Transcript Frank & Bernanke 4th edition, 2009 Ch. 6: Wages and Unemployment Economists long ago tried to justify the vast inequalities that seemed so.

Frank & Bernanke
4th edition, 2009
Ch. 6: Wages and Unemployment
1
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 “marginalproductivity 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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Labor Market Trends





During the last century real wages in the
industrialized world increased substantially.
Since the 70s, the rate of growth of real wages
slowed.
Wage inequality rose substantially in the recent
decades in US.
In the US, recent decades saw substantial job
creation.
Western Europe has experienced high
unemployment rates in recent decades.
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Real Wages




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 for unskilled labor declined by onefourth 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.
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http://www.economist.com/node/21528433
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http://www.census.gov/population/socdemo/education/tabA-3.pdf
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http://www.census.gov/prod/2011pubs/acs-14.pdf
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http://www.census.gov/statab/www/employ.html
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http://www.census.gov/statab/www
/govtsoclaw.html
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http://www.census.gov/statab/www/edu.html
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Employment/Unemployment
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.
 Many of the EU countries experienced
very high (some double digit)
unemployment rates for over ten years;
job creation has been very low.

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Explaining The Trends
The labor market trends mentioned will be
explained using the traditional supplydemand 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 “price” on the vertical axis is the real
wage - what firms pay to acquire labor.

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Deriving the Demand for Labor
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.

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Supply and Demand in
the Labor Market

Wages and the Demand for Labor

The demand for labor depends upon:
 The
productivity of workers.
 The price of the worker’s output.
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Demand for Labor
BOB'S BICYCLE FACTORY (Problem 2, p. 182)
# of Workers # of Bikes Marginal Product Value of MP
1
10
2
18
3
24
4
28
5
30
Bob has costs of $100/bike other than labor costs.
Each bike sells for $130. (Labor's contribution is $30)
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Demand for Labor
BOB'S BICYCLE FACTORY (Problem 2, p. 182)
# of Workers # of Bikes Marginal Product Value of MP
1
10
10
$300
2
18
8
$240
3
24
6
$180
4
28
4
$120
5
30
2
$60
Bob has costs of $100/bike other than labor costs.
Each bike sells for $130.
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Bob’s Demand for Labor
How do we define the demand curve?
 At each and every price how much is
demanded in the market.
 Apply this to Bob.
 At each and every real wage, how much
labor will Bob hire?

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Bob's Demand for Labor
$350
Wage
$300
$250
$200
$150
$100
$50
$0
0
1
2
3
4
5
6
# of Workers
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Shifts in Demand
BOB'S BICYCLE FACTORY (Problem 2, p. 182)
# of Workers # of Bikes Marginal Product Value of MP Value of MP(2)
1
10
10
$300
$400
2
18
8
$240
$320
3
24
6
$180
$240
4
28
4
$120
$160
5
30
2
$60
$80
Bob has costs of $100/bike other than labor costs.
Each bike sells for $130.
There is a $10 increase in bike prices.
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Wage
Shifts in Demand
$450
$400
$350
$300
$250
$200
$150
$100
$50
$0
0
1
2
3
Workers
4
5
6
Value of MP
Value of MP(2)
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Shifts in Demand
BOB'S BICYCLE FACTORY (Problem 2, p. 182)
$30
$40
$40+50%
# of Workers # of Bikes Marginal Product MP w/ 50% Value of MP Value of MP(2) VMP(2-50%)
1
10
10
15
$300
$400
$600
2
18
8
12
$240
$320
$480
3
24
6
9
$180
$240
$360
4
28
4
6
$120
$160
$240
5
30
2
3
$60
$80
$120
Bob has costs of $100/bike other than labor costs.
Each bike sells for $130.
There is a $10 increase in bike prices.
Worker productivity increases by 50%.
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Shifts in Demand
$700
$600
$500
$400
$300
$200
$100
$0
0
1
2
Value of MP
3
Value of MP(2)
4
5
6
VMP(2-50%)
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Supply of Labor




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.
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.
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Shifts in Supply of Labor

Any thing that changes the size of the
working age population.
Increase in domestic birth rate.
 Immigration.
 Emigration.
 Change in the age a typical person enters
the work force.
 Change in the age a typical person retires.

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Explaining Political Stands
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?
 Supply curve shifts right, depressing
real wages.

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Immigration
Real Wages
S
S’
Labor
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
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Why Did Real Wages Rise
Fourfold During 20th Century
Average labor productivity rose shifting the
demand for labor to the right.
 The reasons for average labor productivity
growth were

technological advances;
 increases in capital stock;
 increases in human capital.

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Rise in Population and
Average Labor Productivity
Real
wage
MP
L
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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.
 Labor supply increased (labor participation
rates rose) shifting the supply to the right.

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After 1973
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Growth Rates in Productivity
and Real Earnings
Annual Growth Rate (%)
Productivity
Real Earnings
1960 - 1970
2.33
2.89
1970 - 1980
0.84
0.79
1980 - 1990
1.38
1.15
1990 - 2000
1.89
1.92
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
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Increasing Wage Inequality
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.

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Technological Change
S
S
D
Skilled Labor
D
Unskilled Labor
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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.
 Unskilled labor loses in the process.
 However, the bulk of the trade is
between industrialized countries, buying
and selling similar products.

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Globalization
Real wage
Furniture Industry
(Importing)
L
Pharmaceutical Industry
(Exporting)
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The Economist, Feb. 19, 2004

The best-known report, by Forrester Research, a
consultancy, guesses that 3.3m American serviceindustry 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 “traderelated” layoffs represented a mere 0.6% of American
unemployment.
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“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.
The Economist, Feb. 19, 2004
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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
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Should Technology and
Globalization Be Stopped?




Specialization increases the total amount
produced.
Free trade increases the total amount available.
Increasing worker mobility from shrinking to
expanding industries would help.
Providing government help during transition
should be easy because of the increasing pie.
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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.
The Economist, Feb. 19, 2004
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Types of
Unemployment
http://www.npr.org/player/v2
/mediaPlayer.html?action=1
&t=1&islist=false&id=16850
8910&m=168515222
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.
 Cyclical unemployment - unusually high
rates of unemployment experienced during
recessions.

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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.

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http://www.economist.com
/finance/displaystory.cfm?
story_id=E1_RVQRGGT
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Unemployment

Impediments to Full Employment

Minimum Wage Laws:
 Benefit
workers who are employed.
 Hurt those who lose their jobs.
 Create economic inefficiency.
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Do Minimum Wage Laws
Alleviate Poverty?
Minimum wage laws affect 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.

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Wage/P = Real wage
Wage
S
Unemployment
VMP = MP x P
VMP/P = MP
VMP
L
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Unemployment

Labor Unions

Benefits
 Reduced
worker exploitation
 Support progressive labor legislation
 Increase productivity
 Promote democracy in the workplace
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Unemployment

Labor Unions

Costs
 Unions
cause otherwise competitive labor
markets to function inefficiently.
 Unions may prevent companies from
competing in the global economy.
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Labor Unions
It could work as a minimum wage law.
 It could 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.

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Unemployment

Unemployment Insurance:
Helps to reduce the costs of
unemployment.
 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.

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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.
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Unemployment

Other Government Regulations

Health and Safety Regulations
 These
regulations can reduce the demand for
labor by:


Increasing employer costs.
Reducing productivity.
 The


reduction in demand will:
Increase unemployment.
Lower wages.
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Other Regulations
Some health and safety regulations
increase the cost of labor significantly.
 It works similar to minimum wage laws.
 Employment cost index keeps track of
the benefits plus wages.

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Barriers That Create Structural
Unemployment
Minimum wage laws.
 Labor unions.
 Unemployment insurance.
 Other governmental regulations.

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Unemployment Rates in
Western Europe, 1980 - 2001
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Why Unemployment Rates Are
Very High in EU?



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Structural barriers are very strong in EU because
of political commitment to social safety laws.
Higher percentage of workers are unionized.
Unemployment insurance is very generous.
Benefits and severance pay provisions are much
higher than US.
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Why Did EU Unemployment
Rates Soar the Last 20 Years?
Technological change with skill bias.
 Globalization.
 Both of these forces reduced the demand
for unskilled labor yet social safety laws
kept the wages high.

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http://www.economist.com/surveys/displaystory.cfm?story_id=8621685
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http://www.economist.com/surveys/dis
playstory.cfm?story_id=E1_RGNTGG
S
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