive management costs are to real wages.

Wages are not determined by intersection of labor demand.

What determines the demand for labor?

Once firms decide how much to pay their workforce to minimize labor costs, they decide their demand for workers based on the marginal product of labor.

Marginal cost of hiring workers includes both wages and management costs. Taking wages as given, marginal cost of hiring one more worker is

Marginal benefit of hiring one more worker, MPL. Firm maximizes profits by hiring workers until

( )W WcP P

( )W WMPL cP P

At a given wage w, a firm chooses a labor demand which sets MPL = w +c(w)

WP

MPL

LD

wA

LA

c

c

c(wA) c(wA)

c(wB)wB

LB

Labor Demand at Efficiency Wages

Labor demand is demand for labor at given wage once management costs are factored in.

Gap between labor demand and MPL curve is larger at lower wages because management costs are larger relative to wage costs.

Wage offer is decided at Labor solves we + c(we) = MPL

Labor supply does not affect equilibrium labor market so there may be positive unemployment.

Labor demand determined by efficiency ways.

WP

MPL

LD

we

L*

c

c

Young workers most likely to be unemploymed because they are least skilled and management costs are high, so efficiency wages may not

drop down to their level.

Nov-1994 Nov-1996 Nov-1998 Nov-2000 Nov-2002 Nov-2004

40

35

30

25

20

15

10

5

0

HK: Unemployment Rate%

Total Age 15 to 19 Age 20 to 29 Age 30 to 39Age 40 to 49 Age 50 to 59 Age Above 60

Unemployment is an increasing function of efficiency wage.

WP

LD

we

L*

LS

U(eW)

we’

U(eW’)

Equilibrium Unemployment RateeW

ur

LD

What determines the sensitivity of management costs to wages. Workers are most likely to increase their work

effort when they are afraid of losing their job. This effect will be highest when Unemployment is high.

Efficiency wages are a negative function of the unemployment rate.

Labor market regulations and unions allow firms to fire workers easily.

Social benefits are low relative to workers.

Equilibrium Unemployment RateeW

ur

LD

LSwe*

ur*

Why does unemployment vary across countries. In Europe, labor market regulations make it

difficult for firms to fire workers. This increases management costs and allows workers to demand high wages to avoid shirking.

In Hong Kong, some argue that deflation has pushed up real value of social welfare payments which increases efficiency wage levels.

Increase in Firing Regulation or relative social welfare.

eW

ur

LD

LS

we*

ur*

LS’

ur**

we**

Unemployment may also be a function of economic conditions.

Sep-1983 Sep-1986 Sep-1989 Sep-1992 Sep-1995 Sep-1998 Sep-2001 Sep-2004

5.5

5.0

4.5

4.0

3.5

3.0

2.5

2.0

1.5

JP: Unemployment Rate: Region: Whole Japan%

Unemployment is a negative function of labor demand curve.

WP

LD

we

L*

LS

U(eW)

U(eW’)

Positive Productivity ShockeW

ur

LD

LSwe*

ur*

LD’

ur**

we**