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  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Labor Markets and Unemployment

    Joydeep Bhattacharya

    Iowa State

    March 23, 2009

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    US employment

    1 unemployment very high during depressions (1980-82); much lowerduring booms (1994-2000)

    2 unemployment far from zero even when economy is doing well

    We need to study what factors change the quantity of labordemanded and supplied.

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Labor demandY = AK N1; hold A and K xed; MPN > 0; MPN falls as N rises

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Labor demand: Supply shocks

    All else same, if A goes down, Y goes down. So, same number ofworkers using the same amount of capital produce less output.reduces MPN at every N.

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Labor market

    Imagine a world where

    1 all workers are identical,

    2 large number of rms; each pay going nominal (in $) market wage(W ); competitive

    3 rms are only interested in maximizing prots when it comes tohiring/ring workers, and

    4 there is only one good and all rms sell this good at per unit price P.

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Notation

    MPN = marginal product of labor

    P = price of output

    MRPN = marginal revenue product of labor =

    P MPNW = nominal wage

    w = real wage =WP

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    OptimumWhat does MPN measure? the extra benet of employing anadditional worker in terms of extra output produced.What does MRPN measure? the extra benet in $ of employing anadditional worker in terms of extra revenue produced.What is the $ cost associated with employing an additional worker?the wage W .Therefore, optimal employment (from the point of view of the rm)occurs when MRPN = W , or

    MPN =WP

    (1)

    this denes the labor demand curve in the labor marketTo maximize prots, the rm should increase employment ifMRPN > W . Why?

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Labor demand curve

    Optimal employment is at N.

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Cobb-Douglas example

    Fix K = K , A = A. Then,

    Y = AKN1

    MPN = (1 )hAKi

    N

    N =

    0@ (1 )hAKi

    w

    1A1

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Labor supplyCompare the costs and benets of working: cost of working an extrahour is the loss of an hour of leisure; benet is an increase in realincome of W/P. If benets exceed the cost, then increase theamount of time you work.

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Increase in wage

    Two opposite eects on labor supply:

    1 substitution eect: an increase in real wages raises the benet ofworking which makes the worker want to supply more labor (andsubstitute away from leisure)

    2 income eect: an increase in real wages makes people wealthier:same amount of work earns them a higher real income means theycan now aord to buy more leisure.

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Examples

    Example: U(c , z) = c0.5z0.5; c = wl ; l = labor supply, z = leisure;l + z = 1; result: inelastic labor supply

    Example: U(c , z) = 1000c + 10000z c2; c = wl ; 10 < w < 20,w > 20

    backward-bending labor supply?

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Trend in hours worked

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Cross country evidence

    income eect of wage change on labor supply explains why richcountries have shorter work-weeks.Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Equilibrium

    why is it an equilibrium? because wages are exible in both directionsJoydeep Bhattacharya Iowa StateLabor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Equilibrium

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Notion of e ciency wages

    Workers may choose to shirk; unobservable to employer; gets red ifcaught but gets re-hired at market clearing wage

    e ciency wage raises the opportunity cost of shirking; higher wagesassociated with low labor demand and may cause unemployment

    induces worker discipline in two ways

    explains why unemployment does not go to zero even during booms

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Wage inequality

    Between 1945-1970, real wages in the US grew at a steady pace.Since 1970,

    1 overall growth in real wages has slowed considerably

    2 real wages have become more unequal

    Figure: takes 1970 as the starting point (0). Then looks at thechange in real wages relative to 1970 for all groups of workers.

    Notion of wage distribution.

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Wage inequality

    The line1-10 shows the change in the average real wage of workerswhose wages are in the bottom 10% of the wage distribution in anygiven year.

    Points to note: lowest-paid workers have suered signicant declinesin their real wages; even the top-paid 40% of workers have seen onlymodest gains in real wages. What are some explanations for this?

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    skill-biased technical change

    To understand this, we introduce the notion of skill-biased technicalchange.

    Assume there are two types of workers: skilled and unskilled.

    Skill-biased technical change refers to a change in A that raises theproductivity of highly trained workers more than that of the unskilled.

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Joydeep Bhattacharya Iowa State

    Labor Markets and Unemployment

  • The Labor Market Labor Demand Labor Supply Labor Market Equilibrium Technical change and wage inequality Unemployment

    Initial equilibrium: Point A in left gure is higher than point A inright gure

    Introduction of computers is a benecial sh