The Labor Market Basic Concepts Labor force employed unemployed Unemployment rate U LF A unemployed person must be out of a job and actively looking for work Unemployment rate will never be zero Frictional and structural unemployment are inevitable and desirable Frictional due to normal working of the labor market used to denote short run job skill matching problems Structural due to changes in the structure of the economy that result in signi cant loss of jobs in certain industries Cyclical increase in unemployment that occurs during recessions and depressions The Classical View of the Labor Market Classical economists believe that labor market always clears If demand for labor shifts left equilibrium wage rate will fall and anyone who wants a job at that wage rate will have one Always full employment The Classical Labor Market and the Aggregate Supply Curve Classical idea that wages adjust to clear labor market is consistent with view that wages respond quickly to price changes Absence of sticky wages AS curve is vertical Unemployment Rate and the Classical View Unemployment is not necessarily a good measure of whether labor market is working well Explaining the Existence of Unemployment Sticky Wages The downward rigidity of wages Wages get stuck and do not fall when demand for labor decreases Why Social or Implicit Contracts Unspoken agreements between workers and rms that rms will not cut wages Wage cuts hurt worker morale and negatively affect worker productivity Relative wage explanation of unemployment if workers are concerned about their wages relative to other workers in other rms and industries they may be unwilling to accept a wage cut unless they know that all other workers are receiving similar cuts Explicit Contracts Employment contracts that stipulate workers wages usually for period of 1 to 3 years Adjust with cost of living adjustments contract provisions that tie wages to changes in cost of living Greater the in ation rate more wages are raised Protect workers from unexpected in ation Ef ciency Wage Theory The productivity of workers increases with wage rate If this is so rms may have incentive to pay wages above market clearing rate There will be people who want to work at the wage laid by rms and cannot nd employment Imperfect Information Firms may not have enough info at their disposal to know what the market clearing wage is so they set wages wrong wages that do not clear labor market If rm sets wages too high more workers will want to work for that rm than the rm wants to employ resulting in potential workers being turned away and becoming unemployed Minimum Wage Laws Laws that set a oor for wage rates minimum hourly rate for any kind of labor The Short Run Relationship Between the Unemployment Rate and In ation Look at relationship between aggregate output Y and umemployment rate For economy to increase aggregate output rms must hire more labor to produce that output so more output implies greater employment Increase in employment means more people working and lower unemployment rate Y and U are negatively related As one increases the other decreased Relationship between aggregate output and overall price level Shape of AS curve is determined by behavior of rms and how they react to increase in demand Positive when P increases Y increases If aggregate demand shifts to right and economy is operating on nearly at part of AS curve far from capacity output will increase but price level will not change If economy is operating on steep part of AS curve close to capacity an increase in demand will drive up price level but output will be constrained by capacity and will not increase much What happens following an event that leads to increase in aggregate demand Firms experience unanticipated decline in inventories and respond by increasing output Y and hiring workers unemployment rate falls If economy is not close to capacity there will be little increase in price level If however aggregate demand continues to grow the ability of the economy to increase its output will eventually reach limit as aggregate demand shifts farther and farther to the right along AS curve price level increases more and more and output begins to reach limit Where AS curve is vertical output cannot rise any further and unemployment rate cannot be pushed any lower Negative relationship between unemployment rate and price level Phillip curve shows relationship between in ation rate and unemployment rate Conservatives argued for choosing point with low in ation and higher unemployment Liberals argued for more in ation to keep unemployment at low level See PowerPoint on phillip s curve The Long Run Aggregate Supply Curve Potentisl Output and the Natural Rate of Unemployment If the AS curve is vertical in the long run so is the Phillips Curve In the long run the Phillips Curve corresponds to the natural rate of unemployment that is the unemployment rate that is consistent with the notion of a xed long run output at potential output Logic behind vertical Phillips Curve is that whenever unemployment rate is pushed below natural rate wages begin to rise thus pushing up costs this leads to lower level of output which pushes unemployment rate back up to natural rate At natural rate economy is said to be in full employment The Nonaccelerating In ation Rate of Unemployment NAIRU Graph of interest plots change in in ation rate on vertical axis and unemployment rate on horizontal Negatively related downward Slopimg straight line Value of unemployment where curve crosses zero is the nonaccelerating in ation rate of unemployment If actual unemployment rate is to left of NAIRU change in in ation rate will be positive If actual unemployment rate is to right of NAIRU change in in ation rate will be negative
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