2. 1 Frank & Bernanke 4th edition, 2009 Ch. 6: Wages and Unemployment

3. 2 Economists long ago tried to justify the vast inequalities that seemed so troubling in the mid-19th century—inequalities that are but a pale shadow of what we are seeing in America today. The justification they came up with was called “marginal- productivity theory.” In a nutshell, this theory associated higher incomes with higher productivity and a greater contribution to society. It is a theory that has always been cherished by the rich. Evidence for its validity, however, remains thin. Joseph E. Stiglitz, Nobel Prize in Economics http://www.vanityfair.com/society/features/2011/05/top-one-percent-201105?currentPage=all&wpisrc=nl_wonk

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5. 4 Labor Market Trends During the last century real wages in the industrialized world increased substantially. During the last century real wages in the industrialized world increased substantially. Since the 70s, the rate of growth of real wages slowed. Since the 70s, the rate of growth of real wages slowed. Wage inequality rose substantially in the recent decades in US. Wage inequality rose substantially in the recent decades in US. In the US, recent decades saw substantial job creation. In the US, recent decades saw substantial job creation. Western Europe has experienced high unemployment rates in recent decades. Western Europe has experienced high unemployment rates in recent decades.

6. 5 Real Wages Compared to before the Great Depression, an average American worker earns five times as much. Compared to before the Great Depression, an average American worker earns five times as much. Real wages grew at a rate of 2.5% between 1960 and 1973 fell at a rate of 1.1% between 1973 and 1996 and rose at 1% 1996-2004. No change between 1973 and 2007. Real wages grew at a rate of 2.5% between 1960 and 1973 fell at a rate of 1.1% between 1973 and 1996 and rose at 1% 1996-2004. No change between 1973 and 2007. Real wages for unskilled labor declined by one- fourth since the 70s. Real wages for unskilled labor declined by one- fourth since the 70s. Real wages for bachelor’s and master’s degree holders increased substantially; a master’s holder earns three times the highschool graduate. Real wages for bachelor’s and master’s degree holders increased substantially; a master’s holder earns three times the highschool graduate.

7. 6

8. 7 http://www.economist.com/node/21528433

9. 8 http://www.census.gov/population/socdemo/education/tabA-3.pdf

10. 9 http://www.census.gov/prod/2011pubs/acs-14.pdf

11. 10 http://www.census.gov/statab/www/employ.html

12. 11 http://www.census.gov/statab/www /govtsoclaw.html http://www.census.gov/statab/www /govtsoclaw.html

13. 12 http://www.census.gov/statab/www/edu.html

14. 13 Employment/Unemployment In 1970, 57% of over 16 population had jobs; in 1999, 64% had jobs. In 1970, 57% of over 16 population had jobs; in 1999, 64% had jobs. Between 1980 and 2007, US economy created more than 46 million new jobs. Between 1980 and 2007, US economy created more than 46 million new jobs. Many of the EU countries experienced very high (some double digit) unemployment rates for over ten years; job creation has been very low. Many of the EU countries experienced very high (some double digit) unemployment rates for over ten years; job creation has been very low.

15. 14 Explaining The Trends The labor market trends mentioned will be explained using the traditional supply- demand analysis. The labor market trends mentioned will be explained using the traditional supply- demand analysis. The “product” demanded is the “labor” of the worker. The horizontal axis can be measured in terms of number of workers or number of hours worked. The “product” demanded is the “labor” of the worker. The horizontal axis can be measured in terms of number of workers or number of hours worked. The “price” on the vertical axis is the real wage - what firms pay to acquire labor. The “price” on the vertical axis is the real wage - what firms pay to acquire labor.

16. 15 Deriving the Demand for Labor Demand for labor comes from employers/firms. Demand for labor comes from employers/firms. An employer will have to do the marginal benefit vs. marginal cost calculation to determine how many people (or many hours of work) to hire. An employer will have to do the marginal benefit vs. marginal cost calculation to determine how many people (or many hours of work) to hire.

17. 16 Supply and Demand in the Labor Market Wages and the Demand for Labor Wages and the Demand for Labor The demand for labor depends upon: The demand for labor depends upon: The productivity of workers. The productivity of workers. The price of the worker’s output. The price of the worker’s output.

18. 17 Demand for Labor

19. 18 Demand for Labor

20. 19 Bob’s Demand for Labor How do we define the demand curve? How do we define the demand curve? At each and every price how much is demanded in the market. At each and every price how much is demanded in the market. Apply this to Bob. Apply this to Bob. At each and every real wage, how much labor will Bob hire? At each and every real wage, how much labor will Bob hire?

21. 20

22. 21 Shifts in Demand

23. 22

24. 23 Shifts in Demand

25. 24

26. 25 Supply of Labor The decision to work or not to work, again, depends on the cost-benefit principle. The decision to work or not to work, again, depends on the cost-benefit principle. If your reservation price (how much you would pay another to do the job) is less than what you are offered to do the job, you should take the job. If your reservation price (how much you would pay another to do the job) is less than what you are offered to do the job, you should take the job. In this view, the higher the real wage, the more hours of work will be offered by workers. In this view, the higher the real wage, the more hours of work will be offered by workers. There is also the substitution effect: leisure for work. There is also the substitution effect: leisure for work.

27. 26 Shifts in Supply of Labor Any thing that changes the size of the working age population. Any thing that changes the size of the working age population. Increase in domestic birth rate. Increase in domestic birth rate. Immigration. Immigration. Emigration. Emigration. Change in the age a typical person enters the work force. Change in the age a typical person enters the work force. Change in the age a typical person retires. Change in the age a typical person retires.

28. 27 Explaining Political Stands Employers usually favor immigration while labor unions oppose it. Given our simple Supply and Demand analysis, explain why. Employers usually favor immigration while labor unions oppose it. Given our simple Supply and Demand analysis, explain why. What happens to real wages due to immigration? What happens to real wages due to immigration? Supply curve shifts right, depressing real wages. Supply curve shifts right, depressing real wages.

29. 28 Immigration Real Wages Labor S S’ We find that all European countries experienced a decrease in their average wages and a worsening of their wage inequality because of emigration. Whereas, contrary to the popular belief, immigration had nearly equal but opposite effects: positive on average wages and reducing wage inequality of non-movers. http://www.nber.org/papers/w16646

30. 29 Why Did Real Wages Rise Fourfold During 20th Century Average labor productivity rose shifting the demand for labor to the right. Average labor productivity rose shifting the demand for labor to the right. The reasons for average labor productivity growth were The reasons for average labor productivity growth were technological advances; technological advances; increases in capital stock; increases in capital stock; increases in human capital. increases in human capital.

31. 30 Rise in Population and Average Labor Productivity L Real wage MP

32. 31 Why Did Real Wages Rose Much Slowly After 1973 Average labor productivity slowed down significantly, eliminating the large rightward shifts in the demand for labor. Average labor productivity slowed down significantly, eliminating the large rightward shifts in the demand for labor. Labor supply increased (labor participation rates rose) shifting the supply to the right. Labor supply increased (labor participation rates rose) shifting the supply to the right.

33. 32 After 1973

34. 33 Growth Rates in Productivity and Real Earnings 1960 - 19702.332.89 1970 - 19800.840.79 1980 - 19901.381.15 1990 - 20001.891.92 Observations Reduced growth in productivity reduces the demand for labor and real wage growth Increases in the supply will cause employment to increase and hold real wages down Annual Growth Rate (%) ProductivityReal Earnings

35. 34 Increasing Wage Inequality Technological changes in services favored skilled labor against unskilled labor unlike the technological changes in manufacturing. Technological changes in services favored skilled labor against unskilled labor unlike the technological changes in manufacturing. Looking at two labor markets, skilled and unskilled, the changes in demand would create the observed gap. Looking at two labor markets, skilled and unskilled, the changes in demand would create the observed gap.

36. 35 Technological Change Skilled Labor Unskilled Labor D S S D

37. 36 Increasing Wage Inequality Trade dependent on comparative advantage, lowers the demand for labor by importing industry but raises the demand for labor by exporting industry. Trade dependent on comparative advantage, lowers the demand for labor by importing industry but raises the demand for labor by exporting industry. Unskilled labor loses in the process. Unskilled labor loses in the process. However, the bulk of the trade is between industrialized countries, buying and selling similar products. However, the bulk of the trade is between industrialized countries, buying and selling similar products.

38. 37 Globalization Furniture Industry Pharmaceutical Industry (Importing) (Exporting) Real wage L

39. 38 The Economist, Feb. 19, 2004 The best-known report, by Forrester Research, a consultancy, guesses that 3.3m American service- industry jobs will have gone overseas by 2015—barely noticeable when you think about the 7m-8m lost every quarter through job-churning. And the bulk of these exports will not be the high-flying jobs of IT consultants, but the mind-numbing functions of code-writing. The best-known report, by Forrester Research, a consultancy, guesses that 3.3m American service- industry jobs will have gone overseas by 2015—barely noticeable when you think about the 7m-8m lost every quarter through job-churning. And the bulk of these exports will not be the high-flying jobs of IT consultants, but the mind-numbing functions of code-writing. Even at their peak in 2001, the number of all “trade- related” layoffs represented a mere 0.6% of American unemployment. Even at their peak in 2001, the number of all “trade- related” layoffs represented a mere 0.6% of American unemployment.

40. 39 “Outsourcing” Even at the best of times, the American economy has a tremendous rate of “churn”— over 2m jobs a month.... The process allocates resources—money and people—to where they can be most productive, helped by competition, including from outsourcing, that lowers prices. In the long run, higher productivity is the only way to create higher standards of living across an economy. Even at the best of times, the American economy has a tremendous rate of “churn”— over 2m jobs a month.... The process allocates resources—money and people—to where they can be most productive, helped by competition, including from outsourcing, that lowers prices. In the long run, higher productivity is the only way to create higher standards of living across an economy. The Economist, Feb. 19, 2004

41. 40 Sucking Sound? Between 1980 and 2002, America's population grew by 23.9%. The number of employed Americans, on the other hand, grew by 37.4%. Today, 138.6m Americans are in work, a near-record, both in absolute terms and as a proportion of the population. The Economist, Feb. 19, 2004

42. 41 Should Technology and Globalization Be Stopped? Specialization increases the total amount produced. Specialization increases the total amount produced. Free trade increases the total amount available. Free trade increases the total amount available. Increasing worker mobility from shrinking to expanding industries would help. Increasing worker mobility from shrinking to expanding industries would help. Providing government help during transition should be easy because of the increasing pie. Providing government help during transition should be easy because of the increasing pie.

43. 42 Churning + Productivity In 1960 only one in 25 workers was employed in the business-services and health-care industries. Today, one in six is. In terms of output, manufacturing has risen, but, thanks to that productivity spurt, these goods are produced by fewer people—12% of the workforce, less than half the proportion of three decades ago. In 1960 only one in 25 workers was employed in the business-services and health-care industries. Today, one in six is. In terms of output, manufacturing has risen, but, thanks to that productivity spurt, these goods are produced by fewer people—12% of the workforce, less than half the proportion of three decades ago. The Economist, Feb. 19, 2004

44. 43 Types of Unemployment Frictional unemployment - the short-term unemployment when people are searching for a job that match their wishes. Frictional unemployment - the short-term unemployment when people are searching for a job that match their wishes. Structural unemployment - long-term mismatch between the skills and jobs. Structural unemployment - long-term mismatch between the skills and jobs. Cyclical unemployment - unusually high rates of unemployment experienced during recessions. Cyclical unemployment - unusually high rates of unemployment experienced during recessions. http://www.npr.org/player/v2 /mediaPlayer.html?action=1 &t=1&islist=false&id=16850 8910&m=168515222

45. 44 Unemployment Total unemployment is the sum of frictional, structural and cyclical unemployment. Total unemployment is the sum of frictional, structural and cyclical unemployment. Even if the economy is producing at full employment, there will be structurally and frictionally unemployed. Even if the economy is producing at full employment, there will be structurally and frictionally unemployed.

46. 45 http://www.economist.com /finance/displaystory.cfm? story_id=E1_RVQRGGT

47. 46 Unemployment Impediments to Full Employment Impediments to Full Employment Minimum Wage Laws: Minimum Wage Laws: Benefit workers who are employed. Benefit workers who are employed. Hurt those who lose their jobs. Hurt those who lose their jobs. Create economic inefficiency. Create economic inefficiency.

48. 47 Do Minimum Wage Laws Alleviate Poverty? Minimum wage laws affect unskilled labor. Minimum wage laws affect unskilled labor. Higher wages should increase the income of the unskilled labor. Higher wages should increase the income of the unskilled labor. If the labor market is in equilibrium, a minimum wage law that sets the wage above equilibrium will create unemployment and solve the poverty of some by making other poor worse off. If the labor market is in equilibrium, a minimum wage law that sets the wage above equilibrium will create unemployment and solve the poverty of some by making other poor worse off.

49. 48 Unemployment L Wage VMP S Wage/P = Real wage VMP = MP x P VMP/P = MP

50. 49 Unemployment Labor Unions Labor Unions Benefits Benefits Reduced worker exploitation Reduced worker exploitation Support progressive labor legislation Support progressive labor legislation Increase productivity Increase productivity Promote democracy in the workplace Promote democracy in the workplace

51. 50 Unemployment Labor Unions Labor Unions Costs Costs Unions cause otherwise competitive labor markets to function inefficiently. Unions cause otherwise competitive labor markets to function inefficiently. Unions may prevent companies from competing in the global economy. Unions may prevent companies from competing in the global economy.

52. 51 Labor Unions It could work as a minimum wage law. It could work as a minimum wage law. It could increase unemployment. It could increase unemployment. In a perfectly competitive labor market with low costs of searching for a job, labor unions would increase unemployment. In a perfectly competitive labor market with low costs of searching for a job, labor unions would increase unemployment. In monopsony situations labor unions improve efficiency. In monopsony situations labor unions improve efficiency.

53. 52 Unemployment Unemployment Insurance: Unemployment Insurance: Helps to reduce the costs of unemployment. Helps to reduce the costs of unemployment. May give the unemployed an incentive to search longer and less intensely. May give the unemployed an incentive to search longer and less intensely. Unemployment benefits must balance the benefit of providing support to the worker with the cost of reducing the incentive to work. Unemployment benefits must balance the benefit of providing support to the worker with the cost of reducing the incentive to work.

54. 53 Unemployment Insurance A state that pays unemployment insurance for 13 weeks will force the unemployed to search for a job more vigorously than a state that pays unemployment insurance for 52 weeks. A state that pays unemployment insurance for 13 weeks will force the unemployed to search for a job more vigorously than a state that pays unemployment insurance for 52 weeks.

55. 54 Unemployment Other Government Regulations Other Government Regulations Health and Safety Regulations Health and Safety Regulations These regulations can reduce the demand for labor by: These regulations can reduce the demand for labor by: Increasing employer costs. Increasing employer costs. Reducing productivity. Reducing productivity. The reduction in demand will: The reduction in demand will: Increase unemployment. Increase unemployment. Lower wages. Lower wages.

56. 55 Other Regulations Some health and safety regulations increase the cost of labor significantly. Some health and safety regulations increase the cost of labor significantly. It works similar to minimum wage laws. It works similar to minimum wage laws. Employment cost index keeps track of the benefits plus wages. Employment cost index keeps track of the benefits plus wages.

57. 56 Barriers That Create Structural Unemployment Minimum wage laws. Minimum wage laws. Labor unions. Labor unions. Unemployment insurance. Unemployment insurance. Other governmental regulations. Other governmental regulations.

58. 57 Unemployment Rates in Western Europe, 1980 - 2001

59. 58 Why Unemployment Rates Are Very High in EU? Structural barriers are very strong in EU because of political commitment to social safety laws. Structural barriers are very strong in EU because of political commitment to social safety laws. Higher percentage of workers are unionized. Higher percentage of workers are unionized. Unemployment insurance is very generous. Unemployment insurance is very generous. Benefits and severance pay provisions are much higher than US. Benefits and severance pay provisions are much higher than US.

60. 59 Why Did EU Unemployment Rates Soar the Last 20 Years? Technological change with skill bias. Technological change with skill bias. Globalization. Globalization. Both of these forces reduced the demand for unskilled labor yet social safety laws kept the wages high. Both of these forces reduced the demand for unskilled labor yet social safety laws kept the wages high.

61. 60 http://www.economist.com/surveys/displaystory.cfm?story_id=8621685

62. 61 http://www.economist.com/surveys/dis playstory.cfm?story_id=E1_RGNTGG S