Motivation
The determination of the level of aggregate output in an economy:
- Role of demand: government spending, consumer and business confidence, interest rate, etc. — short run
- Role of supply: how much the economy can produce depends on technology, capital, and the size and skill of the labour force — medium run
The labour market
Measuring the Labour Market
- Population in the working age (PWA)
- Labour force (L): sum of people employed (N) + sum of people unemployed (U)
- Out of labour force: neither working nor looking for work
- Employment (N): number of people who have a job
- Unemployment (U): number of people who do not have a job but are looking for one
Definitions:
- Unemployment rate: unemployment / labour force
- Participation rate: ratio of the labour force to the population in the working age (L / PWA)
Flows of Workers
Definition:
- Separations: workers who are leaving or losing or changing (still employed) their jobs (includes quits and layoffs)
- Hires: workers newly employed by firms
- Duration of unemployment: average length of time people remain unemployed (usually measured in months). The average duration of unemployment is the inverse of the proportion of unemployed people leaving unemployment each month.
Wage Determination
Wages are set in an economy by:
- Bargaining between the employer and individual employees
- Collective bargaining
- Is bargaining between a union (or a set of unions) and a firm (or a set of firms)
Bargaining
- Most workers have some bargaining power — even if there is no collective bargaining in place
- Bargaining power depends on
- how costly would it be for the firm to replace the worker & how hard would it be for the worker to find a new job
- the nature of the job & the labour market conditions
wages set under this theory implies that
Efficiency Wages
- Regardless of worker’s bargaining power, firms may want to pay more than the reservation wage
- Because higer wages may increase productivity
wages set under this theory implies that
Wages, Prices, and Unemployment
The aggragate nominal wage W depends on:
- : expected price level
- because both firms and workers care more about the real wages (relative to price levels)
- : unemployment rate
- explained as above two theories
- : other variables that may affect wage setting
- by definition, an increase in increases wages; a decrease in decreases wages
Price Determination
Firms’ production function:
- A: labour productivity (output per worker)
- N: employment
Assume firms set their price according to:
- W is the cost of employing one more worker (assume one worker produce one product)
- m is the mark-up of the price over the cost.
The Natural Rate of Unemployment
Assume that W depends on the actual price level (P) rather than the expected price level ()
Wage-Setting Relation
Since , thus
thus
Negative relation between the real wage and the unemployment rate
Price-Setting Relation
Price determination:
thus , therefore
An increase in the mark-up decrease the real wage
Equilibrium in the Labour Market
Combining the both relaions, get
when achieving equilibrium, the rate is called the natural rate of unemployment ()
When z (unemployment benefit) increases
When m increases
Natural Level of Output
Equilibrium in the labour market determines the equilibrium unemployment rate — the natural rate of unemployment. For a given labour force, this determines the level of employment. And given the production funtion, the level of output is determined which is called the natural level of output ().
Factors Determine Output
- In the short run
- the factors that determine movements in output are monetray policy, fiscal policy, and so on
- In the medium run
- having the assumption:
Wage-Price Setting v.s. Labour Supply-demand
Above derivations use the wage and price setting. We can also use the relationship between labour supply and demand to derivate the wage. But there are some differences:
- Labour supply relation gives the wage at which a given number of workers are willing to work. The wage-setting is a result of bargaining or firms setting wages.
- Labour demand relation (standard) derived from competitive markets. The price-setting includes market power from firms
- In the standard labour supply-labour demand framework, unemployment is voluntary. In the wage and price setting framework, unemployment may be involuntary
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