Labor Markets• In the news• Some facts about labor markets• Collective bargaining and efficiency wages• Wage determination• Price determinationIn the news• Friday’s jobs report: – February job growth = 21,000– Well below administration’s ``210,000” projections made in Oct,2003– Unemployment remains constant at 5.6%• Last week: – European Central Bank keeps interest rates at 2% despite weak growth in Euro area.– Canadian Central Bank lowers interest rates.Labor market facts: Worker flows• Flows of workers in and out of employment are large.– Separations consist of quits and layoffs.• Flows of workers in and out of unemployment are large in relation to the number unemployed.– Average duration of unemployment is 3 months.• Flows of workers in and out of labor force are large.– Many workers go straight into employment (e.g. discouraged workers)• Non-employment rate -- ((pop – employment)/pop) --may be a better measure than the unemployment rate.Labor market facts: Unemployment• Unemployment in U.S. has fluctuated between 3 and 10% since 1950.• When unemployment is high:– the proportion of unemployed who find work is low.– the proportion of workers who lose their job is high.• Implication: High overall unemployment is bad for an individual worker’s welfare.– More likely to lose your job if you have one.– Less likely to find a job if you don’t.Unemployment and wages• Labor market frictions imply wages exceed a worker reservation wage. As a result, we see (involuntary) unemployment.• Wage setting through bargaining implies workers have less ability to obtain an increase in their real wage when unemployment is high.– Bargaining power is low if it is easy for firm to replace worker.– Bargaining power is low if it is hard to find a new job.• Efficiency wage models also imply link between wages and labor market conditions.Wages, prices and unemployment• The aggregate nominal wage depends on– The expected price level (Pe)– The unemployment rate (u)– Other factors (z) that affect the outcome of wage setting (eg: unemployment insurance).W = PeF(u,z)Price determination• Production function relates inputs used in production to quantity of output produced.– Assume labor is only input into production:Y = A*N– A = labor productivity. Normalize A=1Y =N• Firms set price as a constant markup U over marginal cost W:P = (1+ m)W• With perfect competition m=0 and price equals marginal cost.Determining the natural rate• Assume expected price equals actual (Pe=P)• From wage-setting relation we have:W/P = F(u,z)• From price setting we have:W/P = 1/(1+ m)• Unemployment (u) is determined by:F(u,z) =1/(1+m)u1/(1+ m)Determining the natural rate:Wage settingPrice setting1/(1+ m)An increase in unemployment insurance raises the natural rate:WSPSWS’unun’u1/(1+ m)An increase in the markup raises the natural rate:WSPS1/(1+
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