1. Unemployment rate

Transcription

1 1. Unemployment rate Important rates in an economy: interest rate, exchange rate, inflation rate, and unemployment rate. Employment = number of people having a job. Unemployment = number of people not having a job but looking for one. Labour force = Employment + Unemployment Unemployment Unemployment rate = Labour force Labour force Participation rate = Economically active population 1 16 April 2015

2 2 16 April IV/2014 III/2014 II/2014 I/2014 IV/2013 III/2013 II/2013 I/2013 IV/2012 III/2012 II/2012 I/2012 IV/2011 III/2011 II/2011 I/2011 IV/2010 III/2010 II/2010 I/2010 IV/2009 III/2009 II/2009 I/2009 IV/2008 III/2008 II/2008 I/2008 IV/2007 III/2007 II/2007 I/2007 IV/2006 III/2006 II/2006 I/2006 IV/2005 III/2005 II/2005 I/2005 IV/2004 III/2004 II/2004 I/2004 IV/2003 III/2003 II/2003 I/2003 IV/2002 III/2002 II/2002 I/2002 IV/2001 III/2001 II/2001 I/2001 Catalonia, participation rate, 2001I-2014IV TOTAL MEN DONES SPAIN

3 Basic types of unemployment Actual unemployment is divided into three categories (the first two define natural unemployment ). Frictional. Occurs while workers are changing jobs. Structural. Due to structural changes in the economy that create and eliminate jobs and to the institutions that match workers and firms (firing and hiring costs, minimum wages, unemployment benefits, mobility restrictions, lack of training ). Cyclical. Generated by the short-run fluctuations of GDP (rises with recessions, falls with booms) April 2015

4 5,1 4,9 5 4,8 4,7 4,6 4,5 4,4 4,3 4,2 4,1 3,9 4 3,8 3,7 3,6 3,5 3,4 3,3 3,2 3,1 2,9 3 2,8 2,7 2,6 2,5 2,4 2,3 2,2 2,1 1,9 2 1,8 1,7 1,6 1,5 1,4 1,3 1,2 1,1 0,9 1 0,8 0,7 0,6 0,5 0,4 0,3 0,2 0,1 0 Spain, registered unemployment, 1996M1-2015M2 (millions of persons) M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M April 2015 TOTAL WOMEN MEN

5 TOTAL WOMEN MEN Spain, estimated unemployment, 1976III-2004IV (thousands of persons) TIII 1977TII 1978TI 1978TIV 1979TIII 1980TII 1981TI 1981TIV 1982TIII 1983TII 1984TI 1984TIV 1985TIII 1986TII 1987TI 1987TIV 1988TIII 1989TII 1990TI 1990TIV 1991TIII 1992TII 1993TI 1993TIV 1994TIII 1995TII 1996TI 1996TIV 1997TIII 1998TII 1999TI 1999TIV 2000TIII 2001TII 2002TI 2002TIV 2003TIII 2004TII 5 16 April 2015

6 6,5 6 ESTIMATED 5,5 5 4,5 REGISTERED 4 3,5 3 2,5 2 1,5 1 0,5 Spain, registered and estimated unemployment (millions of persons) a061/l0/&file= px&type=pcaxis&l=0 divi=epa&idtab=2193#nogo I 2005-II 2005-III 2005-IV 2006-I 2006-II 2006-III 2006-IV 2007-I 2007-II 2007-III 2007-IV 2008-I 2008-II 2008-III 2008-IV 2009-I 2009-II 6 16 April III 2009-IV 2010-I 2010-II 2010-III 2010-IV 2011-I 2011-II 2011-III 2011-IV 2012-I 2012-II 2012-III 2012-IV 2013-I 2013-II 2013-III 2013-IV

7 7 16 April TIII 1977TII 1978TI 1978TIV 1979TIII 1980TII 1981TI 1981TIV 1982TIII 1983TII 1984TI 1984TIV 1985TIII 1986TII 1987TI 1987TIV 1988TIII 1989TII 1990TI 1990TIV 1991TIII 1992TII 1993TI 1993TIV 1994TIII 1995TII 1996TI 1996TIV 1997TIII 1998TII 1999TI 1999TIV 2000TIII 2001TII 2002TI 2002TIV 2003TIII 2004TII Spain, 1976III-2004IV (thousands of persons) path=/t22/e308/meto_02/pae/px/&file=pcaxis POPULATION LABOUR FORCE UNEMPLOYED

8 8 16 April TIII 1977TII 1978TI 1978TIV 1979TIII 1980TII 1981TI 1981TIV 1982TIII 1983TII 1984TI 1984TIV 1985TIII 1986TII 1987TI 1987TIV 1988TIII 1989TII 1990TI 1990TIV 1991TIII 1992TII 1993TI 1993TIV 1994TIII 1995TII 1996TI 1996TIV 1997TIII 1998TII 1999TI 1999TIV 2000TIII 2001TII 2002TI 2002TIV 2003TIII 2004TII Spain, employment, 1976III-2004IV (thousands of persons) TOTAL MEN WOMEN

9 TIII Catalonia, 1976III-1995IV (thousands of persons) t22/e308/meto_02/pae/px/&file=pcaxis 1977TII 1978TI 1978TIV 1979TIII 1980TII 1981TI 1981TIV 1982TIII 1983TII 1984TI 1984TIV 1985TIII 9 16 April TII 1987TI 1987TIV 1988TIII 1989TII 1990TI 1990TIV 1991TIII 1992TII 1993TI POBLACIÓ EMPLOYMENT TOTAL EMPLOYMENT WOMEN 1993TIV 1994TIII 1995TII

10 10 16 April TIII 1977TII 1978TI 1978TIV 1979TIII 1980TII 1981TI 1981TIV 1982TIII 1983TII 1984TI 1984TIV 1985TIII 1986TII 1987TI 1987TIV 1988TIII 1989TII 1990TI 1990TIV 1991TIII 1992TII 1993TI 1993TIV 1994TIII 1995TII Catalonia 1976III-1995IV, unemployment rate t22/e308/meto_02/pae/px/&file=pcaxis TOTAL MEN WOMEN

11 11 16 April T1 2002T2 2002T3 2002T4 2003T1 2003T2 2003T3 2003T4 2004T1 2004T2 2004T3 2004T4 2005T1 2005T2 2005T3 2005T4 2006T1 2006T2 2006T3 2006T4 2007T1 2007T2 2007T3 2007T4 2008T1 2008T2 2008T3 2008T4 2009T1 2009T2 2009T3 2009T4 2010T1 2010T2 2010T3 2010T4 2011T1 2011T2 2011T3 2011T4 2012T1 2012T2 2012T3 2012T4 2013T1 2013T2 2013T3 2013T4 2014T1 2014T2 2014T3 2014T4 Spain, unemployment rate, 2002I-2014IV TOTAL MEN WOMEN

12 12 16 April T1 2002T2 2002T3 2002T4 2003T1 2003T2 2003T3 2003T4 2004T1 2004T2 2004T3 2004T4 2005T1 2005T2 2005T3 2005T4 2006T1 2006T2 2006T3 2006T4 2007T1 2007T2 2007T3 2007T4 2008T1 2008T2 2008T3 2008T4 2009T1 2009T2 2009T3 2009T4 2010T1 2010T2 2010T3 2010T4 2011T1 2011T2 2011T3 2011T4 2012T1 2012T2 2012T3 2012T4 2013T1 2013T2 2013T3 2013T4 2014T1 2014T2 2014T3 2014T4 Spain, unemployment rate, 2002I-2014IV TOTAL

13 13 16 April IV/2014 III/2014 II/2014 I/2014 IV/2013 III/2013 II/2013 I/2013 IV/2012 III/2012 II/2012 I/2012 IV/2011 III/2011 II/2011 I/2011 IV/2010 III/2010 II/2010 I/2010 IV/2009 III/2009 II/2009 I/2009 IV/2008 III/2008 II/2008 I/2008 IV/2007 III/2007 II/2007 I/2007 IV/2006 III/2006 II/2006 I/2006 IV/2005 III/2005 II/2005 I/2005 IV/2004 III/2004 II/2004 I/2004 IV/2003 III/2003 II/2003 I/2003 IV/2002 III/2002 II/2002 I/2002 IV/2001 III/2001 II/2001 I/2001 Catalonia, unemployment rate, 2001I-2014IV TOTAL MEN WOMEN 16-24

14 14 16 April TIII 1977TII 1978TI 1978TIV 1979TIII 1980TII 1981TI 1981TIV 1982TIII 1983TII 1984TI 1984TIV 1985TIII 1986TII 1987TI 1987TIV 1988TIII 1989TII 1990TI 1990TIV 1991TIII 1992TII 1993TI 1993TIV 1994TIII 1995TII 1996TI 1996TIV 1997TIII 1998TII 1999TI 1999TIV 2000TIII 2001TII 2002T1 2002T4 2003T3 2004T2 2005T1 2005T4 2006T3 2007T2 2008T1 2008T4 2009T3 2010T2 2011T1 2011T4 2012T3 2013T2 2014T1 2014T4 Spain, unemployment rate, 1976III-2014IV

15 AD (aggregate expenditure) Y (aggregate production) (inflation rate) (unemployment rate) April 2015

16 2. Okun s law Okun s law is an empirical relationship suggested in 1962 by the US economist Arthur Okun ( ). Okun s law: there is a negative relationship between the change = in the unemployment rate and =, the rate of growth of real GDP. A simple formal expression of the law is = where and are positive constants that depend on the economy considered and the period with respect to which variables and are measured April 2015

17 D = slope (in absolute value) D = April 2015

18 = slope (in absolute value) D = D April 2015

19 Okun s law (US version) /1 Expressing the variables as annual percentages, in the US, 1.5 and 0.5. Therefore: = 1.5 /2 or = /2. represents the increase in that occurs when the economy does not grow: if = 0, then =. For instance, if = 2% and = 0, then = + /2 = /2 = 3.5. Hence, if the unemployment rate at the beginning of the year is 2% and the economy does not grow, then at the end of the year the rate is 3.5% April 2015

20 Okun s law (US version) /2 measures the ability of the economy to transform GDP growth into a smaller unemployment rate: 0.5 means that increasing by one point reduces by 0.5 points. If = 2%, then = /2 = /2 = If = 3%, then = /2 = /2 =. Therefore, increasing from 2% to 3% reduces from to. There is a gain of 0.5 points: an additional 1% in reduces by 0.5 points April 2015

21 Okun s law, US, Percentage change in real GDP = Okun s law, US, Change in unemployment rate April 2015

22 5 4,5 4 Okun s law, Spain ( ) 3, ,5 2 1, , ,5-1 -0,5 0 0,5 1 1,5 2 2,5 3-0, April 2015

23 2 1,8 1,6 Okun s law, Spain (1976IV 1998IV) 1,4 1,2 1 0,8 0,6 0,4 0, ,8-0,6-0,4-0,2 0 0,2 0,4 0,6 0,8 1 1,2 1,4 1,6 1,8 2-0,2-0,4-0,6-0, April 2015

24 24 16 April ,6-1,4-1,2-1,0-0,8-0,6-0,4-0,2 0,0 0,2 0,4 0,6 0,8 1,0 1,2 1,4 1, TIII 1977TII 1978TI 1978TIV 1979TIII 1980TII 1981TI 1981TIV 1982TIII 1983TII 1984TI 1984TIV 1985TIII 1986TII 1987TI 1987TIV 1988TIII 1989TII 1990TI 1990TIV 1991TIII 1992TII 1993TI 1993TIV 1994TIII 1995TII 1996TI 1996TIV 1997TIII 1998TII 1999TI 1999TIV 2000TIII 2001TII 2002T1 2002T4 2003T3 2004T2 2005T1 2005T4 2006T3 2007T2 2008T1 2008T4 2009T3 2010T2 2011T1 2011T4 2012T3 2013T2 2014T1 2014T4 Spain, unemployment rate, quarterly GDP growth rate, 1976III-2014IV UNEMPLOYMENT GDP

25 25 16 April ,5-4,0-3,5-3,0-2,5-2,0-1,5-1,0-0,5 0,0 0,5 1,0 1,5 2,0 2,5 3,0 3,5 4,0 4,5 5,0 5,5 6,0 6, TIII 1977TII 1978TI 1978TIV 1979TIII 1980TII 1981TI 1981TIV 1982TIII 1983TII 1984TI 1984TIV 1985TIII 1986TII 1987TI 1987TIV 1988TIII 1989TII 1990TI 1990TIV 1991TIII 1992TII 1993TI 1993TIV 1994TIII 1995TII 1996TI 1996TIV 1997TIII 1998TII 1999TI 1999TIV 2000TIII 2001TII 2002T1 2002T4 2003T3 2004T2 2005T1 2005T4 2006T3 2007T2 2008T1 2008T4 2009T3 2010T2 2011T1 2011T4 2012T3 2013T2 2014T1 2014T4 Spain, unemployment rate, annual GDP growth rate, 1976III-2014IV UNEMPLOYMENT GDP

26 2001I Spain, Okun s law, 1976III-2014IV 0/&file=01011.px&type=pcaxis /&file=04002.px&type=pcaxis T3/Datos.htm?t= ,8 1,6 1,4 1,2 1 0,8 1984I 0,6 0,4 D 0,2 0-0,2-0,4-0,6-0,8-1 -1,2-1,4-1,8-2,6-2,4-2,2-2 -1,8-1,6-1,4-1,2-1 -0,8-0,6-0,4-0,2 0 0,2 0,4 0,6 0,8 1 1,2 1,4 1,6 1,8 2 2,2 2,4 2,6 2,8 3 3,2 3,4 3, April I -1,6

27 = D ,8 1,6 1,4 2001I 1,2 1984I 1 0,8 0,6 0,4 D 0,2 0-0,2-0,4-0,6-0,8 Spain, Okun s law, 1976III-2014IV 0/&file=01011.px&type=pcaxis 0/&file=04002.px&type=pcaxis it3/datos.htm?t= I -1-1,2-1,4-1,6-1,8-2,6-2,4-2,2-2 -1,8-1,6-1,4-1,2-1 -0,8-0,6-0,4-0,2 0 0,2 0,4 0,6 0,8 1 1,2 1,4 1,6 1,8 2 2,2 2,4 2,6 2,8 3 3,2 3,4 3, April 2015

28 3. The Phillips curve It is an empirical relationship described in 1960 by Paul Samuelson and Robert Solow based on a 1958 paper by the New Zealand economist Alban William Housego Phillips ( ). The Phillips curve expresses a negative relationship between the unemployment rate and the inflation rate : the lower, the higher. With and positive constants, a linear Phillips curve is represented by an equation of the sort = April 2015

29 Trade-off between and Expressing and in percentage terms, that = means that, to reduce one percentage point the unemployment rate, it is necessary to accept an increase in the inflation rate of points. Let = 10 and = 2. If = 4%, then = = 2%. Then, for to be reduced one point (from 4% to 3% ), must be increased in two percentage points (from = 2% to = = 4% ). is the inflation rate that obtains with zero unemployment. It is a measure of underlying inflation April 2015

30 Unstability of the Phillips curve In contrast to Okun s law, the Phillips curve is in general unstable, since is a volatile parameter. depends on inflation expectations and the firms cost structure: an increase in expected inflation or in the production costs rises. When rises, the curve shifts upward, so more inflation must be paid to reduce the unemployment rate. indicates how sensitive is to changes in. It depends on institutional factors, like the bargaining power of trade unions (more power, higher ) April 2015

31 Spain, Phillips curve (1976IV 2014IV) path=/t22/e308_mnu&file=inebase&n=&l=0 path=%2ft25%2fp138&file=inebase&l= IV IV April 2015

32 28 26 Spain, Phillips curve (1976IV 2014IV) IV IV April 2015

33 27 Spain, Phillips curve (1976IV 1986IV) IV IV April 2015

34 7,5 7 6,5 Spain, Phillips curve (1987I 1994IV, 1996I 2014IV) 1987 I 6 5,5 5 4, IV 3, I 2,5 2 1,5 1 0,5 0-0, IV April 2015

35 Spain, inflation rate, unemployment rate (1976III 2014IV) III 1977III 1978III 1979III 1980III 1981III 1982III 1983III 1984III 1985III 1986III 1987III 1988III 1989III 1990III 1991III 1992III 1993III 1994III 1995III 1996III 1997III 1998III 1999III 2000III 2001III 2002III 2003III 2004III 2005III 2006III 2007III 2008III 2009III 2010III 2011III 2012III 2013III 2014III April 2015

36 Japan s Phillips curve looks like Japan (1980M1 2005M8) smith/econ116a/japan.pdf April 2015

37 4. The Swan diagram ( h ) April 2015

38 Internal and external balance Internal balance requires full employment of resources (sufficiently low unemployment rate) and price stability (low and stable inflation rate). External balance corresponds to a balanced current account (the supply and demand for the domestic currency are balanced). For simplicity, external balance is defined as zero trade balance. Internal balance and external balance both are assumed to depend on two variables: domestic expenditures and the real exchange rate April 2015

39 The internal balance (IB) function /1 The IBfunction drawn on the next slide is assumed increasing for the following reason. Suppose the economy is initially at point. If a real appreciation occurs (the real exchange rage increases), then imports rise and exports fall. That is, there is a switch in demand from domestic to foreign goods. As a result, unemployment goes up and the economy moves from point to. To restore internal balance by reaching point, unemployment must be eliminated. This requires an increase in domestic expenditure April 2015

40 Interpreting the IBfunction /1 ( h ) April 2015

41 The internal balance (IB) function /2 If follows from the previous analysis that points above the IB function (excessive expenditure abroad) imply the existence of unemployment. Below the IBfunction failure of internal balance is not due to unemployment but to inflation. For instance, at point, given the corresponding real exchange rate, domestic expenditure is excessive with respect to the level required to reach internal balance. This excess of domestic expenditure manifests itself in the form of inflation April 2015

42 Interpreting the IBfunction /2 ( h ) April 2015

43 The external balance (EB) function /1 The EB function drawn on the next slide is assumed decreasing for the following reason. Suppose the economy is initially at point, where the trade balance is zero. If domestic expenditure increases, GDP and, consequently, income also increase. Part of this additional income is spent buying foreign goods. A trade deficit ensues. To restore external balance by reaching point, the trade deficit must be neutralized. This requires a reduction in the real exchange rate: a real depreciation (an improvement of competitiveness) April 2015

44 Interpreting the EB function /1 ( h ) April 2015

45 The external balance (EB) function /2 If follows from the previous analysis that points above the EB function (excessive domestic expenditure) generate a trade deficit. Below the EB function failure of external balance is not due to a trade deficit but to trade surplus. For instance, at point, given the corresponding level of domestic expenditure, the real exchange rate is smaller than the value required to reach external balance with. That is, the economy is too competitive and therefore runs a trade surplus April 2015

46 Interpreting the EB function /2 ( h ) April 2015

47 The Swan (or Meade-Swan) diagram The Swan diagram (due to Trevor W. Swan) combines the IBand EB functions. It separates the plane into four regions. In region I, the economy experiences unemployment and trade deficit (Spain, Egypt, Poland). In region II, inflation coexists with a trade deficit (Brazil, Turkey, Colombia, Morocco). In region III, there is inflation and a trade surplus (China, Russia, Korea). In region IV, the economy has unemployment and runs a trade surplus (Hungary, Slovakia) April 2015

48 The Swan diagram in action Suppose the economy is in Region I and, specifically, around the numeral I in Region I. At that point, the economy has unemployment. It may appear that more expenditure is needed to reduce unemployment. The diagram suggests that the unemployment problem this economy faces is not solved by changing expenditure (increasing it) but by shifting expenditure. To reach the intersection of the IB and EB lines, domestic expenditure must be reduced and net exports increased (through depreciation) April 2015

49 5. Involuntary unemployment Involuntary unemployment occurs when, at the prevailing wage rate in the economy, there are people willing to work but are not given a job. The models developed next illustrate basic reasons for the existence of involuntary unemployment: too high wage rates (classical explanation); insufficient labour demand, due to insufficient aggregate demand (Keynesian explanation); existence of market power (trade unions); existence of labour discrimination; and structural reasons (last model) April 2015

50 The classical labour market model /1 ( = ) * = * ( ) April 2015

51 The classical labour market model /2 It is a standard competitive model in which price is represented by the real wage (the nominal wage W divided by some price level P) and quantity is labour (labour supplied and demanded). The higher, the higher the labour supply (up to the maximum labour that can be supplied: the economically active population ). The labour supply function is therefore increasing. The labour demand function is decreasing: the higher, the lower the labour demand April 2015

52 Competitive labour demand /1 A labour demand function can be constructed as follows. Take any firm using labour to produce a certain commodity by means of the production function that establishes the total amount of that can be produced using units of labour. Define the firm s profit function as =, where is the amount of labour the firms hires, is the price at which the firm sells (in a competitive market for ), and is the nominal wage (the cost of hiring each unit of labour) April 2015

53 Competitive labour demand /2 Suppose the aim of the firm is to choose to maximize the profit function. Assuming the function ( ) differentiable, the first order condition for a maximun is = 0. Since the firm is a ( ) price taker in the commodity market, ( ) ( ) = = 0. The derivative ( ) is the marginal product of labour (MPL ). Therefore, = / implicitly defines the firm s labour demand function April 2015

54 Competitive labour demand /3 is typically supposed to be decreasing: the more labour is hired, the smaller the contribution that the last unit makes to production (each additional unit of labour is less productive). As a result, when represented graphically in the space (, ), the function = is decreasing. This says that the firm hires labour until its marginal product coincides with the real cost of hiring labour (the real wage ). Equivalently, labour is paid according to the value of its marginal productivity: = April 2015

55 Example If = 2 /, = ( ) = 2 = / = /. The firm s labour demand function is = Therefore, / =. Solving for, = 1 / =. Labour demand stimulated by a rising price of the product or a falling wage rat Since / = / < 0, the demand for labour is a decreasing function of the real wage / April 2015

56 Equilibrium in the labour market Since the labour demand of each firm is inversely correlated with a certain wage rate, one may jump to the conclusion that the aggregate demand for labour in an economy is inversely correlated with the economy s real wage. The equilibrium real wage rate * is such that labour supplied at * equals labour demanded at *. Given *, there is no involuntary unemployment: everyone willing to get hired at * is hired. The difference * can be viewed as voluntary unemployment ( would be the participation rate) April 2015

57 Unemployment in the classical model /1 Establishing a mininum real wage above the equilibrium wage rate * generates involuntary unemployment in a competitive labour market. The next slide illustrates this possibility. Market equilibrium occurs at point. If the minimum wage rate is set, the market state is no longer represented by but by : although workers are willing to be at, firms cannot be forced to hire more workers than the amount given by. At the prevailing wage rate there is an excess supply, interpreted as involuntary unemployment April 2015

58 Unemployment in the classical model /2 ( ) April 2015

59 Unemployment in the classical model /3 Involuntary unemployment in a competitive labour market may also temporarily arise if the real wage rate adjusts sluggishly. The next slide illustrates this situation. Market equilibrium occurs initially at, with wage rate. The demand for labour function shifts to the left. The new equilibrium would be represented by. But if the real wage rate takes time to adjust (decrease), the wage rate in the market may temporarily remain at the initial level. The market is then at, where involuntary unemployment exists April 2015

60 Unemployment in the classical model /4 ( ) April 2015

61 An atypical example /1 Suppose the function combines a flat with an upward sloping section, as shown in the next slide. The flact section at real wage * could be interpreted in the sense that, when the real wage is *, (i) workers are, in principle, indifferent between supplying labour or not, and (ii) some random variable determines the amount actually supplied. Market equilibrium occurs at, where employment is *. If workers finally choose to supply (effective labour supply represented by ), there is involuntary unemployment given by * April 2015

62 An atypical example /2 ( ) * * ( ) April 2015

63 (Derived) demand for labour Firms do not hire workers because they aim at accumulating workerts. The labour forces is a tool to produce commodities and obtain a profit by selling the commodities produced. For that reason, it is said that the demand for labour by firms is a derived demand: it arises as an intermediate step in the process of reaching the firms final goal, which is making profits. Hence, the demand for labour crucially depends on sales expectations: no matter how cheap labour is, workers will not be hired if firms do not expect to sell what these workers would produce April 2015

64 Supply-side market power: unions /1 The monopsony analysis shows that demand-side market power generates less employment and lower wages than perfect competition. Supply-side market power is typically associated with the existence of trade unions. For any given amount of labour, the wage rate unions demand to supply will be higher than the wage rate dictated by the supply of labour function. This follows from the fact that unions (since they can organize strikes) have more bargaining power over wages than individual workers April 2015

65 Supply-side market power: unions /2 As a result, the function associating with each amount of labour the wage rate that unions will ask to be willing to supply must lie above the supply of labour function. The next slide combines the function with a competitive labour demand function. Without trade unions, market equilibrium is at. With unions market equilibrium is at. The distance between and represents involuntary unemployment: given wage, workers would individually like to supply but the presence of the union only allows to be hired April 2015

66 Supply-side market power: unions /3 ( ) ( ) April 2015

67 Fighting involuntary unemployment When the wage is too high, the obvious solution to get rid of unemployment is to lower the wage (or let time pass by for the wage to adjust by itself). When unemployment is due to lack of labour demand, the natural solution is an aggregate demand expansion that induces firms to hire more workers to satisfy the additional demand. When the cause of unemployment is market power (unions), the solution seems harder to implement: how to reduce the unions bargaining power without raising protests by part of the workers? April 2015

68 Price setting & wage setting model /1 In modern economies, the nominal wage rate of a substantial number of workers is determined through collective bargaining involving unions. If workers are represented by unions, at any level of employment, the real wage will be above the wage rate dictated by the labour supply function. It is assumed that unions establish the real wage using a wage setting function sloping upward and lying above the labour supply function. The higher the unions bargaining power, the larger the vertical distance between between and April 2015

69 Price setting & wage setting model /2 Whereas workers (through unions) are assumed to set the nominal wage, firms are supposed to fix the prices of the commodities they produce. A simple price setting rule consists of adding a mark-up > 0 to labour costs: = 1 +. is measured in money (EUR) and in units of product per worker. Thus, is the money paid to workers divided by what they produce. In other words, is the (labour) cost of producing a unit of the commodity April 2015

70 Price setting & wage setting model /3 It follows from = 1 + that =. As > 0, < 1. Therefore, for some > 0, = 1. Thus, 1 =. In sum, production per worker = +. real wage per worker real profit per worker is then a mark-up over output: the fraction of the workers productivity that the firm appropriates April 2015

71 Price setting & wage setting model /4 Under perfect competition in the labour and product markets, =. When prices are set by firms as the marking up of labour costs per worker, = 1. This is called the price setting function S. As 0 < < 1, = 1 means that <. As the function is downward sloping, the function is downward sloping as well. lies below because is a fraction of (the constant 1 is smaller than 1) April 2015

72 The WS and PS model ( ) ( ) April 2015

73 Example Supply of labour function: ω = (ω is the real wage rate). function: = Demand for labour function: ω =. function: ω = 3. function: ω = 1, with = 0.4. Competitive solution: = 20 5 = 3 and ω = 5. - solution: 3 = = 0.6 (20 5 ) = 2 and ω = April 2015

74 Segmented labour market model Suppose workers may have or not some economically irrelevant feature that firms may like or not (for instance, being a man or not). Firms classify workers in two types (I and II) depending on whether they possess the feature or not. Some firms (type I firms) prefer type I workers; the rest (type II) prefer type II workers. Each type of firms defines a different (competitive) labour market. Workers are unaware of the fact that there are two types of firms. From their perspective, the labour market is not segmented April 2015

75 Example /1 Supply of labour function of type I workers: = 4 ω (ω is the real wage rate). Demand for labour function of type I firms: = 60 2 ω ( = 0 if ω > 30). Market equilibrium (type I):, ω = (40, 10). Supply of labour function of type II workers: = 12 ω. Demand for labour function of type II firms: = 80 4 ω ( = 0 if ω > 20). Market equilibrium (type II):, ω = (60, 5) April 2015

76 Example /2 = = 40% of employment corresponds to type I workers and = = 60% to type II. Using these weights, the average real wage rate would be ω = ω + ω = = 7. At ω = 7, no more type I workers than are actually employed would like to be hired. But, at ω = 7, type II workers would like to supply = 12 ω = 84. Since employment of type II workers equals = 60, involuntary unemployment appears to be ω = 7 = = 24 (unemployment rate = = 19.3% ); see next slide April 2015

77 Though each segment is in equilibrium, there is a sense in which involuntary unemployment exists. ( ) ω = ( ) ( ) April 2015