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Unemployment

Unemployment. Gavin Cameron University of Oxford. OUBEP 2006.

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Unemployment

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  1. Unemployment Gavin Cameron University of Oxford OUBEP 2006

  2. “When in any country the demand for those who live by wages… is continually increasing; when every year furnishes employment for a greater number than had been employed the year before, the workmen have no occasion to combine to raise their wages. The scarcity of hands occasions competition among masters, who bid against one another, in order to get workmen…” Adam Smith (1776) introduction OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  3. job separation and job finding • The workforce= employed + unemployed • L=E+U • When unemployment is stable, the number of job separations must equal the number of jobs found. • sE=fU • but since E=L-U • s(L-U)=fU, divide both sides by L to obtain • s(1-U/L)=fU/L and solve for U/L to find • (U/L)*= s/(s+f) • The steady-state unemployment rate is an increasing function of the job separation rate and a decreasing function of the job finding rate. OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  4. labour supply When real wages rise, the budget line rotates around point A (the endowment of time remains unchanged) and becomes steeper. This allows both consumption and leisure to increase at the same time (income effect). Because leisure is more expensive, however, some is given up (substitution effect). In the case depicted here, the substitution effect dominates at first, but not in the extreme. OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  5. the supply of labour Individual real wage Aggregate The aggregate curve is less steep than for an individual since new workers enter the workforce as wages rise. employment OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  6. the demand for labour real wage A competitive firm demands labour up until the point where MC=MR, that is W=MPL*P, which is the same as W/P=MPL As more workers are added into the workforce, for a given level of capital and technology, the marginal product of labour, and hence the demand for labour, falls. labour demand, Ld employment OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  7. the natural rate of unemployment real wage workforce labour supply, Ls equilibrium wage labour demand, Ld natural rate equilibrium employment employment OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  8. the natural rate and the NAIRU • The natural rate model assumes that markets clear and that there is competition in all markets. • In fact, the labour market may be dominated by unions. • If so, there is bargaining between unions and firms. • Other things being equal, this will raise the level of unemployment for any given real wage. • Also, goods markets may be dominated by a few large sellers (imperfect competition) in which case the labour demand curve may be less steep, possibly even horizontal. OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  9. wage bargaining • Unemployment is the means by which the competing claims of employers and unions are reconciled. • Unions bargain over wages relative to prices (the wage-setting curve) and reduce their demands when unemployment is high. • Unions care about the employed (insiders) without caring too much about the unemployed (outsiders). • Employers set prices relative to wages: this leads to a relatively flat labour demand schedule (the price-setting curve). OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  10. wage-setting and price-setting real wage labour supply, Ls wage-setting, WS workforce price-setting: firms set a constant mark-up of prices over costs, PS employment OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  11. two views of the labour market • The natural rate model suggests that most equilibrium unemployment is voluntary in the sense that workers could find jobs at the current real wage, but choose not to. • The NAIRU model suggests that some equilibrium unemployment is involuntary in the sense that workers would like to work at the current real wage but cannot find jobs. OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  12. the NRU and the NAIRU real wage labour supply, Ls wage-setting, WS workforce labour demand, Ld price-setting: firms set a constant mark-up of prices over costs, PS involuntary voluntary employment NAIRU OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  13. unemployment equilibrium • Unions claim real wages that rise with employment: target wage = base + aggression (employment) • Firms offer real wages as a proportion of labour productivity: feasible wage = productivity * (100%-markup) • In equilibrium, the target wage equals the feasible wage when: employment= productivity * (100%-markup) – base aggression • If productivity and the markup don’t vary with employment, then we have the horizontal price-setting curve from the NAIRU diagram. OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  14. minimum wages in a secondary labour market workforce real wage labour supply, Ls The secondary labour market (typically for unskilled, young workers) is potentially vulnerable to the effect of a minimum wage. minimum wage equilibrium wage labour demand, Ld equilibrium employment employment OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  15. a monopsony labour market A monopsonist who pays all workers the same equates its demand for labour with its marginal cost, Wm, when setting employment at Em. real wage marginal cost of labour labour supply Ls competitive wage equilibrium wage labour demand Ld Em Ec employment OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  16. In 1914, the Ford Motor Company paid its workers $5 per day when the going rate was between $2 and $3. Why? “A low wage business is always insecure… The payment of five dollars a day for an eight hour day was one of the finest cost-cutting moves we ever made”, Henry Ford Why would this policy reduce costs? Workers might work harder and staff turnover might be reduced because workers don’t want to run the risk of a big cut in wages (moral hazard). The firm may also attract better quality workers. If many firms pay efficiency wages, it will be harder for the unemployed to find jobs, and so unemployment will be higher. why pay above the going rate? OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  17. how to reduce unemployment • Active Labour Market Policies: training and work experience schemes for long-term unemployed, unskilled, youths, women, older workers; • Reform of the benefit system, especially duration; • Limitations on union power – no closed shops, no secondary picketing, secret ballots; • Changes to wage bargaining, especially increased employer coordination; • Tax reform (lower payroll taxes for the unskilled etc); • Increased labour mobility. • Flexicurity: Cuts to employment protection, coupled with active labour market policies; OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  18. how not to reduce unemployment • Cunning demand-side policies (unlikely to have much effect in the long-run, plus very expensive); • Job-sharing or cuts in working hours; • Increased investment by firms (although this will raise wages); • Protectionism (any benefit to workers massively outweighed by costs to consumers). OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  19. unemployment around the world Source: Faggio and Nickell (2006) OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  20. Source: BIS (2006) OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  21. Source: O’Mahony and Van Ark (2003), table I.1. OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  22. Source: OECD (2005)

  23. “When large numbers of people are out of work…. unemployment invariably follows”, Calvin Coolidge (US President, 1923-1929). summary OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

  24. syndicate topics • What is the effect on unemployment of (a) a fall in union strength or (b) a fall in real benefits? • Would unemployment fall if working hours were cut? • Do firms pay workers their marginal product? • Is competition from the South a cause of unemployment in the North? • Why has the relative pay of the unskilled fallen since 1980? • What are the current trends in unemployment around the world? OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

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