The Labor Market: Workers, Wages, and Unemployment Study Notes
The Labor Market: Workers, Wages, and Unemployment
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Learning Objectives
Discuss five important trends that have characterized labor markets in the industrialized world in the past few decades.
Apply a supply and demand model to understand the labor market.
Explain how changes in the supply of and demand for labor account for trends in real wages and employment in the past few decades.
Differentiate among the three types of unemployment defined by economists and the costs associated with each.
Trend 1: Real Wage Growth in Industrialized Countries
Real wage growth in the 20th century:
Industrialized countries have experienced significant growth in real wages.
As of 2018, U.S. real earnings are about twice what they were in 1960.
U.S. real earnings are more than five times what they were in 1929.
Trend 2: Stagnation of Real Wage Growth
Stagnation since 1973:
Real wage growth has stagnated since 1973, with the highest growth occurring during the 1960s and early 1970s.
Data on real wage growth:
1960 to 1973: 2.5% per year
1973 to 1995: 0.9% per year
1996 to 2007: 1.8% per year
2007 to 2016: 0.7% per year
Trend 3: Increased Wage Inequality
Wage Inequality increase in the U.S.:
Between the 1970s and 2018, average real weekly earnings of workers at the low end of the income distribution decreased while the highest-skilled workers enjoyed wage increases.
Income comparison based on education levels:
Income with an advanced college degree is about twice that of a high school graduate.
Income with a college degree is about three times that of a worker who did not graduate from high school.
Trend 4: Job Growth Over Time
Substantial job growth over the last 50 years:
The percentage of people over 16 with jobs increased from 57% in 1970 to 64% in 2000, and then slightly declined to 61% in 2019.
The number of jobs grew from 1980 to 2000 by 38%, while the number of people grew only by 27%.
Trend 5: Unemployment Rates in Western Europe vs. U.S.
Higher unemployment in Western Europe:
Unemployment rates from 1990 to 2018:
France: 9.9%
Italy: 9.6%
Spain: 16.6%
U.S.: 5.9%
The Labor Market Overview
Supply and demand analysis: Used to determine the price of labor (real wages) and the quantity (employment).
Labor market function:
The market is considered an input market, where firms purchase labor to produce goods and services.
Macroeconomics examines aggregate levels of employment and real wages.
Microeconomics looks at wage determination for specific categories of workers.
Wages and Demand for Labor
Factors determining the demand for labor:
Productivity of workers: Increased productivity leads to higher employment rates.
Price of the worker’s output: Higher output prices increase employment levels.
Diminishing returns to labor:
Assumes non-labor inputs are held constant; adding an additional worker increases output but at a decreasing rate.
Value of Marginal Product (VMP): Represents the extra revenue generated by hiring an additional worker.
Example: Banana Computer Company (BCC)
Production data:
Number of Workers and corresponding Computers per Year:
1 Worker - 25 Computers
2 Workers - 48 Computers
3 Workers - 69 Computers
4 Workers - 88 Computers
5 Workers - 105 Computers
6 Workers - 120 Computers
7 Workers - 133 Computers
8 Workers - 144 Computers
Marginal Product for each additional worker:
Worker 1: 25
Worker 2: 23
Worker 3: 21
Worker 4: 19
Worker 5: 17
Worker 6: 15
Worker 7: 13
Worker 8: 11
Value of Marginal Product: Varies as workers are added:
1 Worker: $75,000
2 Workers: $69,000
3 Workers: $63,000
4 Workers: $57,000
5 Workers: $51,000
6 Workers: $45,000
7 Workers: $39,000
8 Workers: $33,000
Selling price of computers: $3,000 each.
Demand Curve for Labor
Firms will hire an extra worker if the VMP exceeds the wage paid.
Example:
If wage is $60,000, BCC will hire 3 workers.
If wage is $50,000, BCC will hire 5 workers.
General rule: The lower the wage, the more workers are employed.
Shifting Demand for Labor
Demand shifts occur when:
The VMP for a worker changes due to variations in output price or productivity of workers.
Factors influencing demand:
Price of the company’s output: Increased market demand increases labor demand.
Worker productivity: Involves greater quantities of non-labor inputs or organizational changes (e.g., training and education).
Price of Output Increases
When the price of products, such as computers, increases, demand for labor shifts to the right.
Each possible output price has a corresponding demand for labor curve.
Impact of price increase on labor demand:
Example with increased price of output (e.g., from $3,000 to $5,000):
Employment and real wages adjust accordingly.
Higher Productivity Effects
Increases in productivity shift the demand curve to the right.
Employers are more likely to hire more workers at any given wage level.
Individual Labor Supply
Reservation wage: The lowest wage a worker will accept for a job.
The opportunity cost of working is related to leisure activities, and work compensates for lost leisure.
For unpleasant or dangerous jobs, workers may require a premium above the reservation wage.
Aggregate Labor Supply
Macroeconomic determinants of labor supply:
Working-age population dynamics:
Domestic birth rates
Immigration and emigration rates
Ages of entrance into and retirement from the workforce
Willingness of working-age population to participate in the workforce.
The Supply of Labor
The labor supply curve slopes up, showing that as real wages increase, more individuals are willing to work.
Shifts in Labor Supply
Causes of shifts in labor supply:
An increase in the working-age population.
Growth in the share of the working-age population that is willing to work.
Trend 1 Analysis: Increasing Real Wages
Sustained productivity growth in the 20th century led to:
Increased demand for labor, resulting in both higher real wages and increased employment levels.
Main drivers of productivity growth:
Technology advancements.
Increases in capital investment.
Trend 2 Analysis: Stagnated Wage Growth Since 1970
Stagnation can be attributed to either:
Slower growth in demand for labor or
Faster growth in the supply of labor.
The correlation between productivity growth and real wages is demonstrated across different decades:
Average Growth Rates (%):
1970 – 1980: Productivity 0.8%, Real Earnings 0.6%
1980 – 1990: Productivity 1.5%, Real Earnings 1.3%
1990 – 2000: Productivity 2.0%, Real Earnings 2.2%
2000 – 2010: Productivity 1.6%, Real Earnings 0.8%
2010 – 2018: Productivity 0.8%, Real Earnings 0.9%
The slower demand growth explains slower wage growth, though it does not account for rapid employment growth.
Increased labor supply factors:
Greater workforce participation among women.
The Baby Boom generation.
High immigration rates.
Trend 3 Analysis: Increased Wage Inequality in the U.S.
Globalization effects:
Expansion of markets has increased specialization and efficiency, based on the principle of Comparative Advantage.
Certain domestic sectors have diminished due to international competition.
Wage inequality increases as wages in importing industries fall while wages in exporting industries rise:
Low-skill industries face significant competition.
Political resistance to free trade has risen.
Worker mobility: Refers to the movement of workers between jobs, firms, and industries as economic incentives push labor to sectors like technology over textiles.
Transitional aid by the government can help facilitate this shift.
Trend 3 Visualization
Illustrative labor market transitions:
Labor supply/demand graph shows shifts and the impact on wages and employment across different sectors (e.g., software vs. textiles).
Skill-Biased Technological Change
Employment and wage rates are affected differently for skilled and unskilled workers:
Employment trajectories diverge, with skilled workers generally experiencing greater wage increases compared to unskilled counterparts.
Types of Unemployment
Frictional unemployment: Workers between jobs; generally short-lived and low economic cost; can increase overall economic efficiency.
Cyclical unemployment: Arises during economic downturns; typically short in duration but contributes to GDP decline.
Structural unemployment: Long-term unemployment due to skill mismatches, language barriers, and systemic issues; can be exacerbated by barriers to employment such as minimum wages, unions, and unemployment insurance.
Economic, psychological, and social costs are high for individuals experiencing this type of unemployment (e.g., steel and telecommunications industries).
Structural Barriers to Employment
Unemployment insurance: Helps mitigate unemployment costs but may incentivize prolonged job searching.
For efficiency, benefits should be limited and set below potential working income.
Other Government Regulations
Health and safety regulations can decrease labor demand by raising employer costs and potentially lowering productivity, resulting in increased unemployment and reduced wages.
Impediments to Full Employment
Differences in employment rates between the U.S. and Western Europe arise from various impediments:
Highly regulated European labor markets with high minimum wages, inflexible benefits, and powerful unions frustrate employment opportunities.
Globalization and skill-biased technological change have further reduced the employment prospects for many Europeans, resulting in a substantial number of workers being deemed non-competitive in the modern labor market due to these regulations.