1. Wages and Unemployment
Chapter 17
McGraw-Hill/Irwin
Copyright © 2015 by McGraw-Hill Education (Asia). All rights reserved.

2. Learning Objectives
Discuss the four important trends that have characterized labor markets in industrialized countries
Apply a supply and demand model to understand the labor market
Explain how changes in the supply of and the demand for labor explain trends in real wages and employment since 1960
Define and calculate the unemployment rate and the participation rate
Differentiate among the three types of unemployment defined by economists and the costs associated with each

3. Trend 1: Increasing Real Wages
Common in industrialized countries in the 20th century
U.S. real earnings are about twice real earnings in 1960
2010
U.S. real earnings are nearly five times real earnings in 1929

4. Trend 2: Slower Wage Growth Since 1973
The annual rate of real wage growth is uneven
Data on real wage growth in the United States:
1960 – % per year
1973 – % per year
1996 – % per year
1973 – % per year

5. Hourly Wage Index in Manufacturing, 1990–2011 (2005 = 100.0)
Year
U.S.A.
Japan
Canada
S. Korea
1990
75.3
86.0
77.6
36.9
1995
86.2
95.0
90.9
70.2
2000
86.5
96.4
88.9
65.1
2005
100.0
2010
112.4
97.1
106.4
124.1
2011
114.4
99.2
109.8
126.2
Rate of Increase ( )
1.52
1.15
1.4
3.42

6. Trend 3: Increased Wage Inequality in US and many industrialized countries
Between 1960 and 2010
Average real weekly earnings of production workers decreased
Real wages of the least-skilled, least-educated workers decreased 25 to 30%
Best-educated, highest-skilled workers' real wages increased
Income with an advanced university degree is
Three times the income of a high school graduate
Four times the income of a worker who did not graduate from high school

7. Trend 4: Increasing Employment in US and Asian Economies
In 2007, 146 million people in the US had jobs
46 million new jobs since 1980
In 1970, 57% of the over-16 population had jobs
In 2007, 63% worked
Between 1980 and 2007 employment increased 46%
At the same time over-16 population increased 38%

8. The Labor Market
Supply and demand analysis can be used to find the price of labor (real wages) and the quantity (employment)
Analysis will consider the number of workers employed, not work-hours per year
Labor market is an input market
Firms hire labor to produce goods and services
Macroeconomics look at aggregate levels of employment and real wages
Microeconomics looks at wage determination for a category of workers

9. Wages and Demand for Labor
The demand for labor depends upon:
The productivity of workers
Greater productivity increases employment
The price of the worker’s output
A higher real price increases employment
Diminishing returns to labor
Assumes non-labor inputs are held constant
Adding one worker increases output but by less than the previous worker added
Value of Marginal Product (VMP) is extra revenue that an added worker generates

10. Banana Computers (BCC)
BCC can sell all its computers for $3,000 each
Number of Workers
Computers per Year 1 25 2 48 3 69 4 88 5
105 6
120 7
133 8
144
Marginal Product 25 23 21 19 17 15 13 11
Value of Marginal Product
$75,000
69,000
63,000
57,000
51,000
45,000
39,000
33,000

11. Demand Curve for Labor
Hire an extra worker if and only if the VMP exceeds the wage paid
If wage is $60,000, BCC will hire 3 workers
At $50,000, BCC hires 5 workers
The lower the wage, the more workers employed 3 60
Wage ($000s) 50 5
Labor Demand
Employment

12. Shifting Demand for Labor
Demand shifts when the value of the marginal product of a worker changes
Two factors determine the demand (VMP) for labor
The price of the company’s output
An increase in market demand
The productivity of the workers
Greater quantity of non-labor inputs
Organizational change
Training and education

13. Price of Output Increases
If the price of computers increases, demand for labor shifts to the right
There is a separate demand for labor curve for each possible output price
An increase in the price of workers' output increases the demand for labor
Employment
Real Wage ($000s)
Labor Demand
(P = $3,000) 60 3 50 5 7 8
Labor Demand
(P = $5,000)

14. Higher Productivity Increases in productivity increase VMP
Demand curve shifts right
Employers hire more workers at any given wage
Labor Demand
(after productivity increase)
Real Wage
Labor Demand
(before productivity increase)
Employment

15. Individual Labor Supply
Reservation wage is the lowest wage a worker would accept for a given job
Opportunity cost of working is your leisure activity
Work compensates you for lost leisure
If working conditions are unpleasant or dangerous, a premium for that would be included in the wage
Cost – Benefit Principle at work

16. Aggregate Labor Supply
Macroeconomic determinants of labor supply
Size of the working age population
Domestic birthrate
Immigration and emigration
Ages when people enter and retire from the workforce
Share of working-age population willing to work

17. The Supply of Labor
Labor Supply
The labor supply curve slopes up because at a higher real wage, more people are willing to work
Real Wage
Employment

18. Shifts in Labor Supply
A shift in labor supply is caused by any change in the number of workers willing to work at each wage
Increase in the working-age population
Baby Boom
Higher net immigration
Increasing age at retirement
Increase in the share of working-age population willing to work
Women's participation in the labor force has increased in the last 50 years

19. Trend 1: Increasing Real Wages
Industrialized countries have had sustained growth in productivity in the 20th century
Increases demand for labor
Both real wages and employment increased
Productivity increases were due to
Technological progress
Increases in capital D' S
Real Wage W' N' W D N
Employment

20. Trend 2: Slower Wage Growth Since 1970
Slower growth in real wages could be either
Slower growth in demand for labor OR
Faster growth in the supply of labor
Productivity growth and real wages move together
Annual Growth Rate (%)
Productivity
Real Earnings
1960 – 1970
2.74%
2.27%
1970 – 1980
1.71
1.23
1980 – 1990
1.60
0.71
1990 – 2000
2.04
1.50
2000 – 2010
2.60
0.92

21. Trend 2: Slower Wage Growth Since 1970
Slower demand growth explains slower wage growth
Does not explain rapid growth in employment
Supply of labor must have increased as well
Increased participation by women
Baby Boom
High rates of immigration
Looking forward
Labor supply growth will slow
Partly depends on whether productivity growth continues

22. Trend 3: Increased Wage Inequality in US and Industrialized Countries
Globalization results in an expansion of many markets to worldwide supply
Increasing ease of goods and services crossing national borders
Benefit of globalization is increased specialization and efficiency
Principle of Comparative Advantage
Globalization also means that some goods produced domestically are no longer competitive
Some domestic sectors shrink

23. Trend 3: Increased Wage Inequality in US and Industrialized Countries
Textiles
Software
D'S SS ST
D'T
W'S
N'S
Real Wage W
W’T
N'T
Domestic market starts in equilibrium at wage W. NT workers are in the textile industry and NS workers are in the software industry.
Globalization opens borders and US begins importing textiles and exporting software.
Demand for domestic textiles decreases as some textiles are bought overseas. This decreases the wage in the textile idustry to W'T and employment decreases to N'T.
The opposite happens in the software industry. Exports cause an increase in demand, employment, and wages.
The result is a wage differential (W'S – W'T) where none existed before. DT DS NT NS
Employment
Employment

24. Trend 3: Increased Wage Inequality in US and Industrialized Countries
When wages in importing industries fall and wages in exporting industries rise, wage inequality increases
Low-skill industries face the toughest international competition
Political resistance to free trade grows
Worker mobility is the movement of workers between jobs, firms, and industries
Market incentives move workers out of textiles and into software
Transition aid by government can assist workers to make the change

25. Trend 3: Increased Wage Inequality in US and Industrialized Countries
Technological change can be a source of increasing wage inequality
Occurs if technical change favors higher-skilled or better-educated workers
Some innovation renders old skills less valuable
Addition and the calculator and computer
Skill-biased technological change affects the marginal products of higher skilled workers differently from those of lower-skilled workers
Recent changes favor higher skilled workers
Automobile production lines increasingly use robots

26. Skill-Biased Technological Change
Unskilled Workers
Skilled Workers SU
D'S SS
D'U
Real Wage
N'S
W'S WS WS
W'S
N'U DU DS NU NS
Employment
Employment

27. Unemployment
Statistical authorities around the world estimate employment and unemployment monthly. In US:
Labor force = employed + unemployed
Unemployment rate = unemployed / labor force
Participation rate = labor force / population 16+
Population Age 16+
Out of the Labor Force
Employed
Unemployed

28. U.S. Employment Data, June 2013
Employed
million
Unemployed
12.25 million
Labor Force
million
Not in the Labor Force
88.46 million
Working-Age Population
million
Unemployment Rate
7.8%
Participation rate
64.0%

29. US Unemployment Rate

30. Costs of Unemployment Economic costs Psychological costs Social costs
Lost wages and production
Decreased taxes and increased transfers
Psychological costs
Individual self-esteem
Family stress of decreased income and increased uncertainty
Social costs
Potential increases in crimes and social problems
Social resources spent to address these

31. Duration of Unemployment
Costs of unemployment are directly related to the length of time a person has been unemployed
Unemployment spell is the period during which an individual is continuously unemployed
Duration of unemployment is the length of the unemployment spell
The unemployed population in US in June 2013
Duration (weeks)
5 or less
5 – 14
More than 14
% of unemployed
23%
24%
53%

32. Duration of Unemployment
Long-term unemployed have been out of work for 6 months or longer
Short-term unemployed have several possible outcomes
Find a permanent job after searching a few weeks
Economic costs are low
Leave the labor force
Short-term or temporary job that leads to unemployment again
These chronically unemployed have costs similar to the long-term unemployed

33. Other Unemployment Issues
Discouraged workers would like to have a job but they have not looked for work in the past four weeks
Counted as out of the labor force
Willing and ready to work
Could be counted as unemployed but they are not
Involuntary part-time workers are people who like to work full-time but cannot find a full-time job
Counted as employed
June 2013 unemployment rate in US was 7.8%
Including discouraged workers and involuntary part-time workers would make the rate much higher

34. Types of Unemployment
Frictional unemployment occurs when workers are between jobs
Short duration, low economic cost
May increase economic efficiency
Cyclical unemployment is the increase in unemployment during economic slow-downs
Usually short duration
Economic cost is the decline in real GDP

35. Types of Unemployment
Structural unemployment is long-term, chronic unemployment in a well-functioning economy
Lack of skills, language barriers, or discrimination
Structural shifts in production create a long-term mismatch between workers and market needs
Barriers to employment such as
Minimum wages ■ Unions
Unemployment Insurance
High economic, psychological, and social costs
Example: U.S. steel, telecommunications manufacturing

36. Structural Barriers to Employment
Minimum Wage Laws
Setting a minimum wage (Wmin) above equilibrium (W) creates (NB – NA) unemployment
Workers who find a minimum-wage job get a higher wage
Others are unemployed S A
Wmin NA B NB
Real Wage W D N
Employment

37. Structural Barriers to Employment
Labor union benefits
Reduced worker exploitation
Support progressive labor legislation
Increase productivity
Promote democracy in the workplace
Labor union costs
Introduces inefficiency into competitive markets
May keep companies from competing globally
Increase labor supply in non-union sector
Decreases wages for non-union workers

38. Structural Barriers to Employment
Unemployment insurance is a government transfer to unemployed workers
Helps to reduce the costs of unemployment
May give the unemployed an incentive to search longer and less intensely
To work efficiently, unemployment benefits should be
For a limited time
Less than the income received when working

39. Other Government Regulations
Health and safety regulations can reduce the demand for labor by
Increasing employer costs
Reducing productivity
The reduction in demand will increase unemployment and lower wages

40. Wages and Unemployment
Four Trends
Labor Market
Unemployment
Costs
Types
Demand for Labor
Supply of Labor