ECON204 - UNIT 9

Statistics useful for evaluating labour market performance in a country and for comparing labour markets across countries.

1) the participation rate 2)the unemployment rate (most common) 3) the employment rate

Figure 9.12 Equilibrium and demand-deficient (cyclical) unemployment.

An unemployed person at point B is also involuntarily unemployed. In fact, such a person would accept a job with a wage below the wage shown at B, and still be willing to work hard on the job.

What models determine economy-wide unemployment rate and real wage?

Models price-setting and wage-setting behavior of firms

Optimal Price (referring to the price of the product)

Price producing best value to buyer

Labour Market Equilibrium

The combination of the real wage and the level of employment determined by the intersection of the wage-setting and the price-setting curves. This is the Nash equilibrium of the labour market because neither employers nor workers could do better by changing their behaviour.

employment rent

The economic rent a worker receives when the net value of her job exceeds the net value of her next best alternative (that is, being unemployed)

What will determine the height of the price-setting curve?

Two things have an important influence on the price-setting curve, even in the absence of government intervention: 1) Competition - The less the competition, the greater the markup. - a steeper demand curve, which results from less competition among firms, will lead to a higher markup and increase the profit per worker. 2) Labour productivity - For any given markup, the level of labour productivity—how much a worker produces in an hour—determines the real wage. - greater the level of labour productivity (λ), the higher the real wage that is consistent with a given markup.

QUESTION 9.2 CHOOSE THE CORRECT ANSWER(S) Which of the following statements is correct? a) participation rate = employed ÷ labour force b) unemployment rate = unemployed ÷ population of working age c) employment rate = employed ÷ population of working age d) employment rate + unemployment rate = 1

employment rate = employed ÷ population of working age This is the definition of the employment rate.

unit labor cost

hourly wage rate divided by output per labor-hour For example: if W = $30 and λ = 10, then unit labour cost is $3, that is $30/10 units = $3 per unit.

Excess supply of labour (involuntary unemployment) is a feature of

labour markets, even in equilibrium

Wages

price of labor

excess supply (surplus)

quantity of a good supplied is greater than the quantity demanded at the current price

Prices that firms charge for their products are influenced by

the demand for their goods and the cost of labour, the wage

Steps HR can take to lower cyclical unemployment

1) Lower wages would lower costs. 2) The degree of competition facing the firm has not changed, so it would want to set a price to restore the profit-maximizing markup. 3) Given the lower costs, firms would therefore cut prices. 4) Because the demand curve facing the firm is downward-sloping they would sell more, expanding output and employment.

unemployment

A situation in which a person who is able and willing to work is not employed. unemployed are the people who: 1) were without work during a reference period (usually four weeks), which means they were not in paid employment or self-employment 2) were available for work 3) were seeking work, which means they had taken specific steps in that period to seek paid employment or self-employment

population of working age

A statistical convention, which in many countries is all people aged between 15 and 64 years.

QUESTION 9.7 CHOOSE THE CORRECT ANSWER(S) Which of the following statements is correct regarding the effects of a rise in the real wage on the labour supply of a worker? a) The income effect means that the worker will increase his labour supply. b) The substitution effect means that the worker will increase his consumption of free time. c) The income and substitution effects always enhance each other, leading to higher labour supply. d) At high wage levels, the income effect dominates the substitution effect, leading to lower labour supply.

At high wage levels, the income effect dominates the substitution effect, leading to lower labour supply. ** The negative income effect and the positive substitution effect always work against each other. At high wages the former more than offsets the latter, implying that the worker reduces his labour supply (he already earns enough).

QUESTION 9.5 CHOOSE THE CORRECT ANSWER(S) The following diagram depicts the price-setting curve. Based on this information, which of the following statements is correct? a) At point A, the markup is too high, and therefore the firm will raise its price. This leads to lower demand for the good and hence lower employment towards B. b) At point C, the real wage is too low and the markup is too high. Therefore the firm is able to increase profit by lowering prices and hiring more workers. c) Higher competition implies a lower price-setting curve. d) For any given markup, higher labour productivity implies a lower price-setting curve, which means a lower real wage.

At point C, the real wage is too low and the markup is too high. Therefore the firm is able to increase profit by lowering prices and hiring more workers. ** Point B is the profit-maximizing point. Therefore the firm is able to increase its profit by moving from C to B, by lowering its price (which reduces the markup and increases the real wage) and hiring more workers.

Monetary policy

Central bank (or government) actions aimed at influencing economic activity through changing interest rates or the prices of financial assets

Fiscal policy

Changes in taxes or government spending in order to stabilize the economy.

QUESTION 9.1 CHOOSE THE CORRECT ANSWER(S) Which of the following statements is correct? a) To maximize profits, firms set the wage at the level where the workers are indifferent between working and not working. b) Firms aim to set as high a price as possible. c) In equilibrium, the wage clears the labour market, so there is no unemployment. d) If all firms set the same price and pay the same nominal wage, then the higher the real wage that they pay, the lower is their markup.

If all firms set the same price and pay the same nominal wage, then the higher the real wage that they pay, the lower is their markup ** The real wage is W/P while the markup is (P − W)/P = 1 − (W/P). So the higher the former, the lower the latter.

Involuntary unemployment in labour market equilibrium (always)

If there was no unemployment: The cost of job loss is zero (no employment rent) because a worker who loses her job can immediately get another one at the same pay. Therefore some unemployment is necessary: It means the employer can motivate workers to provide effort on the job. Therefore the wage-setting curve is always to the left of the labour supply curve. It follows that in any equilibrium, where the wage and price-setting curves intersect, there must be unemployed people: This is shown by the gap between the wage-setting curve and the labour supply curve.

Figure 9.9 The price-setting curve.

Shows the outcome of the price-setting decisions of firms in the whole economy and we use P to represent the economy-wide price level. The top horizontal line shows firms' revenues per worker in real terms: the average product of labour. What we call the price-setting 'curve' is not really much of a curve: it is just a single number that gives the value of the real wage that is consistent with the markup over costs, when all firms set their price to maximize their profits. The value of the real wage consistent with the markup does not depend on the level of employment in the economy, so it is shown as in Figure 9.9 as a horizontal line at the height of wPS.

Figure 9.11 Equilibrium in the labour market.

The equilibrium of the labour market is where the wage- and price-setting curves intersect. This is a Nash equilibrium because all parties are doing the best they can, given what everyone else is doing.

Price Setting Process for Firms

The firm's decision comes from the interaction between the firm's three departments. 1) human resources (HR), 2) the marketing department, and 3) the production department (PD)

Figure 9.8 The firm's profit-maximizing choice of price, quantity, and employment.

The firm's price decision This determines the division of the total revenue between profits and wages. ** When the firm sells q* goods at a price p*, its total revenue is p*q*. Notice from the figure that once the firm has set a price, it has determined the division of the total revenue between profits and wages. This is based on the markup (p − W)/p (or 1 − (W/p)).

cyclical unemployment

The increase in unemployment above equilibrium unemployment caused by a fall in aggregate demand associated with the business cycle.

labour market

The market where labour is bought and sold. People supply their labour and it is in turn demanded by firms.

The table in Figure 9.3 provides a picture of the Norwegian and Spanish labour markets between 2000 and 2015, and shows how the labour market statistics relate to each other.

Norway is a low-unemployment, high-employment economy (the other Scandinavian countries—Sweden, Denmark, and Finland—are similar) and Spain is a high-unemployment, low-employment economy (the other southern European economies—Portugal, Italy and Greece—are other examples).

QUESTION 9.6 CHOOSE THE CORRECT ANSWER(S) Figure 9.11 depicts the labour market model. Consider now a reduction in the degree of competition faced by the firms. Which of the following statements is correct regarding the effects of reduced competition? a) The price-setting curve shifts up. b) The wage-setting curve shifts down. c) The equilibrium real wage falls. d) The unemployment level falls.

The equilibrium real wage falls. ** Decreased competition leads to a lower price-setting curve, while the wage-setting curve is unaffected. Therefore the equilibrium (the intersection of the two curves) shifts down and to the left, implying lower real wage and higher unemployment.

employment rate

the ratio of the number of employed to the population of working age. *See Image for Calculation

participation rate T

the ratio of the number of people in the labour force to the population of working age. which shows the proportion of the working age population that is in the labour force. It is calculated as follows: (see Image)

Aggregate demand, for example, is

the sum of the demand for all of the goods and services produced in the economy, whether from consumers, firms, the government, or buyers in other countries.

QUESTION 9.8 CHOOSE THE CORRECT ANSWER(S) Figure 9.12 depicts the labour market when there has been a negative aggregate demand shock. Based on this information, which of the following statements is correct? a) The new equilibrium B is a Nash equilibrium. b) At B, unemployment is purely cyclical. c) At B, the firms are able to make higher profits by lowering the wage. d) The adjustment back from B to X is immediate.

At B, the firms are able to make higher profits by lowering the wage. At B, the real wage is above the wage-setting curve, so firms are able to lower the wage and still make the workers work hard. This leads to higher profits.

Figure 9.14 A firm raises output and employment following an increase in demand as a result of monetary or fiscal policy. (Government policies)

Before the increase in demand As before, the firm begins at point B. The demand curve shifts to the right Remember, the isoprofit curves do not shift when the demand curve shifts. The firm moves on to a new higher isoprofit curve if demand rises as a result of higher economy-wide demand following monetary or fiscal policy actions.

QUESTION 9.4 CHOOSE THE CORRECT ANSWER(S) Figure 9.8 depicts the market's demand curve and the firm's isoprofit curves. Based on this information, which of the following statements is correct? a) The slope of the demand curve is the firm's marginal rate of substitution. b) Between points A and C, the firm would prefer point A as the output is higher. c) Having chosen its profit-maximizing price p*, the firm would then set its nominal wage level. d) If the firm finds itself producing at point C, it can increase its profit by selling more units at a lower price.

If the firm finds itself producing at point C, it can increase its profit by selling more units at a lower price. ** The profit-maximizing point is B, in which the firm produces more and charges less than at point C.

QUESTION 9.3 CHOOSE THE CORRECT ANSWER(S) Figure 9.5 depicts the wage-setting curve and how it is derived using the best response function of the employees and the isocost lines for effort of the employers. Based on this figure: a) A cut in the unemployment benefit would shift the best response function to the left, and raise the wage-setting curve. b) If the expected period of unemployment increased, it would shift the best response function to the right, raising the wage-setting curve. c) In a country where the stigma attached to unemployment is high, the wage-setting curve would be lower. d) A sudden drop in the working age population (due, for example, to the retirement of the baby-boomer generation) would shift the wage-setting curve lower.

In a country where the stigma attached to unemployment is high, the wage-setting curve would be lower. ** If there is high stigma attached to unemployment, then the workers' best response functions would move to the left. This reduces the equilibrium wage for a given unemployment rate, resulting in a lower wage-setting curve.

Figure 9.13 A firm raises output and employment following a cut in wages.

The new isoprofit curve The new (lower wage) isoprofit curve passing through the original point B is now steeper than the demand curve, so the firm can do better by lowering its price and moving down the demand curve, selling more. Maximum profits It will continue doing this until it reaches a point on the demand curve where one of the new darker blue isoprofit curves is tangent to the demand curve. The firm maximizes profits at point X.

real wage

The nominal wage, adjusted to take account of changes in prices between different time periods. It measures the amount of goods and services the worker can buy.

labour force

The number of people in the population of working age who are, or wish to be, in work outside the household. They are either employed (including self-employed) or unemployed.

Equilibrium unemployment

The number of people seeking work but without jobs, which is determined by the intersection of the wage-setting and price-setting curves. This is the Nash equilibrium of the labour market where neither employers nor workers could do better by changing their behaviour.

Figure 9.10 The price-setting curve.

The profit-maximizing price Point B is the firm's profit-maximizing price and profit margin. Given economy-wide demand, total profits are lower at A and C for firms facing the demand curve in Figure 9.8. Point A - If the real wage is too high, it means the markup is too low. Point C - Below the price-setting curve, at a point like C, firms lower their prices and hire more people.

Figure 9.4 The wage-setting curve: Labour discipline and unemployment in the economy as a whole.

The profit-maximizing wage when unemployment is high At 12% unemployment in the economy, the employee's reservation wage is low and the worker will put in a high level of effort for a relatively low wage. The firm's profit-maximizing wage is therefore low.

unemployment rate

The ratio of the number of the unemployed to the total labour force. (Note that the employment rate and unemployment rate do not sum to 100%, as they have different denominators.) *See Image for Calculation

Nominal vs real wage - Think of nominal wage as take-home pay - Think of real wage as purchasing power of your wages.

The real wage The real wage is the nominal wage divided by the price level of the bundle of consumer goods purchased. real wage = W/P 1. Each firm decides on its: price, wage, how many people to hire 2. Adding up all of these across all firms gives the total employment in the economy and the real wage ** real wage is important in measuring the value of workers' labor. it is not only your nominal wage that matters, at the end of the day we need to reflect it in real wage to see whether or not the workers' wellbeing have improved (or not).

unemployment, involuntary

The state of being out of work, but preferring to have a job at the wages and working conditions that otherwise identical employed workers have.

The wage-setting curve

The upward-sloping line is called the wage-setting curve. The curve gives the real wage necessary at each level of economy-wide employment to provide workers with incentives to work hard and well. ** the wage-setting curve for the whole economy is based directly on the employer's wage-setting decision and the employee's effort decision in an economy that is composed of many firms

wages and employment

Think about this in two stages: - First, each firm decides what wage to pay, what price to charge for its products, and how many people to hire. - Then, adding up all of these decisions across all firms gives the total employment in the economy and the real wage. 1) First stage (choosing the wage, price, and employment) takes place in each firm: - The human resources department determines the lowest wage it can pay: - The marketing department sets the price - The production department then calculates how many employees have to be hired to produce the output determined by the marketing department, based on the firm's production function. 2) Second stage - two basic concepts: The wage-setting curve: This gives the real wage necessary at each level of economy-wide employment to provide workers with incentives to work hard and well. The price-setting curve: This gives the real wage paid when firms choose their profit-maximizing price.

firms cannot purchase the work of employees directly but only hire their time

Unit 6, the principal-agent model is used to explain the conflict of interest between the employer and the employee over how hard the worker works, and why this issue cannot be resolved by a contract

Marketing Department sets price

marketing department asks: which combinations of p and q are feasible? These combinations are shown by the demand curve, which will depend on the amounts that other firms are producing, the prices they are setting, the wages they are paying, and other influences on the total level of demand for goods in the economy. ** firm sets the price as a markup on its wage cost, this means that the price per unit of output is split into the profit per unit and the wage cost per unit