1. The Labor Market: The Medium Run
A Medium Run Response to an Increase in Demand
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

2. The Labor Market: The Medium Run
A Medium Run Response to an Increase in Demand
Higher prices lead workers to ask for higher wages….
Prices and wages (the labor market) adjust over the medium run and influence output

3. The Labor Market: The Medium Run
A Tour of the Labor Market
U.S. Population million
Minus: Pop. under 16, million
Armed forces and
Incarcerated
Civilian Noninstitutional Pop million
Civilian Labor Force million
Employed million
Unemployed million
Out of the Labor Force million

4. The Labor Market: The Medium Run
A Tour of the Labor Market
The participation rate=
What has caused the participation rate to increase over time?

5. The Labor Market: The Medium Run
A Tour of the Labor Market
The unemployment rate =

6. The Labor Market: The Medium Run
Labor Force Data, 1994 – 1999 (monthly flows)
Employment
127 million
Job Change
3.5 million
Unemployment
7.0 million
Out of labor
force
66.7 million
1.1
1.3
1.7
1.5
1.8

7. A Tour of the Labor Market
Differences Across Workers
Monthly Separation Rates for Different Groups,
Category
Male: Ages 16-19
35-44
Female: Ages 16-19
Monthly Separation Rate (%)
(Quits and Layoffs)
15.9
1.6
16.1
5.0

8. A Tour of the Labor Market
Differences Across Workers
1998 Unemployment Rate
U.S %
Males %
African-Americans %

9. A Tour of the Labor Market
Movements in Unemployment

10. A 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 5.9
The trend increase is dominated by large fluctuations in the unemployment rate
% (recession )
% (recession )

11. A Tour of the Labor Market
Movements in Unemployment

12. A Tour of the Labor Market
Movements in Unemployment

13. A Tour of the Labor Market
Movements in Unemployment
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

14. A Tour of the Labor Market
Wage Determination 1.
Workers’ wages exceed their reservation wage 2.
Wages depend on labor-market
conditions:
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.

15. A Tour of the Labor Market
Wages and Unemployment
Wage determination:
W = Wage
Pe = Expected price level
u = The unemployment rate
z = Other variables that affect the wage setting

16. A Tour of the Labor Market
Wages and Unemployment:
The expected price level, Pe & wages
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

17. A Tour of the Labor Market
Wages and Unemployment:
The unemployment rate, and wages
Higher unemployment reduces bargaining power and wages
Higher unemployment reduces the efficiency wage

18. A Tour of the Labor Market
Wages and Unemployment:
The other factors and wages
Unemployment insurance: higher benefits leads to higher wages
Structural Economic Change: wages increase when jobs created exceed jobs destroyed

19. A Tour of the Labor Market
Price Determination and the Production Function
Assume labor is the only input, then
Output (Y) = AN
N = Employment
A = Labor Productivity
Assume A=1
Y = N
If Y=N: then marginal cost = Wage (W)

20. A Tour of the Labor Market
Price Determination and the Production Function
When perfect competition exists in the product market
Price (P) = Marginal Cost
Given: Marginal cost = W
Then: P=W
In non-competitive markets
P=(i+µ)W
µ= Markup of price over cost

21. A Tour of the Labor Market
The Natural Rate of Unemployment
The wage-setting relation
Assume: Pe = P
W=PF(u,z) and dividing by P
The higher the unemployment rate (u), the lower the rate wage

22. A Tour of the Labor Market
The Natural Rate of Unemployment
The wage-setting relation: WS
Unemployment Rate, u
Real Wage, W/P
Wage-setting relation
(W/P varies inversely with u)

23. A Tour of the Labor Market
The Natural Rate of Unemployment
The Price-setting relation:
Recall:
Divide by W:
Invert both sides:

24. A Tour of the Labor Market
The Natural Rate of Unemployment
The Price-setting relation:
Recall:
Observe:
If markup (µ) increases
Price (P) increases, given wages (W)
Real wage falls
Price setting a function of markup (µ)

25. A Tour of the Labor Market
The Natural Rate of Unemployment
The Price-setting relation:
Price-setting relation
(W/P is independent of u)
Unemployment Rate, u
Real Wage, W/P PS

26. A Tour of the Labor Market
The Natural Rate of Unemployment
Equilibrium Real Wages, Employment and Unemployment
Labor Market Equilibrium
Wage-setting, F(u, Z) =
Price-setting, WS
Unemployment Rate, u
Real Wage, W/P A PS
un – The natural rate of unemployment

27. A Tour of the Labor Market
The Natural Rate of Unemployment / Structural Rate of Unemployment
Is the natural rate of unemployment “natural”?
Scenario: Increase unemployment benefits (z increases)
WS´ = F(u, Z´)
WS = F(u, Z) un A B
un´ PS
Real Wage, W/P
Unemployment Rate, u
The increase in Z increases un

28. A Tour of the Labor Market
The Natural Rate of Unemployment
Scenario: More stringent antitrust legislation (µ decreases)
WS = F(u, Z)
PS´ un
Real Wage, W/P PS
un´
Unemployment Rate, u
The decrease in u reduces un

29. A Tour of the Labor Market
The Natural Rate of Unemployment / Structural Rate of Unemployment
From Unemployment to Output
The Natural Level of Employment
U = unemployment
N = employment
L = labor force
u = unemployment rate
Rearranging for N: N=L(1-u)

30. A Tour of the Labor Market
The Natural Rate of Unemployment
The Natural Rate of Unemployment / Structural Rate of Unemployment
From Unemployment to Output
The Natural Level of Employment
N=L(1-u)
un = natural rate of unemployment
Nn = natural level of employment
Nn = L(1-un)

31. A Tour of the Labor Market
From Unemployment to Output
The Natural Level of Output
Assuming the Production Function:
Y = N
Yn = Nn = L(1-un)

32. A Tour of the Labor Market
From Unemployment to Output
Equilibrium Unemployment Rate:
Natural level of output:

33. A Tour of the Labor Market
Equilibrium Real Wages, Employment, and Unemployment
At Yn the associated
and the real wage chosen in wage setting equals the real wage implied by price setting.

34. A Tour of the Labor Market
A 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

35. A Tour of the Labor Market
Where We Go From Here
Recall:
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

36. A Tour of the Labor Market
The Appropriate Time Frame
Short-Run
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