Macroeconomics Prof Juan Gabriel Rodrguez

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Macroeconomics Prof Juan Gabriel Rodrguez Powered By Docstoc
            Prof. Juan Gabriel Rodríguez

Chapter 8

The Labor Market

 Thus far, we have assumed constant prices and wages…
 But firms respond to increases in demand by increasing
 In turn, higher production leads to lower unemployment…
 Lower unemployment increase wages so production costs also
 Higher production costs lead to higher prices…
 …and therefore to higher wages, and so on.
                       The Medium Run:
 Exploration of how price and wage adjustments affect output
Definition of Terms

  The noninstitutional civilian population are the    number
  of people potentially available for civilian employment.

  (not in the military, prisons and mental hospitals)

  The civilian labor force is the   sum of those either working
  or looking for work.

  (Those who are neither working nor looking for work are out
  of the labor force)

  The participation rate is   the ratio of the labor force to the
  noninstitutional civilian population.

  The unemployment rate is      the ratio of the unemployed to
  the labor force.
Participation Rate by Sex (15-64) in Spain
Employment Rate (15-64)
Unemployment Rate (1993-2010)
Unemployment Rate by Sex (1993-2010)
Unemployment Rate for individuals under 25 (1993-2010)
Duality (“insiders and outsiders”):

Hourly Productivity (UE15=100), 1997-2009
Salaries versus Productivity in Spain and the
United Kingdom (1996-2005)
Salaries and Productivity
Unitary Labor Cost (2004-2010)
Unitary Labor Costs: Total and manufactures
Differential Features

     Index                    Spain   OCDE

     Difficulty to employ      78     25.7

     Rigidity of hours         60     42.2

     Difficulty to layoff      30     26.3

     Rigidity of
                               58     31.4

     Costs of layoff (weeks
                               56     25.8
     of salary)
Spanish Labor Market Fails

 The new productive model requires:

 - A more innovative scientific and tecnological system.

 - Higher level of human capital: sharp reduction of drops from the
 education system.

Spanish Labor Market Fails

1st. Our labor regulation provokes firms to adapt their production to the
business cycle by changing the number of workers (―labor rotation‖)
instead of changing the labor structure of the firm.

2nd. Collective bargaining is too centralized.

3rd. Unemployment subsidies in some cases disincentive the search for
a job.

4th. Active policies for unemployed workers present large deficiencies.
Spanish Labor Market Fails

 1st Spanish Labor Market Fail
 Large generation of low-quality jobs in booms which are destroyed
 during economic crisis (Intensive cyclical job creation and
 destruction). Thus,
   a) The unemployment rate has increased 12 points in 2 years.
   b) It has mainly concentrated in temporary contracts.

  Reason: A dual labor market.
  Some workers (insiders) have undefined contracts and their jobs
  are highly secure (45 days of severance pay per worked year).
  Others (outsiders) have temporary contracts and their jobs are
  highly unsecure (8 days of severance pay per worked year).
Spanish Labor Market Fails

 One solution for the dual labor market:

 Temporary contracts must disappear and there should be an unique
 undefined contract (now there are 17 different contracts!).
 Severance payments should increase with antiquity.

 1. A unique labor market
 2. Improvement for young people, women and immigrants.
 3. Increase of partial jobs.
Spanish Labor Market Fails

 2nd Spanish Labor Market Fail

 Agreements at the firm level should be superior to agreements at
 higher levels.

 1. Higher adaptation of labor conditions in the firm to business
 2. Improvements in productivity.
Spanish Labor Market Fails

 3rd Spanish Labor Market Fail

 Subsidies (pasive policy) should be larger at the beginning but
 lower at the end (less smooth) to incentive the search for a job.


 Gratifications to those firms that lay off less workers.
 Punishments to those firms that lay off more workers.
Spanish Labor Market Fails

 4th Spanish Labor Market Fail

 - Active policies for employment should focus on low-skilled
 workers (they suffer more from long-run unemployment). Example:
 Spain 0.5% of GDP while Denmark 1.5% of GDP.

 - Evaluation of active policies to improve their design (programs,
 agencies and public servants).

 - Not only public but also private agencies.
Wage Determination

Workers are typically paid a wage that exceeds their
   reservation wage, the wage that would make them
   indifferent between working or being unemployed.

Wages typically depend on labor market conditions and the
nature of the job…
Wage Determination

How much bargaining power a worker has depends on:

  How costly it would be for the firm to replace him—the nature
   of the job.

  How hard it would be for him to find another job—labor market
Wage Determination

 The theories that link the productivity or the efficiency of
 workers to the wage they are paid are called efficiency
 wage theories.

 These theories also suggest that wages depend on both the
 nature of the job and on labor-market conditions:

     Firms that see employee morale and commitment as
      essential to the quality of their work, will pay more than
      firms in sectors where workers’ activities are more routine.

     Labor market conditions will affect the wage: when
      unemployment is low, a firm must increase wages to avoid
      quits. Therefore, the lower the unemployment rate, the
      higher the wages.
Example of Efficiency Wages

In 1914,Henry Ford decided his company would pay every
qualified employee a minimum of $5 per day for an eight-hour day
(before it was around $2 per day for a nine-hour day). While the
effects support efficiency wage theories, Ford probably had other
objectives as well for raising his wages (publicity, avoiding the

               Annual Turnover and Layoff Rates
               (%) at Ford, 1913-1915
                            1913              1914         1915
  Turnover Rate              370               54          16
  Layoff Rate                 62                7           0.1
Wage Determination

  The aggregate nominal wage, W, depends on three
    The expected price level, Pe
    The unemployment rate, u
    A catchall variable, z, that stands for all other
     variables that may affect the outcome of wage setting.
Wage Determination

   The Expected Price Level
Both workers and firms care about real wages (W/P), not nominal
wages (W).

 Workers do not care about how many dollars they receive but
  about how many goods they can buy with those dollars.

 Firms do not care about the nominal wages they pay but
  about the nominal wages, W, they pay relative to the price of
  the goods they sell, P.

 But nominal wages are set before the relevant prices so…
Wage Determination

   The Unemployment Rate
     Also affecting the aggregate wage is the
     unemployment rate, u.

     If we think of wages as being determined by
     bargaining, then higher unemployment weakens
     workers’ bargaining power, forcing them to accept
     lower wages. Higher unemployment allows firms to
     pay lower wages and still keep workers willing to
Wage Determination

   The Other Factors
    The third variable, z, is a catchall variable that
    stands for all the factors that affect wages, given
    the expected price level and the unemployment

    Unemployment insurance is the payment of
    unemployment benefits to workers who lose their
    jobs. But also minimum wage and employment
Price Determination

 The production function is the relation between the
 inputs used in production and the quantity of output
 produced. Assuming that firms produce goods using
 only labor, the production function can be written as:

  Y = output
  N = employment
  A = labor productivity, or output per worker (constant returns to
  labor in production but it increases over time)

  Further, assuming that one worker produces one unit of
  output—so that A = 1, then, the production function
                                         This implies that MgC = W!
Price Determination

  Under a perfect competitive market P=MgC and, therefore,
  P=W but many goods markets are not competitive so they
  charge a price higher than their MgC…

        Firms set their price according to:

       The term  is the markup of the price over the
       cost of production. If all markets were perfectly
       competitive,  = 0, and P = W.
The Natural Rate of Unemployment

  Let’s assume that nominal wages depend on the
  actual price level, P, rather than on the expected price
  level, .

  Wage setting and price setting determine the
   equilibrium rate of unemployment.
The Natural Rate of Unemployment

 The Wage-Setting Relation
   Since Pe equals P, then:

 This relation between the real wage and the rate
   of unemployment: wage-setting relation.
The Natural Rate of Unemployment

The Price-Setting Relation

     The price-determination equation is:

   To state this equation in terms of the wage rate, we invert
   both sides:
                                               The price-setting
The Natural Rate of Unemployment

 The natural rate of

                                Real Wage (W/P)
 unemployment is the
 unemployment rate such
 that the real wage chosen in                                         PS
 wage setting is equal to the
 real wage implied by price

                                                  Unemployment rate (u)
The Natural Rate of Unemployment

  Eliminating W/P from the wage-setting and the price-
  setting relations, we can obtain the equilibrium
  unemployment rate, un:

   The equilibrium unemployment rate (un) is called the
   natural or structural rate of unemployment.
The Natural Rate of Unemployment

 The positions of the wage-setting and price-setting
 curves, and thus the natural or structural unemployment
 rate, depend on both μ and z.

  –   At a given unemployment rate, higher unemployment
      benefits lead to a higher real wage. A higher
      unemployment rate is needed to bring the real wage
      back to what firms are willing to pay.

  –   By letting firms increase their prices given the wage,
      less stringent enforcement of antitrust legislation
      leads to a decrease in the real wage.
The Natural Rate of Unemployment

An increase in unemployment     Real Wage (W/P)
benefits leads to an increase
in the natural rate of
unemployment.                                                         PS

                                                  Unemployment rate (u)
The Natural Rate of Unemployment

An increase in markups
decreases the real wage and     Real Wage (W/P)
leads to an increase in the
natural rate of unemployment.                                         PS


                                                  Unemployment rate (u)
The Natural Rate of Unemployment

   Given the rate of unemployment and the level of
   employment (N) we have:

   Employment in terms of the labor force and the
   unemployment rate equals:

   The natural level of employment, Nn, is given by:
The Natural Rate of Unemployment

    Associated with the natural level of employment is
    the natural level of output, and since (Y=N):

    The natural level of output satisfies the following:

    In words, the natural level of output is such that,
    at the associated rate of unemployment,                ,
    the real wage chosen in wage setting is equal
    to the real wage implied by price setting.
The Natural Rate of Unemployment

 If equilibrium in the labor market determines the
 unemployment rate, and therefore, the level of output, we
 should not need the goods and financial markets…

  –   Because in the short run there is no reason to
      believe that the price level equals the expected price
      level, unemployment (output) can be different to the
      natural rate (level) at the short run.

  –   In the short run the factors that determine changes in
      output are monetary and fiscal policies, consumer
      confidence and so on. In the medium run the factors
      are those related to the labor market.

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