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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 αN1�α; 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 pro�ts 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 bene�t of employing anadditional worker in terms of extra output produced.What does MRPN measure? the extra bene�t 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 de�nes the labor demand curve in the labor marketTo maximize pro�ts, 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 = A�K�αN1�α

MPN = (1� α)hA�K�αiN�α

N� =

0@ (1� α)hA�K�αi

w

1A1α

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 bene�ts of working: cost of working an extrahour is the loss of an hour of leisure; bene�t is an increase in realincome of W/P. If bene�ts 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 e¤ects on labor supply:

1 substitution e¤ect: an increase in real wages raises the bene�t ofworking which makes the worker want to supply more labor (andsubstitute away from leisure)

2 income e¤ect: an increase in real wages makes people �wealthier�:same amount of work earns them a higher real income means theycan now a¤ord 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 e¤ect 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 State

Labor 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 su¤ered signi�cant 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 bene�cial shock to the skilled, and anegative shock to the unskilled.

It has been seen that workers who can use computers in their jobsenjoy a 10-15% wage premium over similar workers who are nottrained to use computers.

Fact: unskilled workers have responded to the very low wagesavailable to them by signi�cantly reducing the amount of labor theysupply; e¤ects on welfare.

Joydeep Bhattacharya Iowa State

Labor Markets and Unemployment

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

De�nitionsEvery body is either employed, unemployed, or not in the labor force.

Joydeep Bhattacharya Iowa State

Labor Markets and Unemployment

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

Flows

Joydeep Bhattacharya Iowa State

Labor Markets and Unemployment

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

22% of unemployed people in a typical month will be employed thefollowing month and 13% of the unemployed people will leave thelabor force (say become homemakers or go back to school)

Why is there some unemployment even though the economy may bedoing well?

Natural rate of unemployment: the average rate of unemploymentaround which the unemployment rate in the economy �uctuates

Joydeep Bhattacharya Iowa State

Labor Markets and Unemployment

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

Natural rate

We want to know what determines and changes the natural rateJoydeep Bhattacharya Iowa State

Labor Markets and Unemployment

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

Job Loss, Job Finding and the Natural Rate

Let

N = total population

L = labor force

E = number of employed

U = number of unemployed

L = U + E (2)

Unemployment rate isUL

Joydeep Bhattacharya Iowa State

Labor Markets and Unemployment

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

E = L� ULet s = rate of job separation (fraction of employed workers who losetheir jobs every month)

Let f = rate of job �nding (fraction of unemployed individuals who�nd a job each month)

If the rate of unemployment is not changing, then the number ofpeople losing jobs (sE ) must equal the number of people �nding jobs(fU), or

fU = sE (3)

Joydeep Bhattacharya Iowa State

Labor Markets and Unemployment

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

Since E = L� U, implies

fU = s (L� U) (4)

UL=

s[f + s ]

(5)

or, the rate of unemployment (i.e., UL ) depends on the rate of job�nding (f ), and rate of job separation (s).

Joydeep Bhattacharya Iowa State

Labor Markets and Unemployment

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

higher f implies lower U/Lhigher s implies higher U/LFor the US: when unemployment is high, the proportion ofunemployed workers �nding jobs is low; also, a higher proportion ofworkers lose their jobs.

Joydeep Bhattacharya Iowa State

Labor Markets and Unemployment