Lecture 5Unemployment and Labor Market

UNEMPLOYMENT

Under 16 years(70.5 Million)

A distribution of Total Population to Labor Force, Employment, and Unemployment

TotalPopulation

(296.6 Million)

Disable or Not inLabor Force

(76.8 Million)

Employed(141.7 Million)

Labor Force(149.3 Million)

Unemployed(7.6 Million)

Definition: If a person is capable of working and he is actively looking for a job but cannot find a job then he is called unemployed. Labor force : It is the sum of the employed and unemployed people able to work.Unemployment rate : It is defined as the percentage of the labor force that is unemployed.

Unemployment Rate = Number of Unemployed Labor Force

100

Types of Unemployment

1) Structural Unemployment: Unemployment caused as a result of the decline of industries and the inability of employees to move into jobs being created in new industries. Example: Introduction of computer in office work.

2) Frictional Unemployment: Unemployment caused when people move from job to job. A person can remain unemployed when he is looking for a better job. In such case he might get a job but doesn’t work there because he wants to get a better job.

3) Seasonal Unemployment: Unemployment caused because of the seasonal nature of employment . Example: tourism, etc.

4) Cyclical Unemployment: The unemployment that arise due to business cycle. Example: During recession many people loss their jobs because of the fall of labour demand in the economy.

Labor Demand

• In an economy labor demand comes from firms and government.

• Demand of Labour: The amount of people/labour demanded by firms at different wage rates.

• There is an inverse relationship between the wage rate and the number of people demanded by the firms.

Wage Rate ($ per hour)

Number Employed

DL

10

7

4

10 15 19

There is an inverse relationship between the wage rate and the number of people employed by the firm.

The Labour MarketLabour Demand Curve

Labour Supply

• Supply of Labour: The amount of people offering their labour at different wage rates.

• We can devote our time to either labour or leisure. So how much labour an individual is going to supply

depends on the opportunity cost of labour which is leisure

– Wage rate must be sufficient to overcome the opportunity cost of leisure

Labour Supply CurveWage Rate ($ per hour)

Number employed

SL

5

5.50

35 45

Individual Labour Supply Curve• How an individual labour supply curve will behave depends on

the price effect of labour which can be decomposed into two effects: Substitution effect and Income effect.

• Income effect of a rise in wages:– As wages rise, people feel better off and therefore may not feel a need to

work as many hours and so want enjoy more leisure. So when wages rise people will decrease working hour ( that means they will increase leisure hour). So wages and working hours are negatively related in income effect. This implies income effect of wage increase is always negative.

• Substitution effect of a rise in wages:– As wages rise, the opportunity cost of leisure rises (the cost of every extra

hour taken in leisure rises). So when wages increase people will want to substitute leisure with work that means working hour will increase. So wages and working hours are positively related in substitution effect. This implies substitution effect of wage increase is always positive.

Why individual labor supply curve is backward bending?

• Explanation: The price effect ( wage increase ) of labor supply can be decomposed into substitution effect and income effect.

Price Effect= Substitution Effect + Income EffectPE= SE+ IE (+) (-)The net price effect depends on the relative strength of the income and substitution effects.

Upward Sloping Part of Labor Supply Curve : When wages are low, an increase of wage will have a stronger substitution effect than

income effect. That means a large positive substitution effect will offset small negative income effect. So the price effect will be positive ( PE>0 ). That’s why initially labor supply curve is upward sloping ( increase in wage causes an increase in labor hour)

Backward Bending Part of Labor Supply Curve: When wages become high, an increase of wage will have a stronger income effect than

substitution effect. That means a large negative income effect will offset small positive substitution effect. So the price effect will be negative ( PE<0 ). That’s why labor supply curve will become backward bending ( an increase in wage causes an decrease in labor hour).

Transition Point: The point where the upward sloping labor supply become backward bending is the

transition point. Here the substitution effect is equal to income effect. So they are cancelled out and price effect becomes zero ( PE=0) .

Individual Labour Supply Curve is Backard bending

wage

No of working hours

Why?

Work is “preferred”

Leisure is preferred |IE|>|SE|

|SE| > |IE|

|IE| =|SE|

The Labour MarketEquilibrium in Labour Market

Wage Rate ($ per hour)

Number employed

DL

SL

6.00

30

The market wage rate for a particular occupation therefore will occur at the intersection of the demand and supply of labour. Here equilibrium wage rate is $6 and equilibrium employment is 30

The Labour MarketWage Rate ($ per hour)

Number employed

DL

SL

6.00

Q1

DL1

Q2

7.50

A rise in the demand for labour would force up the wage rate as there would be excess demand for labour.

Excess Demand

The Labour MarketWage Rate ($ per hour)

Number employed

DL

SL1

6.00

Q1 Q2

SL1

Excess Supply

An increase in the supply of labour would lead to a fall in the wage rate as there would be an excess supply of labour.

5.00

SL2

Unemployment from a Strict Wage Above Equilibrium

Labor0

Surplus of labor =Unemployment

Laborsupply

Labordemand

Wage

Minimumwage

LD LS

WE

LE

The Phillips Curve

• Expressed a statistical relationship between the rate of growth of money wages and unemployment.

• Rate of growth of money wages linked to inflationary pressure

• Led to a theory expressing a trade-off between inflation and unemployment

The Phillips CurveWage growth % (Inflation)

Unemployment (%)

The Phillips Curve shows an inverse relationship between inflation and unemployment. It suggested that if governments wanted to reduce unemployment it had to accept higher inflation as a trade-off.

1.5%

6%4%

2.5%

PC1

• Full employment: Full employment is a situation is when the economy is employing all of its available resources. Here the only type of unemployment that exists in the economy is the frictional unemployment.

• Full employment" can be considered as the attainment of the ideal unemployment rate, where the structural unemployment (which reflects labour-market inefficiency) do not exist. Only some frictional unemployment would exist, where workers are temporarily searching for new jobs.

• This simply means that the capital goods and capital resources are at their highest and most efficient utilization within the economy.