The Labor Market in the Macroeconomy The Labor Market Basic Concepts Labor force employed unemployed Unemployment rate number of people unemployed divided by the labor force The unemployment rate will never be zero Frictional unemployment the portion of unemployment that is due to the normal working of the labor market used to denote short run job skill matching problems Structural unemployment the portion of unemployment that is due to changes in the structure of the economy that result in a significant loss of jobs in certain industries Cyclical unemployment the increase in unemployment that occurs during recessions and depressions Employment tends to fall when aggregate output falls Decline in the demand will initially create an excess supply of labor wage rate will fall until the quantity of labor supplied quantity of labor demanded The Classical View of the Labor Market Assumed that the wage rate adjusts to equate the quantity demanded with the quantity supplied thereby implying that unemployment does not exist Labor demand curve a graph that illustrates the amount of labor that firms want to employ at each given wage rate Labor supply curve a graph that illustrates the amount of labor that households want to supply at each given wage rate Classical economists believe decrease in demand for labor demand curve shifts to the left new equilibrium at a lower wage rate in which less people are employed has not caused any unemployment even though fewer ppl are working all ppl interested in working at the lower wage are employed Absence of sticky wages aggregate supply curve is vertical monetary and fiscal policy will have no effect on real output Explaining the Existence of Unemployment Some reasons for unemployment sticky wages efficiency wages imperfect information minimum wage laws Sticky wages o Sticky the downward rigidity of wages as an explanation for the existence of unemployment o When demand for labor decreases the wage stays at W0 initially instead of falling so there is more labor supplied than labor demanded o Social implicit contracts unspoken agreements between workers and firms that firms will not cut wages o Relative wage explanation of unemployment an explanation for sticky wages and therefore unemployment if workers are concerned about their wages relative to other workers in other firms and industries they may be unwilling to accept a wage cut unless they know that all other workers are receiving similar cuts o Explicit contracts employment contracts that stipulate workers wages usually for a period of 1 3 years o Cost of living adjustments COLAs contract provisions that tie wages to changes in the cost of living the greater the inflation rate the more wages are raised Efficiency Wage Theory o Efficiency wage theory an explanation for unemployment that holds that the productivity of workers increases with the wage rate if this is so firms may have an incentive to pay wages above the market clearing rate Imperfect information o Firms may not have enough information at their disposal to know what the market clearing wage is o If a firm sets its wages too high more workers will want to work for that firm than the firm wants to employ unemployment o Objection once a firm realizes they set wages too high they will change the wages only applies to the short run Minimum wage laws o Minimum wage laws laws that set a floor for wage rates that is a min hourly rate for any kind of labor o If the market clearing wage for some groups of workers is below this amount min wage then this group will be unemployed The Short Run Relationship Between the Unemployment Rate and Inflation Relationship between aggregate output income Y and the unemployment rate U o For an economy to increase aggregate output firms must hire more labor to produce that output thus more output means greater employment o Y corresponds negatively to U if Y increases than U decreases Relationship between aggregate output and the overall price level o Positive P increases Y increases Relationship between price level and unemployment rate o Negative relationship as the unemployment rate declines in response to the economy moving closer and closer to capacity output the price level rises more and more Relationship between inflation and unemployment rate o Inflation rate the percentage change in the price level o Phillips curve a curve showing the relationship between the inflation rate and the unemployment rate shows trade off between inflation and unemployment Stability in the 1950s and 1960s bc the primary source of variation in the economy was demand not costs not stable after that bc both demand and costs were varying AD curve shifts with no AS shifts trace out the AS curve positive relationship between Y and P AS shifts with no AD shifts trace out the AD curve negative relationship between Y and P If both AD and AS are shifting there is no relationship between Y and P Expectations another reason why the Phillips curve isn t stable The Long Run Aggregate Supply Curve Potential Output and the Natural Rate of Unemployment AS curve in the long run is vertical y0 can be called potential output When aggregate output exceeds y0 there is upward pressure on input prices and costs At levels of aggregate output above y0 costs will rise the AS curve will shift to the left and the price level will rise Potential output is the level of aggregate output that can be sustained in the long run without inflation Those who believe the AS curve is vertical in the long run at potential output also believe that the Phillips Curve is vertical in the long run at some natural rate of unemployment Natural rate of unemployment the unemployment that occurs as a normal part of the functioning of the economy sometimes taken as the sum of frictional unemployment and structural unemployment Whenever the unemployment rate is pushed below the natural rate wages begin to rise thus pushing up costs this leads to a lower level of output which pushes the unemployment rate back up to the natural rate Economy is at full employment at the natural rate NAIRU nonaccelerating inflation rate of unemployment value of the unemployment rate where the PP curve crosses 0 graph has change in the inflation rate on the vertical axes and unemployment rate on horizontal o If the actual unemployment rate is to the left of NAIRU the change in the inflation rate will be positive o PP curve can shift for the same reasons as the AS curve o A favorable shift for
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