THE LABOR MARKET: WAGES, EMPLOYMENT, AND UNEMPLOYEMENT

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Chapter 8

• THE LABOR MARKET WAGES, EMPLOYMENT, AND
  UNEMPLOYEMENT

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1. Factor Markets

• The circular-flow diagram of Chapter 2 showed
  that firms operate simultaneously in two types of
  markets. In the product market, they solve the
  what problemwhat to produce and, if a price
  searcher, how much to charge.
• In the factor market, firms solve the how
  problemhow to combine the factors of production
  effectively to produce output.
• A factor (input) market is one in which firms
  purchase land, labor, or capital inputs.
• The price-taking buyer, with a small share of
  total market, must simply pay the going market
  rate.

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1. Factor Markets cont.

• The price-searching buyer, with a sufficiently
  large share of the market, can affect the price
  by buying more or less of it.
• There is less price searching in factor markets
  than in product markets.
• A firm must thus compete for inputs with all
  firms that use the same inputs.
• E.g. New York Citys, universities, foundations,
  major corporations, etc. all compete against each
  other for secretaries, computer programmers,
  etc. they do not compete against each other in
  product markets, but they do compete in factor
  markets.

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2. Supply and Demand in Factor Markets

• Just like prices in product markets, the prices
  of labor, capital, and land are determined by
  supply and demand.
• As there are market supply and demand for curves
  for goods, so there are market supply and demand
  curves for the factors of production.
• This chapter focus on labor, but the principles
  apply to all three factor productions.

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2.1 The Supply Factor

• The supply of all the factors of
  productionlabor, land and capitaldepends on
  their opportunity costs.
• For example the amount of unskilled labor offered
  at different wage rates depends on the
  alternatives sacrificed in other lines of
  employment.
• If the wage rate offered for garbage collection
  is low, fewer unskilled workers will conclude
  that garbage collection is superior to their
  next-best alternative.

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2.1.1 The Supply Curve

• The supply curve of a factor of production is the
  quantity offered at different factor prices all
  other things remaining the same.
• The opportunity cost principle reveals a normal
  shape to this supply curve.
• The higher the factor price (the wage), the
  larger the quantity of the factor typically
  supplied, ceteris paribus.

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2.2 The Demand for a Factor

• The demand for the factors of production depends
  on the productivity of the factor and the demand
  for the product the factor is used to produce.

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2.2.1. The Factor Demand Curve

• The demand curve for a factor shows the
  quantities of that factor that would be purchased
  (demanded) at different prices, ceteris paribus.
• In most general terms, this demand depends on two
  forces the demand for the product the factor
  produces (derived demand) and the productivity of
  the factor.

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2.2.2. Derived Demand

• Firms purchase inputs because they produce goods
  and services that can be sold.
• No matter how productive an input, it will not be
  hired unless it produces a good demanded in the
  marketplace.
• Labor and Derived Demand The Case of the
  Handwritten Bible Example

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2.2.2. Derived Demand cont.

• The demand for a factor of production is a
  derived demand because it results (is derived)
  from the demand for the goods and services the
  factor of production helps to produce.
• There is a clear linkage between the demand for
  the product the factor produces and the demand
  for the factor.
• When the demand for new houses falls, there is
  unemployment in the lumber-producing states.

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2.2.3. Marginal Productivity

• The marginal product of a factor of production
  (MP) is the increase in output that results from
  increasing the factor by one unit.
• The law of diminishing returns states that as
  ever larger quantities of a variable factor will
  eventually decline as the firm expands its
  output, MP will fall in the short run.
• The marginal product of any factor depends on the
  quantity and quality of the cooperating factors
  of production (farm worker with modern farm
  machinery).

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2.2.4. Marginal Revenue Product

• On the output, side, the firm maximizes profit by
  producing that output at which MRMC.
• The marginal revenue product (MRP) of a factor of
  production (P) is the extra revenue generated by
  increasing the factor by one unit. MRP MR x MP
• The MRP curve is the firms demand curve for that
  factor.

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2.3. Factor Market Equilibrium

• The demand for a factor increases whenever MRP
  increases. MRP increases when the price of the
  product rises or when the marginal productivity
  increases.
• Increases in the products price and in MP raise
  factor prices.
• An increase in productivity has the same effect
  MRP increases and the demand for the factor
  increases, and again the factor prices rises.

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3. Labor Markets

• The prices (wages) of labor of different grades
  and types are determined in a labor market.
• A labor market brings buyers and sellers of labor
  services together to agree on conditions of work
  and pay. They can be local, national, or
  international.
• The labor market differs from other factor
  markets in four respects1) people cannot be
  bought and sold (no slavery) 2) different job
  preferences 3) we have alternative use of time
  (leisure vs. work) 4)workers can join unions.

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3.1. Wage Differentials

• Jobs Are Different
• Compensating wage differentials are the higher
  rewards that must be paid to compensate for
  undesirable job characteristics.(Offshore oil
  workers vs. food processing workers)
• People Are Different
• Noncompeting groups are those groups of people
  differentiated by natural ability and education,
  training, and experience to the extent that they
  do not compete with another for jobs. (Dig
  ditcher vs. brain surgeon vs. basketball player)

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3.2. Human Capital, Productivity, and Income
Distribution

• Human capital is investment in schooling,
  training, and health that raises productivity.
• Any activity that raises the productivity of a
  resource is an investment e.g. any expenditure
  on human capital is as much an investment as
  those of a firm building a new plant or acquiring
  new machinery.
• People acquire additional human capital until
  marginal costs and marginal benefits are equal.

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4. The Macroeconomic Labor Market

• The Employment Act of 1964 commits the federal
  government to create and maintain useful
  employment opportunities for those able,
  willing, and seeking to work.
• The Great Depression of the 1930s with its high
  unemployment has left a lasting imprint on the
  American consciousness.
• In 1929, less than 3 percent of the labor force
  was unemployed by 1933, 25 percent was
  unemployed.

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4.1 The Definition on Unemployment

• According to the Bureau of Labor Statistics, a
  person is unemployed if he or she
• Did not work at all during the previous week.
• Actively looked for work during the previous four
  weeks.
• Is currently available for work.
• The labor force equals the number of persons
  employed plus the number unemployed. (People not
  in labor force are full-time homemakers or
  students and retirees)
• The unemployment rate equals the number of
  unemployed divided by the labor force (the sum of
  employed and unemployed persons). Unemployment is
  an indicator of the labor market.

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4.2 Frictional and Cyclical Unemployment

• The unemployed search for jobs the employed look
  for better jobs.
• Frictional unemployment is the unemployment
  associated with the changing of jobs in a dynamic
  economy.
• Cyclical unemployment is unemployment associated
  with general downturns in the economy.
• During cyclical downturns, fewer goods and
  services are purchased, employers cut back on
  jobs, and people find themselves without jobs.

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4.3 Macroeconomic Supply and Demand for Labor

• The entire economys demand for labor depends on
  its marginal productivity, which fall as more and
  more people are hired willingness to work
  depends on the wage rate.
• Real wages are measured by money wages, W,
  divided by the price level, Pthat is, W/P.
• The natural rate of employment is that rate at
  which the number of available jobs (V) is equal
  to the number of qualified unemployed workers
  (U).
• The natural rate of unemployment is when there is
  an approximate balance between the number of
  unfilled jobs and the number of qualified job
  seekers.

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4.4 Wage Flexibility and Unemployment

• If the labor market is like other markets, the
  wage should fall whenever there is a gap between
  the number of people wishing to work and the
  number of jobs available at the prevailing wage.
• Much of macroeconomics focuses on why wages are
  less flexible than other prices an explanation
  is that labor is often hired under long-term
  contracts.
• If normal wages are inflexible, and the demand
  for labor falls, unemployment in excess of the
  natural rate can be created.

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5. Unions, Layoffs, and Inflexible Wages

• A labor union is a collective organization of
  workers and employees whose goal is to affect
  conditions of pay and unemployment.
• Currently, about one in nine members of the
  American labor force belongs to a union (?since
  19501 out of 4).
• Collective bargaining is union bargaining with
  management.

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5. Unions, Layoffs, and Inflexible Wages cont.

• A strike occurs when unionized employees cease
  work until management agrees to specific union
  demands.
• Unions objectiveshigher pay and high employment
  of union member are not compatible unions must
  balance these two.
• When laid-off union workers want to be recalled,
  their unemployment does not cause wages to fall
  generally in the economy.