Lecture 6_LaborMkt

Lecture 6: The Labor Market

Reading: Blanchard, Chapter 7

Overview of Previous Lectures

• IS-LM Model: Combines goods market (IS) and money market (LM) to explain general equilibrium in the short run.

• Short Run Assumptions:

  • Price levels (P) remain constant.

  • Fixed inflation (𝜋) and expected inflation (𝜋𝑒).

• Output Determinants: Demand (Z) greatly influences output.

• Focus Shift: Moving from demand examination to the supply side of the economy, specifically how firms hire workers to produce goods and services.

Outline of Key Topics

• Basic facts about the labor market.

• Definition and cyclicality of labor-related variables.

• Overview of a model for the labor market.

• Mechanisms of price determination in the labor market.

• Wage determination processes.

• Understanding the natural rate of unemployment and the natural level of output.

Key Definitions

• Employment (N): Total number of currently employed individuals.

• Unemployment (U): Individuals who are not employed but actively seeking work.

• Out of Labor Force (O): Individuals not seeking employment.

• Labor Force (L): Total of employed and unemployed individuals: L = N + U.

• Unemployment Rate (u):

  • Percentage of the labor force that is unemployed.

  • Calculated as (U / L) x 100.

• Employment Rate: Percentage of the working-age population that is employed.

• Participation Rate: Percentage of the working-age population that is either employed or actively looking for work.

• Discouraged Workers: Individuals who have stopped searching for jobs and are not included in the labor force.

Duration of Unemployment in the US

• Average Duration:

  • Approximately 3 months as of 2016.

  • Many European countries report greater average durations.

• Chart Trends: Illustrate average duration of unemployment across countries (2001-2016), highlighting regional employment recovery differences.

• Relation to Unemployment Rate (u): High unemployment rates tend to correlate with longer durations of unemployment.

Unemployment Rate Dynamics

• Employment to Unemployment Transition: During high unemployment periods, employed individuals face significant job loss risks, resulting in a high monthly unemployment percentage.

• Long-term Unemployment: When general unemployment rates rise, finding new employment becomes increasingly difficult, leading to prolonged unemployment periods.

Worker Groups and Unemployment Sensitivity

• Research Findings: Different groups in the labor market respond variably to changes in national unemployment rates.

  • Example: Female workers tend to be less sensitive to rising unemployment rates during economic downturns.

Price Determination in the Labor Market

• Price Formula: Price (P) = (1 + Markup) x Marginal Cost (MC) of production.

• Markup Representation: Indicates the market power of firms; competitive markets exhibit a zero markup.

• Cost Factors: Costs related to hiring additional workers (W), with the marginal product of labor (A) crucial for output determination.

Wage Determination Process

• Nominal Wage Equation: Nominal wage (W) is related to Marginal Product of Labor (A), Expected Price Level (Pe), and factors including the unemployment rate (u).

• Wage Negotiation Dynamics: Wages are affected by worker productivity, market conditions, and employee bargaining power; they tend to be 'sticky' and not frequently adjusted.

Natural Rate of Unemployment

• Defined as the equilibrium unemployment rate where wage-setting and price-setting align.

• Wage-Setting (WS) Relation: Explains how wages depend on labor productivity and unemployment factors.

• Price-Setting (PS) Relation: Describes how prices relate to wages and markups.

• Shifts in Relations: Changes in unemployment benefits and labor market dynamics can shift these relations, affecting the natural unemployment rate (un).

Business Environment Impact

• Policies Influencing Firms: Favorable policies can lead to increased market power and reduced employee benefits, contributing to higher unemployment rates.

Next Class Agenda

• Discussion of the Phillips Curve, focusing on the relationship between inflation (𝜋) and unemployment (u).

• Reinforcement of IS-LM-PC Model: Developments as outlined in Chapter 9.