The Labor Market
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
The Labor Market
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Christina Zauner Department of Economics, University of Vienna
May 4th , 2011
Motivation
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
In the IS-LM model (short run analysis) we have assumed that firms are willing to supply any demanded quantity at the given price level
I
For a medium run analysis this assumption is not feasible anymore: firms’ production depend on the available production factors
I
For simplicity, we will assume that firms use only labor in their production process
I
Thus, for a medium run analysis we have to include the labor market in our model
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
What is the Labor Market?
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
In the labor market firms buy and individuals sell labor
I
The price of labor is called wage and will be denoted by W
I
Both the wage demanded by workers and the wage offered by firms will depend on the price level P
I
We will say that the labor market is in equilibrium if the real wage ( W P ) demanded by workers is equal to the real wage offered by firms
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Labor Market Definitions
The Labor Market Christina Zauner
I
Noninstitutional civilian population: number of people potentially available for civilian employment (i.e. total population excluding children, people in the armed forces etc.)
Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
I
Labor force: people either working or looking for work (i.e. employed and unemployed people)
I
Out of the labor force: sum of those neither working in the market place nor looking for work (e.g. retirees, housewives, discouraged workers)
I
Unemployment rate (u): ratio of unemployed to the labor force
I
Participation rate (ρ): ratio of the labor force to the noninstitutional civilian population
The Labor Market
The Labor Market in Austria
Christina Zauner Introduction
Total population: 8,214.4 ⇓
Wage Determination Price Determination Labor Market Equilibrium
Noninstitutional civilian population: 6,905.1
Conclusion
⇓
⇓
Civilian labor force: 4,213.5
Out of the labor force: 2,691.6
⇓
⇓
Employed 4,027.9
Unemployed 185.6
A Simple Model of the Labor Market
Table: Austrian Labor Market (in thousand; Statistik Austria, 2007)
Movements in the Labor Market
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
The unemployment rate can reflect an active (i.e. many separations and hires) or a sclerotic (i.e. stagnant pool of unemployed) labor market
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Unemployment in Austria
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Figure: Monthly Austrian Unemployment Rate (1950:1-2009:1, IHS)
Stylized Facts
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
I
Typically wages exceed the so-called reservation wage, i.e. the wage at which a worker is indifferent between working and being unemployed Reasons: 1. Workers have bargaining power 2. Sometimes firms have an interest to pay more than the reservation wage
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Stylized Facts
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
ad 1) bargaining power depends on two factors: I
I
I
conditions on the labor market (e.g. low unemployment makes it difficult for firms to find replacement workers) nature of the job (e.g. high skilled workers are more difficult to replace)
ad 2) efficiency wage theories: a higher wage increases the productivity of workers (and decreases employee turnover)
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
The Labor Market
Formal Analysis
Christina Zauner Introduction
Formally, the nominal wage demanded by workers is given by:
A Simple Model of the Labor Market
W = P e F (u, z)
Wage Determination Price Determination Labor Market Equilibrium
with
∂F ∂u
< 0 and
∂F ∂z
Conclusion
>0
I
W . . . nominal wage
I
P e . . . expected price level
I
u . . . unemployment rate
I
z . . . catchall variable (other factors affecting wages, e.g. unemployment insurance, minimum wages, employment protection)
I
F . . . a function (decreasing in u and increasing in z)
Formal Analysis
The Labor Market Christina Zauner
I
Wages demanded by workers are an increasing function of the (expected) price level since workers do not care about how much money they get but how many goods they can buy with their money.
I
Therefore, if workers expect the price level to double, they will ask for a doubling of their nominal wage (in order to hold real wages constant).
I
Also firms don’t care just about the nominal wages they have to pay but about the relationship between the price level and the marginal cost (in our simple model the nominal wage)
IMPORTANT Since workers don’t know the actual price level at the time of wage negotiations, they can only base their decisions on the expected price level
Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
The Labor Market
The Wage-Setting Relation
Christina Zauner Introduction
I
If we assume that P = P e (reasonable in medium run only) then we can write W = PF (u, z) ⇔
W = F (u, z) P
A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
(1)
I
Equation (1) implies that the real wage asked for by workers is decreasing in the unemployment rate u and increasing in z
I
The relation between the real wage and the unemployment rate described by (1) is called wage-setting relation
Wage-Setting Relation
The Labor Market Christina Zauner
Graphical Representation
Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Figure: The WS-curve
Production Function
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
Prices set by firms depend on the costs of production and thus on the production technology
I
We will assume that labor is the sole input factor to this technology: Y = AN I I I
Y . . . aggregate output N . . . employment (i.e. number of workers) A . . . labor productivity (i.e. output per worker)
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Price-Setting in a Competitive Market
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
If a worker gets wage W and he produces A units of output then the wage costs per unit of output are equal to W /A
I
So the costs of producing one more unit of output, i.e. the marginal costs of production, are equal to W /A
I
In a perfectly competitive market, price equals marginal costs, i.e. P = W /A
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Price-Setting with Market Power
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
I
We will not assume perfect competition; instead we assume that firms have some market power and charge a positive markup µ Therefore firms set prices according to P = (1 + µ)(W /A)
I
Since price P exceeds production costs W /A firms make profits
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
The Labor Market
The Price-Setting Relation
Christina Zauner Introduction
I
A Simple Model of the Labor Market
Rewriting the relation between the price level P and nominal wages W yields A W = P 1+µ
Wage Determination Price Determination Labor Market Equilibrium
(2)
I
Equation (2) implies that the real wage offered by firms is decreasing in the markup µ and increasing in productivity A
I
The relation is called price-setting relation
I
In the graphical representation, the price-setting relation is a horizontal line, i.e. the real wage implied by price setting is independent of the unemployment rate
Conclusion
Price-Setting Relation
The Labor Market Christina Zauner
Graphical Representation
Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Figure: The PS-curve
Equilibrium Condition
The Labor Market Christina Zauner Introduction
I
Equilibrium in the labor market requires that the real wage asked for by workers equals the real wage offered by firms
I
Formally, denoting the equilibrium unemployment rate by un (natural rate of unemployment), the equilibrium is given by A F (un , z) = 1+µ
I
In the graphical representation, the equilibrium is given by the intersection of the WS-curve (wage-setting relation) and the PS-curve (price-setting relation)
A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Labor Market Equilibrium Graphical Representation
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Figure: Equilibrium in the Labor Market
Determinants of Labor Market Equilibrium
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
From the equilibrium condition F (un , z) = A/(1 + µ) we see that un is determined by the markup µ, the catchall variable z and the productivity A
I
In graphical terms: the positions of the wage-setting curve (WS) and the price-setting curve (PS), and therefore the labor market equilibrium, depend on µ, z and A.
I
Consequently, no other variables can influence the unemployment rate in the medium run (i.e. when price expectations are correct)!!!
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Increase in Unemployment Benefits
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
I
An increase in unemployment benefits can be modeled by an increase in z
I
From the wage-setting relation we know that if z increases the real wage W /P demanded by workers goes up for any unemployment rate. Thus, the WS-curve shifts up.
Conclusion
Increase in Unemployment Benefits Graphical Representation
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Figure: A Shift of the WS-curve
Increase in Unemployment Benefits
The Labor Market Christina Zauner
The shift of the WS-curve implies that the equilibrium 0 moves from point A to A . Therefore the natural rate of unemployment un increases if unemployment benefits increase
Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Intuition: I
If unemployment benefits increase, firms would have to pay higher real wages (because the reservation wage of workers increases and the prospect of becoming unemployed is less distressing)
I
Since firms are not willing to pay higher wages, workers will start to quit their jobs and unemployment will go up
I
This increase in unemployment leads to a decrease in the bargaining power of workers until they are satisfied again with the real wage offered by firms
Relaxation of Antitrust Regulation
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
Next consider a less stringent enforcement of existing antitrust legislation.
I
This is likely to result in more market power for firms (e.g. collusion) and thus a higher markup µ
I
From the price-setting relation we know that if µ increases the real wage W /P goes down for any unemployment rate. Thus the PS-curve shifts down
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Relaxation of Antitrust Regulation Graphical Representation
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Figure: A Shift of the PS-curve
Relaxation of Antitrust Regulation
The Labor Market Christina Zauner
The shift of the PS-curve implies that the equilibrium moves 0 from point A to A . Therefore the natural rate of unemployment un increases if antitrust regulation is relaxed Intuition: I
Given nominal wages W an increase in the markup µ leads to higher prices and therefore to lower real wages W /P
I
However, at the initially low unemployment rate the prospect of being unemployed is not very deterring and therefore workers won’t accept the lower real wage offered by firms but quit their jobs instead. Therefore, the unemployment rate increases.
I
A rising unemployment rate means that the bargaining power of workers decreases until they are satisfied with the lower real wage offered by firms
Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
The Labor Market
The Natural Level of Output
Christina Zauner Introduction A Simple Model of the Labor Market
I
I
The natural rate of unemployment un is associated with a natural level of output In the following, U denotes unemployment, N employment and L the labor force u≡
I
L−N N U = =1− L L L
Rearranging (3) yields N = L(1 − u)
(3)
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
The Natural Level of Output
The Labor Market Christina Zauner
I
Recall that the production function was given by Y = AN
I
Therefore the natural level of output is given by Yn = AL(1 − un )
I
Solving for the natural rate of unemployment yields un = 1 − Yn /AL
I
Substituting this into our labor market equilibrium condition we get A Yn ,z = F 1− AL 1+µ which implicitly determines Yn depending only on the exogenous parameters A, L, z, µ and the function F . If in particular the function F is known (and not too complicated) this equation can be solved for Yn .
Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Summary
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
Equilibrium in the labor market requires that the real wage asked for by workers is equal to the real wage offered by firms
I
The main assumption in this respect is that the price level equals the expected price level, i.e. P = P e
I
In the short-run, however, this assumption might not be true and therefore u 6= un
I
Since expectations are unlikely to be systematically wrong, in the medium run P = P e will hold and u = un
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
The Labor Market
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Christina Zauner Department of Economics, University of Vienna
May 4th , 2011
Motivation
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
In the IS-LM model (short run analysis) we have assumed that firms are willing to supply any demanded quantity at the given price level
I
For a medium run analysis this assumption is not feasible anymore: firms’ production depend on the available production factors
I
For simplicity, we will assume that firms use only labor in their production process
I
Thus, for a medium run analysis we have to include the labor market in our model
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
What is the Labor Market?
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
In the labor market firms buy and individuals sell labor
I
The price of labor is called wage and will be denoted by W
I
Both the wage demanded by workers and the wage offered by firms will depend on the price level P
I
We will say that the labor market is in equilibrium if the real wage ( W P ) demanded by workers is equal to the real wage offered by firms
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Labor Market Definitions
The Labor Market Christina Zauner
I
Noninstitutional civilian population: number of people potentially available for civilian employment (i.e. total population excluding children, people in the armed forces etc.)
Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
I
Labor force: people either working or looking for work (i.e. employed and unemployed people)
I
Out of the labor force: sum of those neither working in the market place nor looking for work (e.g. retirees, housewives, discouraged workers)
I
Unemployment rate (u): ratio of unemployed to the labor force
I
Participation rate (ρ): ratio of the labor force to the noninstitutional civilian population
The Labor Market
The Labor Market in Austria
Christina Zauner Introduction
Total population: 8,214.4 ⇓
Wage Determination Price Determination Labor Market Equilibrium
Noninstitutional civilian population: 6,905.1
Conclusion
⇓
⇓
Civilian labor force: 4,213.5
Out of the labor force: 2,691.6
⇓
⇓
Employed 4,027.9
Unemployed 185.6
A Simple Model of the Labor Market
Table: Austrian Labor Market (in thousand; Statistik Austria, 2007)
Movements in the Labor Market
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
The unemployment rate can reflect an active (i.e. many separations and hires) or a sclerotic (i.e. stagnant pool of unemployed) labor market
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Unemployment in Austria
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Figure: Monthly Austrian Unemployment Rate (1950:1-2009:1, IHS)
Stylized Facts
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
I
Typically wages exceed the so-called reservation wage, i.e. the wage at which a worker is indifferent between working and being unemployed Reasons: 1. Workers have bargaining power 2. Sometimes firms have an interest to pay more than the reservation wage
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Stylized Facts
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
ad 1) bargaining power depends on two factors: I
I
I
conditions on the labor market (e.g. low unemployment makes it difficult for firms to find replacement workers) nature of the job (e.g. high skilled workers are more difficult to replace)
ad 2) efficiency wage theories: a higher wage increases the productivity of workers (and decreases employee turnover)
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
The Labor Market
Formal Analysis
Christina Zauner Introduction
Formally, the nominal wage demanded by workers is given by:
A Simple Model of the Labor Market
W = P e F (u, z)
Wage Determination Price Determination Labor Market Equilibrium
with
∂F ∂u
< 0 and
∂F ∂z
Conclusion
>0
I
W . . . nominal wage
I
P e . . . expected price level
I
u . . . unemployment rate
I
z . . . catchall variable (other factors affecting wages, e.g. unemployment insurance, minimum wages, employment protection)
I
F . . . a function (decreasing in u and increasing in z)
Formal Analysis
The Labor Market Christina Zauner
I
Wages demanded by workers are an increasing function of the (expected) price level since workers do not care about how much money they get but how many goods they can buy with their money.
I
Therefore, if workers expect the price level to double, they will ask for a doubling of their nominal wage (in order to hold real wages constant).
I
Also firms don’t care just about the nominal wages they have to pay but about the relationship between the price level and the marginal cost (in our simple model the nominal wage)
IMPORTANT Since workers don’t know the actual price level at the time of wage negotiations, they can only base their decisions on the expected price level
Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
The Labor Market
The Wage-Setting Relation
Christina Zauner Introduction
I
If we assume that P = P e (reasonable in medium run only) then we can write W = PF (u, z) ⇔
W = F (u, z) P
A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
(1)
I
Equation (1) implies that the real wage asked for by workers is decreasing in the unemployment rate u and increasing in z
I
The relation between the real wage and the unemployment rate described by (1) is called wage-setting relation
Wage-Setting Relation
The Labor Market Christina Zauner
Graphical Representation
Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Figure: The WS-curve
Production Function
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
Prices set by firms depend on the costs of production and thus on the production technology
I
We will assume that labor is the sole input factor to this technology: Y = AN I I I
Y . . . aggregate output N . . . employment (i.e. number of workers) A . . . labor productivity (i.e. output per worker)
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Price-Setting in a Competitive Market
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
If a worker gets wage W and he produces A units of output then the wage costs per unit of output are equal to W /A
I
So the costs of producing one more unit of output, i.e. the marginal costs of production, are equal to W /A
I
In a perfectly competitive market, price equals marginal costs, i.e. P = W /A
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Price-Setting with Market Power
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
I
We will not assume perfect competition; instead we assume that firms have some market power and charge a positive markup µ Therefore firms set prices according to P = (1 + µ)(W /A)
I
Since price P exceeds production costs W /A firms make profits
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
The Labor Market
The Price-Setting Relation
Christina Zauner Introduction
I
A Simple Model of the Labor Market
Rewriting the relation between the price level P and nominal wages W yields A W = P 1+µ
Wage Determination Price Determination Labor Market Equilibrium
(2)
I
Equation (2) implies that the real wage offered by firms is decreasing in the markup µ and increasing in productivity A
I
The relation is called price-setting relation
I
In the graphical representation, the price-setting relation is a horizontal line, i.e. the real wage implied by price setting is independent of the unemployment rate
Conclusion
Price-Setting Relation
The Labor Market Christina Zauner
Graphical Representation
Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Figure: The PS-curve
Equilibrium Condition
The Labor Market Christina Zauner Introduction
I
Equilibrium in the labor market requires that the real wage asked for by workers equals the real wage offered by firms
I
Formally, denoting the equilibrium unemployment rate by un (natural rate of unemployment), the equilibrium is given by A F (un , z) = 1+µ
I
In the graphical representation, the equilibrium is given by the intersection of the WS-curve (wage-setting relation) and the PS-curve (price-setting relation)
A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Labor Market Equilibrium Graphical Representation
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Figure: Equilibrium in the Labor Market
Determinants of Labor Market Equilibrium
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
From the equilibrium condition F (un , z) = A/(1 + µ) we see that un is determined by the markup µ, the catchall variable z and the productivity A
I
In graphical terms: the positions of the wage-setting curve (WS) and the price-setting curve (PS), and therefore the labor market equilibrium, depend on µ, z and A.
I
Consequently, no other variables can influence the unemployment rate in the medium run (i.e. when price expectations are correct)!!!
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Increase in Unemployment Benefits
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
I
An increase in unemployment benefits can be modeled by an increase in z
I
From the wage-setting relation we know that if z increases the real wage W /P demanded by workers goes up for any unemployment rate. Thus, the WS-curve shifts up.
Conclusion
Increase in Unemployment Benefits Graphical Representation
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Figure: A Shift of the WS-curve
Increase in Unemployment Benefits
The Labor Market Christina Zauner
The shift of the WS-curve implies that the equilibrium 0 moves from point A to A . Therefore the natural rate of unemployment un increases if unemployment benefits increase
Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Intuition: I
If unemployment benefits increase, firms would have to pay higher real wages (because the reservation wage of workers increases and the prospect of becoming unemployed is less distressing)
I
Since firms are not willing to pay higher wages, workers will start to quit their jobs and unemployment will go up
I
This increase in unemployment leads to a decrease in the bargaining power of workers until they are satisfied again with the real wage offered by firms
Relaxation of Antitrust Regulation
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
Next consider a less stringent enforcement of existing antitrust legislation.
I
This is likely to result in more market power for firms (e.g. collusion) and thus a higher markup µ
I
From the price-setting relation we know that if µ increases the real wage W /P goes down for any unemployment rate. Thus the PS-curve shifts down
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Relaxation of Antitrust Regulation Graphical Representation
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Figure: A Shift of the PS-curve
Relaxation of Antitrust Regulation
The Labor Market Christina Zauner
The shift of the PS-curve implies that the equilibrium moves 0 from point A to A . Therefore the natural rate of unemployment un increases if antitrust regulation is relaxed Intuition: I
Given nominal wages W an increase in the markup µ leads to higher prices and therefore to lower real wages W /P
I
However, at the initially low unemployment rate the prospect of being unemployed is not very deterring and therefore workers won’t accept the lower real wage offered by firms but quit their jobs instead. Therefore, the unemployment rate increases.
I
A rising unemployment rate means that the bargaining power of workers decreases until they are satisfied with the lower real wage offered by firms
Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
The Labor Market
The Natural Level of Output
Christina Zauner Introduction A Simple Model of the Labor Market
I
I
The natural rate of unemployment un is associated with a natural level of output In the following, U denotes unemployment, N employment and L the labor force u≡
I
L−N N U = =1− L L L
Rearranging (3) yields N = L(1 − u)
(3)
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
The Natural Level of Output
The Labor Market Christina Zauner
I
Recall that the production function was given by Y = AN
I
Therefore the natural level of output is given by Yn = AL(1 − un )
I
Solving for the natural rate of unemployment yields un = 1 − Yn /AL
I
Substituting this into our labor market equilibrium condition we get A Yn ,z = F 1− AL 1+µ which implicitly determines Yn depending only on the exogenous parameters A, L, z, µ and the function F . If in particular the function F is known (and not too complicated) this equation can be solved for Yn .
Introduction A Simple Model of the Labor Market Wage Determination Price Determination Labor Market Equilibrium
Conclusion
Summary
The Labor Market Christina Zauner Introduction A Simple Model of the Labor Market
I
Equilibrium in the labor market requires that the real wage asked for by workers is equal to the real wage offered by firms
I
The main assumption in this respect is that the price level equals the expected price level, i.e. P = P e
I
In the short-run, however, this assumption might not be true and therefore u 6= un
I
Since expectations are unlikely to be systematically wrong, in the medium run P = P e will hold and u = un
Wage Determination Price Determination Labor Market Equilibrium
Conclusion
