Professor K.D. Hoover, Econ 210D Topic 5 Spring 2015 1 Econ 210D Intermediate Macroeconomics Spring...

Professor K.D. Hoover, Econ 210D Topic 5 Spring 2015 1

Econ 210D Intermediate Macroeconomics

Spring 2015

Professor Kevin D. Hoover

Topic 5The Labor Market


Labor Demand

Firm’s demand labor.

The labor demand curve = inverse relationship between labor demanded and the real wage rate (w/p).

Aggregate labor demand curve sums labor horizontally and records sum against the average real wage.


Labor Supply

People supply labor. Leisure is a good: supply of labor +

demand for leisure = 168 hours per week.

Opportunity Cost = of any choice is the value of the best alternative choice that it forecloses.

Real wage (w/p) = opportunity cost of leisure = market price of leisure.


Types of Real Wage

Product real wage:o p = price of the good produced for a firm;o p approximated in aggregate by the

producer price index (PPI). Consumption real wage:

o p = price of bundle of goods consumed by worker;

o p approximated in aggregate by the consumer price index (CPI).


Effect of Changes in Real Wage Rates on the Labor Supply and Labor Demand An increase in the real wage: ceteris

paribus increases income;

An increase in the real wage: ceteris paribus increases the opportunity cost of leisure.


Two Thought Experiments

Set up: initially work 20 hours per week @ $15 per hour, generating $300 per week income.


Experiment #1: pure income effect – 1 Wage rate remains constant at $15 per

hour, but you receive $20 per week legacy independent of any action – hours of work or level of expenditure.

Work more or less?


Experiment #1: pure income effect – 2 normal good = good whose demand

rises as income rises; inferior good = good whose demand

falls as income rises; if leisure normal, then demand for

leisure rises as income rises = supply of labor falls.


Experiment #2: pure substitution effect – 1 Wage rate rises to $16 per hour, but

you face lump-sum tax – i.e., one you must pay independent of any action – hours of work or level of expenditure.

If you continue to work 20 hours, then you continue to receive $300 per week.

Work more or less?


Experiment #2: pure substitution effect – 2 substitution effect = ceteris paribus

demand reduced when price of good rises;

leisure now more expensive (w/p higher) demand for leisure falls;

supply of labor rises;


Changes in Real Wage Rates and Labor Supply – Summing Up An increase in the real wage has two

effects: Income effect:

o reduces supply of labor, if leisure is a normal good;

o increases the supply of labor, if leisure is an inferior good;

Substitution effect:o increases the supply of labor.


Figure 8.8An Empirical Labor-Supply Curve

4

8

12

16

20

24

28

0 10 20 30 40 50 60 70 80 90

Labor Supply (hours per week)

Wag

e (19

79 d

olla

rs p

er h

our)

Each of the 10,036 points represents one (male) worker's weekly hours of work supplied and hourly wage rate. The labor-supply curve is the best fitting non-linear regression line.

Labor Supply


Participation

Earlier question: how many hours? New question: work or don’t work? =

participate in labor force or not?


Opportunity Cost of Participation Factors determining opportunity cost:

o value of idleness;o costs of working: clothes, transport,

childcare;o loses from working: housework left undone;

children unattended. Reservation wage = real wage just

large enough to counteract the opportunity cost of working.


Participation Rate in the Data

)16( yearsPopulationlevantRe

LFPR

65.7%. :2009January dinaugurate Obama

67.9%; :2000May Peak

2015%8.62000,249,899

0157,002,00Februaryin


Three Thought Experiments

Experiment #1: effect of a tax cut Experiment #2: effect of technological

progress Experiment #3: effect of immigration

on the labor market.


Are the Luddites Right?


Two Fallacies

Lump of labor fallacy = a fixed pool of workers has a fixed amount of work to do.o therefore, technical progress necessarily leads

to fewer workers needed and unemployment. Fallacy of composition = what is true of

the parts is true of the whole.o therefore, if workers are redundant at a

particular firm, they are redundant to the whole economy.


Two Types of Unemployment

Voluntary Unemployment = people who choose not to work, because the available real wage is below their reservation wage.

Involuntary Unemployment = people who wish to work, and are qualified to work, at the existing real wage, but are not offered jobs.


Unemployment Rate

Theoretical:

Empirical:

S

D

S

DS

L

L

L

LLU

1

LF

EmploymentLFU

EMPLF

Employment 11


Why Do Real Wages Not Fall in the Face of Involuntary Unemployment? – 1 1. Mismatched Definitions:

o Theoretical question: Do you wish to work at the going wage for work

you are qualified to do?o BLS questions:

Are you employed? If no, are you actively seeking work? Ignores wage rate and qualifications.


Why Do Real Wages Not Fall in the Face of Involuntary Unemployment? – 22. Transitional Unemployment:

o In best of times, some people are between jobs.

3. Real-wage Floor:o Minimum wage laws;o Real efficiency-wage rates


Third Type of Unemployment

Frictional Unemployment = unemployment that for various reasons persists even at the peak of the business cycle.


Real Wages and Wage and Price Movements

Real wages fall whenever wage inflation is less than price inflation.

Price Stickiness = failure of wages to fall fast enough to clear the labor market.

pwp

wˆˆ

^


Why are Wages Sticky?

The Relative Efficiency-Wage Hypothesis o = worker productivity depends on their

wage relative to workers in the same or other firms.


Insert Cartoon


Real versus Relative Efficiency-Wage Hypotheses Real EWH:

o explains unemployment at the peak of the business cycle;

o does not induce nominal price stickiness: firms must adjust w for any change in p.

Relative EWH:o explains cyclical unemployment; o induces nominal price stickiness; any rise in prices

reduces real wages;o does not imply wages never fall: balance between

gains in costs and losses in productivity.


Fairness and Money Illusion

At zero price inflation, 5% wage cut seen as unfair; at 12% price inflation 7% wage rise seen as fair; both = 5% real wage cut.

Money illusion? Are people too stupid to see the difference?

Not necessarily: wage sends signal – boss chooses wage rate; does not choose inflation rate.


A Difficult Fact

Rational or not, wage stickiness real.

Makes involuntary unemployment possible.

A key to business cycles.


END of Topic 5

Next Topic: 6. Aggregate Demand

Professor K.D. Hoover, Econ 210D Topic 5 Spring 2015 1 Econ 210D Intermediate Macroeconomics Spring...

Documents

Transcript of Professor K.D. Hoover, Econ 210D Topic 5 Spring 2015 1 Econ 210D Intermediate Macroeconomics Spring...