Chapter 6: The Labor Market Slide #1Blanchard: Macroeconomics
The Labor Market: The Medium RunThe Labor Market: The Medium Run
Higher production requires an increase in employment
Higher employment reduces unemployment
Lower unemployment puts pressure on wages
Higher wages increase production costs and therefore prices
A Medium Run Response to an Increase in DemandA Medium Run Response to an Increase in Demand
Chapter 6: The Labor Market Slide #2Blanchard: Macroeconomics
The Labor Market: The Medium RunThe Labor Market: The Medium Run
Higher prices lead workers to ask for higher wages….
Prices and wages (the labor market) adjust over the medium run and influence output
A Medium Run Response to an Increase in DemandA Medium Run Response to an Increase in Demand
Chapter 6: The Labor Market Slide #3Blanchard: Macroeconomics
The Labor Market: The Medium RunThe Labor Market: The Medium Run
A Tour of the Labor MarketA Tour of the Labor Market
U.S. Population 1998 270.2 million Minus: Pop. under 16, -65.0 million Armed forces and
Incarcerated
Civilian Noninstitutional Pop. 205.2 million Civilian Labor Force 137.6 million Employed 131.4 million Unemployed 6.2 millionOut of the Labor Force 67.6 million
Chapter 6: The Labor Market Slide #4Blanchard: Macroeconomics
The Labor Market: The Medium RunThe Labor Market: The Medium Run
A Tour of the Labor MarketA Tour of the Labor Market
)1998(%672.205
6.137
PopulationtionalNoninstitu
ForceLabor
The participation rate=
What has caused the participation rate to increase over time?
Chapter 6: The Labor Market Slide #5Blanchard: Macroeconomics
The Labor Market: The Medium RunThe Labor Market: The Medium Run
The unemployment rate =
A Tour of the Labor MarketA Tour of the Labor Market
)1998(%5.46.137
2.6
ForceLabor
Unemployed
Chapter 6: The Labor Market Slide #6Blanchard: Macroeconomics
The Labor Market: The Medium RunThe Labor Market: The Medium Run
Employment127 million
Job Change3.5 million
Unemployment7.0 million
Out of laborforce
66.7 million
1.1
1.3
1.7
1.51.5
1.8
Labor Force Data, 1994 – 1999 (monthly flows)Labor Force Data, 1994 – 1999 (monthly flows)
Chapter 6: The Labor Market Slide #7Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
Differences Across WorkersDifferences Across Workers
Monthly Separation Rates for Different Groups, 1968-1986
Category
Male: Ages 16-19 35-44
Female: Ages 16-19 35-44
Monthly Separation Rate (%)(Quits and Layoffs)
15.91.6
16.15.0
Chapter 6: The Labor Market Slide #8Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
Differences Across WorkersDifferences Across Workers
1998 Unemployment Rate
U.S. 4.5%Males 16-19 16.2%African-Americans 8.9%
Chapter 6: The Labor Market Slide #9Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
Movements in UnemploymentMovements in Unemployment
Chapter 6: The Labor Market Slide #10Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
Small upward trend in the unemployment rate
•1950s 4.5•1960s 4.7•1970s 6.2•1980s 7.3•1990s 5.9The trend increase is dominated by large fluctuations in the unemployment rate•1992 7.7% (recession 1990-91)•1982 9.7% (recession 1981-82)
Chapter 6: The Labor Market Slide #11Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
Movements in UnemploymentMovements in Unemployment
Chapter 6: The Labor Market Slide #12Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
Movements in UnemploymentMovements in Unemployment
Chapter 6: The Labor Market Slide #13Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
Movements in UnemploymentMovements in Unemployment
To Summarize:To Summarize:
High Unemployment:
• Increases the probability of workers losing their jobs•Reduces the probability of the unemployed finding a job• Increases the duration of unemployment
Chapter 6: The Labor Market Slide #14Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
Wage DeterminationWage Determination
1. Workers’ wages exceed theirreservation wage
2. Wages depend on labor-marketconditions:
•How easily can a worker be replaced?•How easily a worker can find another job?
•Efficiency Wages: Wages above the •reservation wage that increase productivity •and reduce the turnover rate.
Chapter 6: The Labor Market Slide #15Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
Wages and UnemploymentWages and Unemployment
Wage determination:Wage determination:
),(
),(
zuFPW e
W = WagePe = Expected price levelu = The unemployment ratez = Other variables that affect the wage setting
Chapter 6: The Labor Market Slide #16Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
The expected price level, Pe & wagesThe expected price level, Pe & wages
Wages and Unemployment:Wages and Unemployment:
),(
),(
zuFPW e
•Workers base their wage request on the purchasing power of their wages or real wage W/P
•Employers base the wage they pay on the price of the product they sell or the real wage W/P
•Therefore, if Price (P) increases, wages (W) increase
Chapter 6: The Labor Market Slide #17Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
Wages and Unemployment:Wages and Unemployment:
),(
),(
zuFPW e
• Higher unemployment reduces bargaining power and wages
• Higher unemployment reduces the efficiency wage
The unemployment rate, and wagesThe unemployment rate, and wagesu
Chapter 6: The Labor Market Slide #18Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
Wages and Unemployment:Wages and Unemployment:
),(
),(
zuFPW e
• Unemployment insurance: higher benefits leads to higher wages
• Structural Economic Change: wages increase when jobs created exceed jobs destroyed
The other factors and wagesThe other factors and wages)(z
Chapter 6: The Labor Market Slide #19Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
Price Determination and the Production FunctionPrice Determination and the Production Function
Assume labor is the only input, thenAssume labor is the only input, then
Output (Y) = ANN = EmploymentA = Labor Productivity
Assume A=1Y = N
If Y=N: then marginal cost = Wage (W)
Chapter 6: The Labor Market Slide #20Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
Price Determination and the Production FunctionPrice Determination and the Production Function
When perfect competition exists in the product marketWhen perfect competition exists in the product market
Price (P) = Marginal CostGiven: Marginal cost = WThen: P=W
In non-competitive markets P=(i+µ)W
µ= Markup of price over cost
Chapter 6: The Labor Market Slide #21Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of UnemploymentThe Natural Rate of Unemployment
The wage-setting relationThe wage-setting relation
Assume: Pe = PW=PF(u,z) and dividing by P
),( zuFP
W
),(
The higher the unemployment rate (u), the lowerthe rate wage
P
W
Chapter 6: The Labor Market Slide #22Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of UnemploymentThe Natural Rate of Unemployment
The wage-setting relation:The wage-setting relation: ),( zuFP
W
),(
WS
Unemployment Rate, u
Rea
l W
age,
W/P
Wage-setting relation(W/P varies inversely with u)
Chapter 6: The Labor Market Slide #23Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of UnemploymentThe Natural Rate of Unemployment
The Price-setting relation:The Price-setting relation:
Recall: WP )1(
Divide by W: 1W
P
Invert both sides:
1
1
P
W
Chapter 6: The Labor Market Slide #24Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of UnemploymentThe Natural Rate of Unemployment
The Price-setting relation:The Price-setting relation:
Recall: μP
W
1
1
Observe: • If markup (µ) increases
• Price (P) increases, given wages (W)
• Real wage falls
• Price setting a function of markup (µ)
Chapter 6: The Labor Market Slide #25Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of UnemploymentThe Natural Rate of Unemployment
The Price-setting relation:The Price-setting relation:
1
1
P
W
PS
Price-setting relation(W/P is independent of u)
Unemployment Rate, u
Rea
l W
age,
W/P
1
1
Chapter 6: The Labor Market Slide #26Blanchard: Macroeconomics
Unemployment Rate, u
Rea
l W
age,
W/P
un – The natural rate of unemployment
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of UnemploymentThe Natural Rate of Unemployment
Equilibrium Real Wages, Employment and UnemploymentEquilibrium Real Wages, Employment and Unemployment
Labor Market Equilibrium
WS
1
1PS
Wage-setting, F(u, Z) = Price-setting, 1
1
A
Chapter 6: The Labor Market Slide #27Blanchard: Macroeconomics
WS´ = F(u, Z´)
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of Unemployment / Structural Rate of UnemploymentThe Natural Rate of Unemployment / Structural Rate of Unemployment
Is the natural rate of unemployment “natural”?Scenario: Increase unemployment benefits (z increases)Is the natural rate of unemployment “natural”?Scenario: Increase unemployment benefits (z increases)
Unemployment Rate, u
Rea
l W
age,
W/P
WS = F(u, Z)
1
1PS
un
A B
un´
The increase in Z increases un
Chapter 6: The Labor Market Slide #28Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of UnemploymentThe Natural Rate of Unemployment
Scenario: More stringent antitrust legislation (µ decreases)Scenario: More stringent antitrust legislation (µ decreases)R
eal
Wag
e, W
/P
WS = F(u, Z)1
1PS
unun´
The decrease in u reduces un
´1
1
PS´
Unemployment Rate, u
Chapter 6: The Labor Market Slide #29Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of Unemployment / Structural Rate of UnemploymentThe Natural Rate of Unemployment / Structural Rate of Unemployment
From Unemployment to OutputFrom Unemployment to Output
The Natural Level of EmploymentU = unemploymentN = employmentL = labor forceu = unemployment rate
L
N
L
NL
L
Uu
1
Rearranging for N: N=L(1-u)
Chapter 6: The Labor Market Slide #30Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
The Natural Rate of UnemploymentThe Natural Rate of Unemployment
From Unemployment to OutputFrom Unemployment to Output
The Natural Level of Employment
N=L(1-u)un = natural rate of unemploymentNn = natural level of employmentNn = L(1-un)
The Natural Rate of Unemployment / Structural Rate of UnemploymentThe Natural Rate of Unemployment / Structural Rate of Unemployment
Chapter 6: The Labor Market Slide #31Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
From Unemployment to OutputFrom Unemployment to Output
The Natural Level of Output
Y = NYn = Nn = L(1-un)Y = NYn = Nn = L(1-un)
Assuming the Production Function:
Assuming the Production Function:
Chapter 6: The Labor Market Slide #32Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
From Unemployment to OutputFrom Unemployment to Output
Equilibrium Unemployment Rate:
1
1),( zuF n
Natural level of output: )1()( nn uLY
1
1),1( z
L
YF n
1
1),1( z
L
YF n
Chapter 6: The Labor Market Slide #33Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
Equilibrium Real Wages, Employment, and UnemploymentEquilibrium Real Wages, Employment, and Unemployment
At Yn the associatedLY
un
n /
1
and the real wage chosen in wage settingequals the real wage implied by price setting.
Chapter 6: The Labor Market Slide #34Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
A SummaryA Summary
Assume: The expected price = actual price level
Then: • Wage setting implies the real wage is inversely related to unemployment
•The price setting real wage is constant
•Labor market equilibrium occurs when W/P wage setting = W/P price setting
•Labor market equilibrium determines the unemployment rate – the natural rate of unemployment
• Wage setting implies the real wage is inversely related to unemployment
•The price setting real wage is constant
•Labor market equilibrium occurs when W/P wage setting = W/P price setting
•Labor market equilibrium determines the unemployment rate – the natural rate of unemployment
Chapter 6: The Labor Market Slide #35Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
Where We Go From HereWhere We Go From Here
Recall: • Labor market equilibrium determines the natural level of unemployment which determines the natural level of output
• Labor market equilibrium determines the natural level of unemployment which determines the natural level of output
Observe: • Monetary policy, fiscal policy, consumer confidence does not impact the natural level of unemployment and output
• Monetary policy, fiscal policy, consumer confidence does not impact the natural level of unemployment and output
Chapter 6: The Labor Market Slide #36Blanchard: Macroeconomics
A Tour of the Labor MarketA Tour of the Labor Market
Short-Run • Price level may not equal the expected price
• Unemployment may not equal natural unemployment level
• Output may not equal natural output
• Price level may not equal the expected price
• Unemployment may not equal natural unemployment level
• Output may not equal natural output
Medium-Term
• Price level tends to equal expected prices
•Unemployment tends to the natural rate
•Output moves toward the natural rate
• Price level tends to equal expected prices
•Unemployment tends to the natural rate
•Output moves toward the natural rate
The Appropriate Time FrameThe Appropriate Time Frame