11

Frank & BernankeFrank & Bernanke4th edition, 20094th edition, 2009

Ch. 6: Wages and Unemployment Ch. 6: Wages and Unemployment

22

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 “marginal-productivity 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 Economicshttp://www.vanityfair.com/society/features/2011/05/top-one-percent-201105?currentPage=all&wpisrc=nl_wonk

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44

Labor Market TrendsLabor Market Trends During the last century real wages in the During the last century real wages in the

industrialized world increased substantially.industrialized world increased substantially. Since the 70s, the rate of growth of real wages Since the 70s, the rate of growth of real wages

slowed.slowed. Wage inequality rose substantially in the recent Wage inequality rose substantially in the recent

decades in US.decades in US. In the US, recent decades saw substantial job In the US, recent decades saw substantial job

creation.creation. Western Europe has experienced high Western Europe has experienced high

unemployment rates in recent decades.unemployment rates in recent decades.

55

Real WagesReal Wages Compared to before the Great Depression, an average Compared to before the Great Depression, an average

American worker earns five times as much.American worker earns five times as much. Real wages grew at a rate of 2.5% between 1960 and 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 1973 fell at a rate of 1.1% between 1973 and 1996 and rose at 1% 1996-2004. No change between 1973 and rose at 1% 1996-2004. No change between 1973 and 2007.2007.

Real wages for unskilled labor declined by one-fourth Real wages for unskilled labor declined by one-fourth since the 70s.since the 70s.

Real wages for bachelor’s and master’s degree holders Real wages for bachelor’s and master’s degree holders increased substantially; a master’s holder earns three increased substantially; a master’s holder earns three times the highschool graduate. times the highschool graduate.

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77

http://www.economist.com/node/21528433

88

http://www.census.gov/population/socdemo/education/tabA-3.pdf

99http://www.census.gov/prod/2011pubs/acs-14.pdf

1010

http://www.census.gov/statab/www/employ.htmlhttp://www.census.gov/statab/www/employ.html

1111

http://www.census.gov/http://www.census.gov/statab/www/govtsoclaw.htmlstatab/www/govtsoclaw.html

1212

http://www.census.gov/statab/www/edu.html

1313

Employment/UnemploymentEmployment/Unemployment In 1970, 57% of over 16 population had In 1970, 57% of over 16 population had

jobs; in 1999, 64% had jobs.jobs; in 1999, 64% had jobs.Between 1980 and 2007, US economy Between 1980 and 2007, US economy

created more than 46 million new jobs.created more than 46 million new jobs.Many of the EU countries experienced Many of the EU countries experienced

very high (some double digit) very high (some double digit) unemployment rates for over ten years; unemployment rates for over ten years; job creation has been very low.job creation has been very low.

1414

Explaining The TrendsExplaining The Trends

The labor market trends mentioned will be The labor market trends mentioned will be explained using the traditional supply-explained using the traditional supply-demand analysis.demand analysis.

The “product” demanded is the “labor” of The “product” demanded is the “labor” of the worker. The horizontal axis can be the worker. The horizontal axis can be measured in terms of number of workers measured in terms of number of workers or number of hours worked.or number of hours worked.

The “price” on the vertical axis is the real The “price” on the vertical axis is the real wage - what firms pay to acquire labor.wage - what firms pay to acquire labor.

1515

Deriving the Demand for LaborDeriving the Demand for LaborDemand for labor comes from Demand for labor comes from

employers/firms.employers/firms.An employer will have to do the marginal An employer will have to do the marginal

benefit vs. marginal cost calculation to benefit vs. marginal cost calculation to determine how many people (or many determine how many people (or many hours of work) to hire.hours of work) to hire.

1616

Supply and Demand inSupply and Demand inthe Labor Marketthe Labor Market

Wages and the Demand for LaborWages and the Demand for LaborThe demand for labor depends upon:The demand for labor depends upon:

The productivity of workers.The productivity of workers.The price of the worker’s output.The price of the worker’s output.

1717

Demand for LaborDemand for LaborBOB'S BICYCLE FACTORY (Problem 2, p. 182)# of Workers # of Bikes Marginal Product Value of MP

1 102 183 244 285 30

Bob has costs of $100/bike other than labor costs.Each bike sells for $130. (Labor's contribution is $30)

1818

Demand for LaborDemand for LaborBOB'S BICYCLE FACTORY (Problem 2, p. 182)# of Workers # of Bikes Marginal Product Value of MP

1 10 10 $3002 18 8 $2403 24 6 $1804 28 4 $1205 30 2 $60

Bob has costs of $100/bike other than labor costs.Each bike sells for $130.

1919

Bob’s Demand for LaborBob’s Demand for Labor

How do we define the demand curve?How do we define the demand curve?At each and every price how much is At each and every price how much is

demanded in the market.demanded in the market.Apply this to Bob.Apply this to Bob.At each and every real wage, how much At each and every real wage, how much

labor will Bob hire?labor will Bob hire?

2020

$0

$50

$100

$150

$200

$250

$300

$350

0 1 2 3 4 5 6

Wag

e

# of Workers

Bob's Demand for Labor

2121

Shifts in DemandShifts 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 $4002 18 8 $240 $3203 24 6 $180 $2404 28 4 $120 $1605 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.

2222

$0$50

$100$150$200$250$300$350$400$450

0 1 2 3 4 5 6

Wag

e

Workers

Shifts in Demand

Value of MP

Value of MP(2)

2323

Shifts in DemandShifts 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 $6002 18 8 12 $240 $320 $4803 24 6 9 $180 $240 $3604 28 4 6 $120 $160 $2405 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%.

2424

Shifts in Demand

$0

$100

$200

$300

$400

$500

$600

$700

0 1 2 3 4 5 6

Value of MP Value of MP(2) VMP(2-50%)

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Supply of LaborSupply of Labor The decision to work or not to work, again, The decision to work or not to work, again,

depends on the cost-benefit principle.depends on the cost-benefit principle. If your reservation price (how much you would If your reservation price (how much you would

pay another to do the job) is less than what you pay another to do the job) is less than what you are offered to do the job, you should take the are offered to do the job, you should take the job.job.

In this view, the higher the real wage, the more In this view, the higher the real wage, the more hours of work will be offered by workers.hours of work will be offered by workers.

There is also the substitution effect: leisure for There is also the substitution effect: leisure for work.work.

2626

Shifts in Supply of LaborShifts in Supply of Labor

Any thing that changes the size of the Any thing that changes the size of the working age population.working age population. Increase in domestic birth rate.Increase in domestic birth rate. Immigration.Immigration.Emigration.Emigration.Change in the age a typical person enters Change in the age a typical person enters

the work force.the work force.Change in the age a typical person retires.Change in the age a typical person retires.

2727

Explaining Political StandsExplaining Political Stands

Employers usually favor immigration Employers usually favor immigration while labor unions oppose it. Given our while labor unions oppose it. Given our simple Supply and Demand analysis, simple Supply and Demand analysis, explain why.explain why.

What happens to real wages due to What happens to real wages due to immigration?immigration?

Supply curve shifts right, depressing Supply curve shifts right, depressing real wages.real wages.

2828

ImmigrationImmigrationReal Wages

Labor

S

S’

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

2929

Why Did Real Wages Rise Why Did Real Wages Rise Fourfold During 20th CenturyFourfold During 20th Century

Average labor productivity rose shifting the Average labor productivity rose shifting the demand for labor to the right.demand for labor to the right.

The reasons for average labor productivity The reasons for average labor productivity growth weregrowth were technological advances;technological advances; increases in capital stock;increases in capital stock; increases in human capital.increases in human capital.

3030

Rise in Population and Rise in Population and Average Labor ProductivityAverage Labor Productivity

L

Realwage

MP

3131

Why Did Real Wages Rose Why Did Real Wages Rose Much Slowly After 1973Much Slowly After 1973

Average labor productivity slowed down Average labor productivity slowed down significantly, eliminating the large significantly, eliminating the large rightward shifts in the demand for labor.rightward shifts in the demand for labor.

Labor supply increased (labor participation Labor supply increased (labor participation rates rose) shifting the supply to the right.rates rose) shifting the supply to the right.

3232

After 1973After 1973

3333

Growth Rates in ProductivityGrowth Rates in Productivityand Real Earningsand 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

Annual Growth Rate (%)

Productivity Real Earnings

3434

Increasing Wage InequalityIncreasing Wage Inequality

Technological changes in services favored Technological changes in services favored skilled labor against unskilled labor unlike skilled labor against unskilled labor unlike the technological changes in the technological changes in manufacturing.manufacturing.

Looking at two labor markets, skilled and Looking at two labor markets, skilled and unskilled, the changes in demand would unskilled, the changes in demand would create the observed gap.create the observed gap.

3535

Technological ChangeTechnological Change

Skilled Labor Unskilled Labor

D

S

S

D

3636

Increasing Wage InequalityIncreasing Wage Inequality

Trade dependent on comparative Trade dependent on comparative advantage, lowers the demand for labor advantage, lowers the demand for labor by importing industry but raises the by importing industry but raises the demand for labor by exporting industry.demand for labor by exporting industry.

Unskilled labor loses in the process.Unskilled labor loses in the process.However, the bulk of the trade is However, the bulk of the trade is

between industrialized countries, buying between industrialized countries, buying and selling similar products.and selling similar products.

3737

GlobalizationGlobalization

Furniture Industry Pharmaceutical Industry

(Importing) (Exporting)

Real wage

L

3838

The Economist, Feb. 19, 2004

The best-known report, by Forrester Research, a The best-known report, by Forrester Research, a consultancy, guesses that 3.3m American service-consultancy, guesses that 3.3m American service-industry jobs will have gone overseas by 2015—barely industry jobs will have gone overseas by 2015—barely noticeable when you think about the 7m-8m lost every noticeable when you think about the 7m-8m lost every quarter through job-churning. And the bulk of these quarter through job-churning. And the bulk of these exports will not be the high-flying jobs of IT consultants, exports will not be the high-flying jobs of IT consultants,

but the mind-numbing functions of code-writing.but the mind-numbing functions of code-writing. Even at their peak in 2001, the number of all “trade-Even at their peak in 2001, the number of all “trade-

related” layoffs represented a mere 0.6% of American related” layoffs represented a mere 0.6% of American

unemployment.unemployment.

3939

““Outsourcing”Outsourcing”

Even at the best of times, the American Even at the best of times, the American economy has a tremendous rate of “churn”—economy has a tremendous rate of “churn”—over 2m jobs a month. ... The process allocates over 2m jobs a month. ... The process allocates resources—money and people—to where they resources—money and people—to where they can be most productive, helped by competition, can be most productive, helped by competition, including from outsourcing, that lowers prices. In including from outsourcing, that lowers prices. In the long run, higher productivity is the only way the long run, higher productivity is the only way to create higher standards of living across an to create higher standards of living across an economy. economy.

The Economist, Feb. 19, 2004

4040

Sucking Sound?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

4141

Should Technology and Should Technology and Globalization Be Stopped?Globalization Be Stopped?

Specialization increases the total amount Specialization increases the total amount produced.produced.

Free trade increases the total amount available.Free trade increases the total amount available. Increasing worker mobility from shrinking to Increasing worker mobility from shrinking to

expanding industries would help.expanding industries would help. Providing government help during transition Providing government help during transition

should be easy because of the increasing pie.should be easy because of the increasing pie.

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Churning + ProductivityChurning + Productivity In 1960 only one in 25 workers was In 1960 only one in 25 workers was

employed in the business-services and employed in the business-services and health-care industries. Today, one in six health-care industries. Today, one in six is. In terms of output, manufacturing has is. In terms of output, manufacturing has risen, but, thanks to that productivity risen, but, thanks to that productivity spurt, these goods are produced by fewer spurt, these goods are produced by fewer people—12% of the workforce, less than people—12% of the workforce, less than half the proportion of three decades ago. half the proportion of three decades ago.

The Economist, Feb. 19, 2004

4343

Types of Types of UnemploymentUnemployment

Frictional unemployment - the short-term Frictional unemployment - the short-term unemployment when people are searching unemployment when people are searching for a job that match their wishes.for a job that match their wishes.

Structural unemployment - long-term Structural unemployment - long-term mismatch between the skills and jobs.mismatch between the skills and jobs.

Cyclical unemployment - unusually high Cyclical unemployment - unusually high rates of unemployment experienced during rates of unemployment experienced during recessions.recessions.

http://www.npr.org/player/v2/mediaPlayer.html?action=1&t=1&islist=false&id=168508910&m=168515222

4444

UnemploymentUnemployment

Total unemployment is the sum of Total unemployment is the sum of frictional, structural and cyclical frictional, structural and cyclical unemployment.unemployment.

Even if the economy is producing at full Even if the economy is producing at full employment, there will be structurally employment, there will be structurally and frictionally unemployed.and frictionally unemployed.

4545

http://www.economist.com/finance/displaystory.cfm?story_id=E1_RVQRGGT

4646

UnemploymentUnemployment

Impediments to Full EmploymentImpediments to Full EmploymentMinimum Wage Laws:Minimum Wage Laws:

Benefit workers who are employed.Benefit workers who are employed.Hurt those who lose their jobs.Hurt those who lose their jobs.Create economic inefficiency.Create economic inefficiency.

4747

Do Minimum Wage Laws Do Minimum Wage Laws Alleviate Poverty?Alleviate Poverty?

Minimum wage laws affect unskilled labor.Minimum wage laws affect unskilled labor.Higher wages should increase the income Higher wages should increase the income

of the unskilled labor.of the unskilled labor. If the labor market is in equilibrium, a If the labor market is in equilibrium, a

minimum wage law that sets the wage minimum wage law that sets the wage above equilibrium will create above equilibrium will create unemployment and solve the poverty of unemployment and solve the poverty of some by making other poor worse off.some by making other poor worse off.

4848

Unemployment

L

Wage

VMP

S

Wage/P = Real wage

VMP = MP x P

VMP/P = MP

4949

UnemploymentUnemployment

Labor UnionsLabor UnionsBenefitsBenefits

Reduced worker exploitationReduced worker exploitationSupport progressive labor legislationSupport progressive labor legislationIncrease productivityIncrease productivityPromote democracy in the workplacePromote democracy in the workplace

5050

UnemploymentUnemployment

Labor UnionsLabor UnionsCostsCosts

Unions cause otherwise competitive labor Unions cause otherwise competitive labor markets to function inefficiently.markets to function inefficiently.

Unions may prevent companies from Unions may prevent companies from competing in the global economy.competing in the global economy.

5151

Labor UnionsLabor Unions

It could work as a minimum wage law.It could work as a minimum wage law. It could increase unemployment.It could increase unemployment. In a perfectly competitive labor market In a perfectly competitive labor market

with low costs of searching for a job, with low costs of searching for a job, labor unions would increase labor unions would increase unemployment.unemployment.

In monopsony situations labor unions In monopsony situations labor unions improve efficiency.improve efficiency.

5252

UnemploymentUnemployment

Unemployment Insurance:Unemployment Insurance:Helps to reduce the costs of Helps to reduce the costs of

unemployment.unemployment.May give the unemployed an incentive to May give the unemployed an incentive to

search longer and less intensely.search longer and less intensely.Unemployment benefits must balance the Unemployment benefits must balance the

benefit of providing support to the worker benefit of providing support to the worker with the cost of reducing the incentive to with the cost of reducing the incentive to work.work.

5353

Unemployment InsuranceUnemployment Insurance

A state that pays unemployment insurance A state that pays unemployment insurance for 13 weeks will force the unemployed to for 13 weeks will force the unemployed to search for a job more vigorously than a search for a job more vigorously than a state that pays unemployment insurance state that pays unemployment insurance for 52 weeks.for 52 weeks.

5454

UnemploymentUnemployment

Other Government RegulationsOther Government RegulationsHealth and Safety RegulationsHealth and Safety Regulations

These regulations can reduce the demand for These regulations can reduce the demand for labor by:labor by:

Increasing employer costs.Increasing employer costs. Reducing productivity.Reducing productivity.

The reduction in demand will:The reduction in demand will: Increase unemployment.Increase unemployment. Lower wages.Lower wages.

5555

Other RegulationsOther Regulations

Some health and safety regulations Some health and safety regulations increase the cost of labor significantly.increase the cost of labor significantly.

It works similar to minimum wage laws.It works similar to minimum wage laws.Employment cost index keeps track of Employment cost index keeps track of

the benefits plus wages. the benefits plus wages.

5656

Barriers That Create Structural Barriers That Create Structural UnemploymentUnemployment

Minimum wage laws.Minimum wage laws.Labor unions.Labor unions.Unemployment insurance.Unemployment insurance.Other governmental regulations.Other governmental regulations.

5757

Unemployment Rates in Unemployment Rates in Western Europe, 1980 - 2001Western Europe, 1980 - 2001

5858

Why Unemployment Rates Are Why Unemployment Rates Are Very High in EU?Very High in EU?

Structural barriers are very strong in EU because Structural barriers are very strong in EU because of political commitment to social safety laws.of political commitment to social safety laws.

Higher percentage of workers are unionized.Higher percentage of workers are unionized. Unemployment insurance is very generous.Unemployment insurance is very generous. Benefits and severance pay provisions are much Benefits and severance pay provisions are much

higher than US.higher than US.

5959

Why Did EU Unemployment Why Did EU Unemployment Rates Soar the Last 20 Years?Rates Soar the Last 20 Years?

Technological change with skill bias.Technological change with skill bias.Globalization.Globalization.Both of these forces reduced the demand Both of these forces reduced the demand

for unskilled labor yet social safety laws for unskilled labor yet social safety laws kept the wages high.kept the wages high.

6060

http://www.economist.com/surveys/displaystory.cfm?story_id=8621685

6161

http://www.economist.com/surveys/displaystory.cfm?story_id=E1_RGNTGGS