1. The Labor Market: Wages … Prices … Wages
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 prices
Higher prices lead workers to ask for higher wages….
Prices and wages (the labor market) adjust over the medium run and influence output

2. Employment Status of the Population
2006
Jan-09
2009 (year)
Total Population
301
306
307
Less: Under 16
Military 73 71
Institutionalized (Jail, Hospital)
____
_____
Non-institutionalized civilian population
228
235
236
Less: Not working or looking
Retired
Home - workers
Full-time students 77 81 82
Idle rich
Discouraged workers
Civilian labor force
151
154
Employed
144
142
140
Unemployed 7 12 14
Participation rate
= Laborforce/Non-inst. Population
66.4%
65.5%
65.4%
Unemployment rate
=Unemployed/Labor force
4.6%
7.6%
9.3%
381,000
734,000
Percent of labor force
0.25%
0.48%

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

4. Labor Market Monthly Flows, 1996 – 2003
Labor Force Data, 1994 – 1999 (monthly flows)
Separation rate = ( )/122 = 6%
per month
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
Unemployed finding work
= 1.4/6.2 = 23% /mo.
Population leaving labor force/month
= ( )/( ) = 2.3 %
Unemployed leaving unemployment each month = ( )/6.2 = 45%
Avg duratation of unemployment = 1/.45 = 2.2 months

8. Monthly Separation Rate (%)
Movements in Unemployment
High Unemployment:
Increases the probability of workers losing their jobs
Reduces the probability of the unemployed finding a job
Increases the duration of unemployment
Differences Across Workers
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

9. 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
Increase productivity
Morale up
Shirking down
Monitoring costs down
Reduce turnover rate.
Reduce hiring costs.

10. Wages and Unemployment
Wage determination:
W = Wage
Pe = Expected price level
u = The unemployment rate
z = Other variables that affect the wage setting

11. Wage Setting Behavior:
The expected price level, Pe & wages
Workers base their wage request on the purchasing power of their wages or real wage they expect, W/Pe
Employers base the wage they pay on the expected price of the product they sell or the real wage, W/Pe
 If Expected Price (Pe) increases, wages (W) increase
The unemployment rate, and wages
Higher unemployment reduces bargaining power of labor  wages decline with u, other things equal
Higher unemployment reduces the efficiency wage
The other factors and wages
Unemployment insurance: higher benefits  higher wages
Structural Economic Change:
…wages increase when jobs created exceed jobs destroyed

12. 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)
In non-competitive markets:
P = (1+µ) W
µ= Markup of price over cost
If markup (µ) increases
Price (P) increases, given wages (W)
Real wage falls

13. The higher the unemployment rate (u), the lower the real wage, W/P
The wage-setting relation
Pe = P in medium run, so
W = Pe F(u,z) = P F(u,z)
The higher the unemployment rate (u), the lower the real wage, W/P

14. The Price-setting relation: The wage-setting relation:WS
Wage-setting relation
(W/P varies inversely with u)
Price-setting relation
(W/P is independent of u)
Unemployment Rate, u
Real Wage, W/P
Unemployment Rate, u
Real Wage, W/P PS

15. Labor Market Equilibrium
Natural Rate of Unemployment …Structural Rate … Equilibrium Rate … NAIRU
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

16. The Natural Rate of Unemployment / Structural Rate of Unemployment
= The unemployment rate at which wage-setters accept the real wage they must accept, given markup μ.
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

17. 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 µ reduces un

18. From Unemployment to Output
U = unemployment
N = employment
L = labor force
u = unemployment rate
As output (Y) and employment (N) increase,
the unemployment rate declines.
As output (Y) increases, the real wage set by wage setters (W/P) increases.
A “natural” or full employment level of output (Yn) corresponds to the “natural” rate of unemployment (un)

19. Equilibrium, Structural, or “Natural” Rate of OutputWS
Real Wage, W/P PS Yn
Output, Y

20. Unemployment may not equal natural unemployment level
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