Week 3

Lectures

4&5

Unemployment and the Labour Market Reference: Bernanke, Olekalns and Frank - Chapter 3 Key Issues - "Aggregate trends in employment & wages" Demand for labour Supply and demand model of the labour market Types of unemployment Impediments to full employment

Demand for Labour Marginal Product of Labour (Table 3.1 (Textbook Chapter 3)) A firm combines workers with a given amount of capital (machines and buildings) to produce computers. As the firm employs more labour its output rises. But we can look at the additional output that is generated by each additional worker. This is the marginal product of labour.
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Example: Wages and the Demand for Labo Labour r

Production Function
160 140 120 Total Product 100 80 60 40 20 0 0 1 2 3

("concave" shape)

No of Workers

Marginal Product of Labour

30 Marginal Product of Labour 25 20 15 10 5 0 0 1 2 3 4 5 6 7 8 9 No. of Workers

Value of Marginal Product

80000 70000 60000 Value of MPL ($) 50000 40000 30000 20000 10000 0 0 1 2 3 4 5 6 7 8 9 No. of Workers

Diminishing marginal product The nature of the production technology is such that each additional worker produces less output than the existing workers. Common assumption in economics Notation:
Y Marginal Product of Labour = MPL = L

Value of Marginal Product = PriceMPL

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Firms Demand for Labour In deciding the number of workers to employ a firm will compare the benefit of an additional worker with the cost of that worker. Benefit to the firm of employing an additional worker Value of Marginal Product = PMPL Cost to the firm of employing an additional worker Wage = W
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Competitive Markets Assume that firm operates in a competitive market It cannot set the wage it pays workers It cannot set the price it receives for its product Firm (i) will be willing to employ labour until:
Pi MPLi = Wi

or

Value of MPL = money wage

Wi MPLi = Pi

Marginal product of labour = real wage

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Fundamental Point Since the MPL decreases as the firm employs more workers, it must be the case that the real wage also has to fall (as more workers are employed) This implies that a firms demand for labour is a decreasing function of the real wage.

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Demand Curve for Labour (Version 1)

Pi MPLi = Wi Wi

Money Wage
LD i = P i MPLi

No. of Workers
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Demand Curve for Labour (Version 2)

Pi MPLi = Wi

Divide both sides by general price level P

Pi MPLi Wi = P P

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Demand Curve for Labour (Version 2)

Wi P

Real Wage
Pi MPLi L = P
D i

No. of Workers
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Demand for Labour at Different Real Wages Real Wage

High

Low
LD i

N1

N2 No. of Workers
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Shifts in the Firms Labour Demand Curve Higher relative price for firms output
Wi P
Pi MPLi L = P
D i

Real

Wage

LD i =

Pi MPLi P

No. of Workers
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 Higher marginal productivity of labour

Wi P
Pi MPLi LD i = P LD i = Pi MPLi P

Real

Wage

No.

of Workers

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Supply of Labour Suppliers of labour are workers and potential workers. At any given wage people have to decide if they are willing to work. Supply of labour is the total number of people willing to
Wi work at each real wage, P .

Labour supply is generally assumed to be an increasing function of the real wage.

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Labour Supply Curve Real Wage

Wi P

LS

No. of Workers

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Labour Supply Response to Higher Real Wage

LS

Real Wage

High Low

N1

N2 No. of Workers
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Factors that Shift Labour Supply Size of working-age population (influenced by birth rate, retirement ages, immigration rates) Participation rate percentage of working age population who seek employment

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Equilibrium in the Labour Market Real Wage

W P
*

LS

LD

N*

Employment
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Effect of Higher Productivity on Real Wage and Employment Real Wage

LS

LD

LD

Employment
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Real Wages and Employment in Australia Growth Rates (%) Real Real Unit Employment Change in Earnings Labour Costs Unemployment 1970s 1980s 1990s 2000s 38.1 1. 0 14.8 6.7 6.7 -9.2 -0.2 -5.2 16.1 25.7 12.5 15.4 +4.5 -0.2 +1.0 -1.9

Real average labour cost Real Unit Labour Costs = Average labour productivity
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Increasing Wage Inequality: Technological Change Technological change increases worker productivity and is the basic source of rising living standards However a given technological innovation can affect different workers in different ways. Skill-biased technical change: Raises the marginal product of high-skill workers Reduces the marginal product of low-skill workers
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real wage

Su

real wage

Ds

Ss

Du Du Employment Unskilled workers Fall in wages and employment

Ds

Employment Skilled workers Rise in wages and employment

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Unemployment Definitions Labour Force equals the total number of people available for work. Labour Force = Employed + Unemployed ABS Definitions Employed: Person worked full-time or part-time during the past week (or was on leave from a regular job)
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Unemployed: Person did not work during the preceding week and made some effort to find work. Not in Labour Force: Person did not work in the past week and was not actively seeking work (e.g. retirees, unpaid homemakers, full-time student). Unemployment Rate = (Employment/Labour Force)*100 Participation Rate = (Labour Force/Working-age (15+) Population)*100

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Labour Force Data: Australia, April-2009 Thousands Employed 10,799 - Part-time 3,126 - Full-time 7,673 +Unemployed 615 =Labour Force 11,414 +Not in Labour Force 6,045 =Working-age (15+) Pop. 17,458 Unemployment Rate 100*(615/11,414) = 5.38% Participation Rate 100*(11,414/17,458)=65.4%

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% 10.0 12.0 0.0 Jan-0 00 May-0 00 Sep-0 00 Jan-0 01 May-0 01 Sep-0 01 Jan-0 02 May-0 02 Sep-0 02 Jan-0 03 May-0 03 Sep-0 03 Jan-0 04 May-0 04 Sep-0 04 Jan-0 05 May-0 05 Sep-0 05 Jan-0 06 May-0 06 Sep-0 06 Jan-0 07 May-0 07 Sep-0 07 Jan-0 08 May-0 08 Sep-0 08 Jan-0 09 May-0 09 Sep-0 09 Jan-10 May-10 2.0 4.0 8.0 60 6.0

Unemployment: p y A Model of Job Finding g

US unemployment p y rate ( (monthly) y)

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% 10.0 12.0 0.0 Feb-1978 Jan-1979 Dec-1979 Nov-1980 Oct-1981 Sep-1982 S Aug-1983 A Jul-1984 Jun-1985 May-1986 M Apr-1987 Mar-1988 Feb-1989 Jan-1990 Dec-1990 Nov-1991 Oct-1992 Sep-1993 S Aug-1994 A Jul-1995 Jun-1996 May-1997 M Apr-1998 Mar-1999 Feb-2000 Jan-2001 Dec-2001 Nov-2002 Oct-2003 Sep-2004 S Aug-2005 A Jul-2006 Jun-2007 May-2008 M Apr-2009 Mar-2010 2.0 4.0 8.0 60 6.0

Unemployment: p y A Model of Job Finding g

Unemployment rate (Australia)

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Australias Unemployment Rate since 1901

Copyright 2008 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 2e by Bernanke Olekalns and Frank Slides prepared by Anne Gleeson, Flinders University

5-34

Monthly Unemployment and Participation Rates

12.0 10.0 8.0 6.0 4.0 2.0 0.0
1/02/78 1/02/80 1/02/82 1/02/84 1/02/86 1/02/88 1/02/90 1/02/92 1/02/94 1/02/96 1/02/98 1/02/00 1/02/02 1/02/04 1/02/06 1/02/08

67.0 66.0 65.0 64.0 63.0 62.0 61.0 60.0 59.0 58.0 57.0

Unemployment rate

Participation rate

%
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Costs of Unemployment Economic costs output that is foregone since workforce is not fully utilised Psychological costs long periods of unemployment can lead to loss of selfesteem, unhappiness and depression Social costs high unemployment can lead to increased crime and associated social problems

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Discouraged Workers: People who have given up looking for work (and so a not counted as unemployed) Types of Unemployment Frictional Short-term unemployment that is associated with people searching for the right job. Will be a characteristic of any dynamic economy Tends to be beneficial rather than costly to an economy
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Structural Longer-term unemployment that can arise when the distribution of skills of some workers does not match the available jobs in the economy Some workers may have a lack of skills or be subject to discrimination and this prevents them from finding stable long-term employment Structural change in the economy may result in a loss of jobs for certain types of specialised workers

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Cyclical Associated with periods of slowdowns in economic activity, called recessions Costly in terms of output foregone

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Factors that affect the rate of unemployment Minimum Wage Laws Legal minimum hourly wage that business must pay workers Known as award wages in Australia Standard labour demand and supply model predicts that setting too high a minimum wage will produce unemployment.

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Binding Minimum Wage Real Wage

wmin

LS

we

LD

ND Ne NS

Employment
35

 Those workers ( 0 N ) who are employed at the minimum wage are better-off than at the marketclearing wage
D

There is still debate in economics about the actual impact of minimum wage laws on the level of employment. The empirical evidence is not clear-cut. A famous study by Card and Krueger (1995) finds little negative employment effects from a 19% rise in the New Jersey minimum wage. For a review see http://en.wikipedia.org/wiki/Minimum_wage

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Labour Unions Workers may negotiate on an individual basis with a firm over wages and conditions Alternatively workers may form labour unions to bargain collectively with a firm. Presence of unions tends to produce a wage outcome that is above the market-clearing wage. The figure for a minimum wage can be re-interpreted as the outcome for a unionised industry, where wmin = wunion
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Unemployment Benefits Government transfer payment paid to the unemployed. Provides a basic income to workers who are unemployed and searching for work. Can have a disincentive effect on a workers search effort. Australia: Newstart Allowance (single, 21+) 2009 payment is $453.30 per fortnight
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International Comparison of Unemployment Benefits and Unemployment Rates

US Replacement R l t rate Benefit duration (year) 50% 0.5 Ger. 63% 8.4% Fra. 57% 3 8.3% UK 38% 5.3% Swe. 80% 1.2 6.2% Aus. 40% (flat) 4.1%

Unemployment 4.6% rate, 2007

AUS. Youth Allowance, Newstart Allowance (Centrelink)