Labour Market

Labour Market Trends

The Labour Market

• When firms increase production due to higher demand, it leads to higher employment and lower unemployment.

• Lower unemployment results in higher wages, increasing production costs for firms, leading to higher prices.

• Higher prices cause workers to demand higher wages, leading to further price increases.

Labour Market Flows in the European Union (2019)

• Figure 7.2 illustrates the average monthly flows between employment, unemployment, and non-participation in the European Union in 2019.

US Unemployment Rate (1948–2018)

• Figure 7.3 shows movements in the US unemployment rate from 1948 to 2018.

Overview of the Labour Market in Malta

• Data from Eurostat and the Central Bank of Malta provide an overview of Malta's labor market.

The Unemployment Rate in Malta During the Pandemic

• Unemployment rates diverged significantly during the pandemic.

• The registered unemployed went up much more than the survey-based measure.

Employment Rate Performance in Malta

• Figure 1 shows that Malta's employment rate performance surpasses that of the EU.

Female Participation Rate in Malta

• Figure 2 shows that the female participation rate in Malta surpasses that of the EU.

Employment Growth in Malta (2018-2023)

• Employment growth based on the Labour Force Survey (LFS) January-September (annual percentage changes).

Inflows and Outflows of Foreign Workers in Malta (2018-2023)

• The chart illustrates the inflows and outflows of foreign workers in Malta from 2018 to 2023.

The Labor Market and Medium Run Analysis

• The focus shifts from the short run (constant price level in the IS-LM model) to the medium run.

• The analysis explores how prices and wages adjust over time and how this affects output.

• The labor market is central to this sequence of events.

Wage Determination

• Collective bargaining occurs between firms and unions.

Common Forces in Wage Determination:

• Workers are typically paid a wage that exceeds their reservation wage.

• Reservation Wage: The wage that makes workers indifferent between working and being unemployed.

• Wages typically depend on labour market conditions: lower unemployment rate leads to higher wages.

Bargaining Power

• A worker's bargaining power depends on:

  • How costly it would be for the firm to replace the employee (nature of the job).

  • How hard it would be for the employee to find another job (labour market conditions).

Efficiency Wage Theories

• Efficiency wage theories link worker productivity/efficiency to the wage they are paid.

• Firms may pay a wage above the reservation wage to:

  • Decrease worker turnover.

  • Increase productivity.

• Firms that value employee morale and commitment pay more than those with routine activities.

• When unemployment is low, firms increase wages to retain workers and avoid increased quit rates.

Efficiency Wages and Labor Market Conditions

• Wages depend on both the nature of the job and labor-market conditions.

• Firms valuing morale/commitment pay more than those in routine sectors.

• Labor market conditions affect wages.

Wages, Prices, and Unemployment

• The aggregate nominal wage $W$ depends on:

  • The expected price level, $P^e$.

  • The unemployment rate, $u$.

  • A catchall variable, $z$, for other factors affecting wage setting.

• The wage-setting relation is given by: $W = P^eF(u, z)$, where $(-, +)$ indicates the effect of $u$ and $z$ on $W$.

The Expected Price Level

• Workers and firms care about real wages $(W/P)$, not nominal wages $(W)$.

  • Workers care about how many goods they can buy with their wages.

  • Firms care about nominal wages relative to the prices of goods they sell.

Unemployment and Wages

• An increase in the unemployment rate decreases wages.

  • Higher unemployment weakens worker bargaining power.

  • Higher unemployment allows firms to pay lower wages while retaining workers.

• $z$ includes factors like:

  • Unemployment insurance: payments to workers who lose their jobs.

  • Employment protection: makes it more expensive for firms to lay off workers.

Production Function

• The production function is the relation between inputs and output.

• Assuming firms produce goods using only labor:

  • $Y = AN$ where:

    • $Y$ = output

    • $N$ = employment

    • $A$ = labor productivity (output per worker)

• If one worker produces one unit of output $(A = 1)$, then $Y = N$.

Price Determination

• Firms set their price according to: $P = (1 + µ)W$

  • $µ$ (or $m$) is the markup of price over production cost.

  • If markets were perfectly competitive, $µ = 0$, and $P = W$.

• Markup depends on the degree of competition in the product market (enforcement of competition laws).

• Weak enforcement allows collusion and increased markups.

The Natural Rate of Unemployment

• Wage and price determination influence unemployment.

• Assume nominal wages depend on the actual price level, $P$, rather than the expected price level, $P^e$.

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

Wage-Setting Relation

• Since $P^e = P$:

  • $W = PF(u, z)$

• Dividing both sides by $P$:

  • $\frac{W}{P} = F(u, z)$

• This relation between the real wage and unemployment rate is the wage-setting relation: W/P varies inversely with u

Price-Setting Relation

• The price-determination equation is: $P = (1 + µ)W$

• Dividing both sides by $W$:

  • $\frac{P}{W} = (1 + µ)$

• Inverting both sides:

  • $\frac{W}{P} = \frac{1}{(1 + µ)}$

Price Setting and Real Wages

• Price setting determines real wages paid by firms.

• The real wage implied by price setting is $\frac{1}{(1 + µ)}$, independent of the unemployment rate.

• The price-setting relation is drawn as the horizontal line PS.

Equilibrium Unemployment Rate

• Eliminating $\frac{W}{P}$ from wage-setting and price-setting relations, we get the equilibrium unemployment rate, or natural rate of unemployment, $u_n$:

  • $F(u_n, z) = \frac{1}{(1 + µ)}$

• The natural rate of unemployment is the rate where the real wage chosen in wage setting equals the real wage implied by price setting.

Types of Unemployment

• Structural:

  Structural unemployment occurs when certain industries decline

  because of long term changes in market conditions. Globalisation is an

  increasingly significant cause of structural unemployment in many

  countries.

• Regional :

  When structural unemployment affects local areas of an economy, it is

  called ‘regional’ unemployment. For example, unemployed coal miners

  in South Wales and ship workers in the North East add to regional

  unemployment in these areas.

• Classical :

  Classical unemployment is caused when wages are ‘too’ high. This

  explanation of unemployment dominated economic theory before the

  1930s, when workers themselves were blamed for not accepting lower

  wages, or for asking for too high wages.

• Seasonal :

  Seasonal unemployment exists because certain industries only

  produce or distribute their products at certain times of the year.

• Frictional :

  Frictional unemployment, also called search unemployment, occurs

  when workers lose their current job and are in the process of finding

  another one. There may be little that can be done to reduce this type

  of unemployment, other than provide better information to reduce the

  search time.

• Voluntary :

  Voluntary unemployment is defined as a situation when workers

  choose not to work at the current equilibrium wage rate. For one

  reason or another, workers may elect not to participate in the labour

  market.

• Factors Affecting Equilibrium

• The positions of wage-setting and price-setting curves, and the equilibrium unemployment rate, depend on $z$ and $μ$.

  • Higher unemployment benefits lead to a higher real wage, requiring a higher unemployment rate to bring the real wage back to what firms are willing to pay.

  • Less stringent enforcement of antitrust legislation allows firms to increase prices, decreasing the real wage.

Unemployment Benefits and Natural Rate

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

Markups and Natural Rate

• Less stringent enforcement of antitrust legislation allows firms to increase prices given the wage, decreasing the real wage.
  An increase in mark-ups decreases the real wage and leads to an increase in the natural rate of unemployment.

Competition and Antitrust Legislation

• More competition & more stringent antitrust legislation (µ decreases).
  The decrease in µ reduces $u_n$.

Natural Level of Employment

• Associated with the natural rate of unemployment is a natural level of employment.

  • $u = \frac{U}{L} = \frac{L - N}{L} = 1 - \frac{N}{L}$

• Employment in terms of the labour force and the unemployment rate equals: $N = L(1 - u)$

• The natural level of employment, $N<em>n$, is given by: $N</em>n = L(1 - u_n)$

• If $L = 150m$ and $u<em>n = 5\%$, natural level of employment is $150(1 - 0.05) = 142.5m$. 7.5 million will be unemployed at $u</em>n$.

Natural Level of Output

• Associated with the natural level of employment is the natural level of output, the level of production when employment is equal to the natural level of employment.

• Given $Y = N$, the natural level of output is $Y<em>n = N</em>n = L(1 - u_n)$

• The natural level of output satisfies the following: $Y<em>n = L(1 - u</em>n)$

Short Run vs. Medium Run

• In the short run, the price level may differ from what is expected when nominal wages are set, so unemployment may not equal the natural rate or output its natural level.

• In the medium run, output tends to return to its natural level because expectations are unlikely to be systematically wrong.