1 Labor Market

2 Deindustrialization? U.S. Manufacturing Employment Millions of Jobs Manufacturing Wage Rate, 2005

3 Wages by Education in the U.S.

4 Marginal Product of Labor Marginal Product of Labor is the additional output produced by a worker Firms employ workers to produce good and services

5 Diminishing Marginal Productivity Diminishing marginal productivity of labor n Fix k MPN MPN depends on A and k/n For given k and A a rise in n leads to a fall in MPN

6 The Determination of Short-Run Labor Demand w = real wage rate To maximize profits the firm should –Increase n if MPN > w* –Decrease n if MPN < w* It follows that the demand for labor function equals the MPN function MPN MPN & w n W* MPN 1 MPN 2 n1n1 n2n2 n* w = MPN Condition of profit maximization

7 Factors that Shift the Aggregate Labor Demand Curve An increase in TFP causes the labor demand curve to shift right. An increase in the capital stock causes the labor demand curve to shift right. w n Increase in A or k

8 The Supply of Labor Labor is supplied by households Aggregate labor supply increases with wages Higher wealth lowers labor supply at any wage w n nsns

9 Short-Run Labor Market Equilibrium (fix k) Real wage is determined so that labor demand equals labor supply at point X. An increase in TFP shifts the MPN curve to MPN*. The new equilibrium is at point Z with higher real wage and employment. MPN* MPN w n X Z

10 Recession Sharp oil price rise Lowers A Lowers demand for labor Lowers real wages and real GDP This is a recession. w n MPN* MPN nsns

11 Oil Price Real Nominal

12 Unemployment

13 Wages across countries and time

14 Does the theory work? Are real wages proportional to labor productivity over time? Are real wages proportional to labor productivity across countries?

15 Real Wages and Productivity over time

16 International Wage Differences

17 Productivity and Wages

18 Real Wages and Productivity Across Countries Wages and Productivity (Output per Worker) Across Countries

19 Do real wages converge?

20 Size Distribution of Firms in the US Over half of all employment is in small firms. Source: Brian Headd, “The Characteristics of Small-Business Employees,” Monthly Labor Review, 2000.

21 Job Creation and Destruction in the US Job creation and destruction is significantly higher than net job creation. 2006Q2: million jobs created million jobs destroyed -.5 million net change in number of jobs Job creation: net employment change of establishments expanding employment Job destruction: net employment change of establishments reducing employment

22 Productivity and Resource Reallocation Churning is the key to economic growth. Source: John Haltiwanger, “New Ideas for Measuring Labor Productivity,” Census Brief, 1998.

23 Structural Transformation and Development Source: Bah El-hadj, The University of Auckland, “Structural Transformation in Developed and Developing Countries,” 2008.

24 Real Wages and Hours Worked

25 Labor Market and Wealth A permanent rise in A raises MPN and thus shifts out the labor demand curve. A permanent rise in A raises wealth and thus shifts left the labor supply curve. The new equilibrium is at point Z with higher real wage and possibly lower employment. Note, though, that hours worked per person may fall, but a rise in wages may lead to a rise in the labor force participation rate (especially for relatively poor countries). MPN* MPN w n X Z ns*ns* nsns

26 Income Inequality

27 Rise in Real Wage Dispersion Two potential explanations –Open trade (greater globalization) –Technological improvements

28 Skill Biased Technical Change w N_unskilled ND_unskilled ND’_unskilled NS_unskilled N_skilled w ND_skilled ND’_skilled NS_skilled Skill biased technical change increases demand for skilled workers and hence their wages The opposite is true for unskilled workers.

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30 Key Message Wage premium for skills have gone up and relative supply have been catching up The information technology (IT) revolution is biased toward skilled labor

31 Skill Premia Across Countries Skill premia are highest for poor countries Poor countries have a shortage of skilled workers Why?