Economics 1B Lecture 11 S2011

Economics 1B Lecture 11 S2011 - 5/5/2011 Economics 1B UC...

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Unformatted text preview: 5/5/2011 Economics 1B UC Davis UC D i Professor Siegler Spring 2011 I. Introduction For almost all of us, the labor market is the most For almost all of us, the labor market is the most important market we will every participate in. Our success in this market will largely determine our material standard of living. Unemployment is a serious problem for both individuals and for the functioning of the macroeconomy. However, not all types of unemployment are bad (e.g., some frictional unemployment is beneficial). 2 1 5/5/2011 I. Introduction The roadmap for tonight is to: p g Introduce the model for a perfectly competitive labor market. Use this model is discuss wage inequality. Modify this model to account for the natural rate of unemployment (i.e., the fact that the unemployment rate is not zero when the economy is at potential output). The problem with the perfectly competitive ) Th bl h h f l model is that there is no unemployment in equilibrium since labor supply equals labor demand. Discuss how labor market data are collected and reported, and discuss the limitations of such data. 3 II. Five Important Labor Market Trends Over a long period, average real wages have risen gp g g substantially both in the United States and in other b i ll b h i h U i d S di h industrialized countries. Despite the longrun upward trend in real wages, average real wage growth in the United States has slowed significantly in the United States since the early 1970s. In the United States, wage and income inequality have increased dramatically since the early 1970s. The real increased dramatically since the early 1970s The real wages of most lowskilled workers have been stagnant or declined, while highskilled workers have continued to rise dramatically, particularly at the very top of the distribution. 4 2 5/5/2011 II. Important Labor Market Trends In the postWorld War II period, employment has grown p p p y g substantially in the United States, much faster than the growth of the workingage population. This is due to the dramatic increase in female labor force participation rates, particularly those of married women. Men, however, have seen their labor force participation decrease. There are large fluctuations in employment and There are large fluctuations in employment and unemployment associated with the business cycle, but there is no longrun upward trend in the unemployment rate. In the longrun, many jobs are destroyed, but even more jobs are created for an expanding population. 5 III. The Perfectly Competitive Labor Market In the labor market, individuals supply labor while pp y firms demand labor. This is in contrast to markets for goods and services where individuals are the demanders and firms are the suppliers. All of the assumptions of perfect competition in output markets extend to input markets (like the labor market). Individuals and firms are price takers (there are so many sellers and buyers that each takes the real wage many sellers and buyers that each takes the real wage as given). There is perfect information concerning real wages and quantities exchanged in the market. Freedom of entry and exit in the long run. 6 3 5/5/2011 III. The Perfectly Competitive Labor Market Nominal Labor Demand Nominal Labor Demand Let's first examine the labor demand for a firm in a perfectly competitive labor market. When we derive a labor demand curve, we are holding everything else constant (the amount of physical capital, the amount of human capital, the quantity of natural resources, and technology). quantity of natural resources and technology) The demand for labor tells us the quantity of workers a firm will hire as the price of workers (the wage) changes, ceteris paribus. 7 III. The Perfectly Competitive Labor Market Nominal Labor Demand Nominal Labor Demand The model predicts that wages are based on the value of a worker's marginal product of labor, sometimes called marginal productivity theory. The model assumes diminishing marginal product of labor. If the amount of capital, other inputs, and technology are held constant, then the greater quantity technology are held constant then the greater quantity of labor already employed, the less each additional worker adds to production. 8 4 5/5/2011 Production and Marginal Product for Banana Computers Number of Workers 0 1 2 3 4 5 6 Computers Produced per Year 0 80 150 210 260 300 330 80 70 60 50 40 30 $80,000 $70,000 $60,000 $50,000 $40,000 $30,000 Marginal Product Value of Marginal Product (at $1,000 per computer) 9 Value of the Marginal Product Curve for Banana Computers w $80K $70K $60K $50K $40K $30K VMP 1 2 3 4 5 6 Number of Workers 10 5 5/5/2011 III. The Perfectly Competitive Labor Market Nominal Labor Demand Nominal Labor Demand A profitmaximizing firm will continue to hire workers as the value of the worker's marginal product exceeds the nominal wage rate. An optimizing firm will stop hiring when the value of the marginal product is equal to the nominal wage. The value of e a gi a p o u i e a gi a e e ue a i the marginal product is the marginal revenue a firm gets from hiring one more worker, while the nominal wage represents the firm's marginal cost. 11 III. The Perfectly Competitive Labor Market "Real" Labor Demand or Labor Demand Real Labor Demand or Labor Demand In the example thus far, we have discussed how labor demand depends on the nominal, or dollar, wage. It is generally more illuminating to examine the real wage, which is the wage expressed in terms of its purchasing power. 12 6 5/5/2011 III. The Perfectly Competitive Labor Market "Real" Labor Demand or Labor Demand Real Labor Demand or Labor Demand In the example thus far, we have discussed how labor demand depends on the nominal, or dollar, wage. It is generally more illuminating to examine the real wage, which is the wage expressed in terms of its purchasing power. 13 Labor Demand for Banana Computers Real wage Labor demand shifts right g if the marginal product of labor increases or if the price of banana computers increases relative to the aggregate price level. Ld1 Ld0 Quantity of Labor 14 7 5/5/2011 III. The Perfectly Competitive Labor Market Labor supply is modeled using a laborleisure choice pp y g model. Substitution effect: As the real wage increases, the opportunity cost of taking leisure increases, so people substitute from leisure to labor, implying that as real wages rise the quantity supplied of labor rises Income effect: As the real wage increases, so does income. Since leisure is a normal good, people will want to consume more leisure and work less, implying tt l i d kl i l i that as real wages rise the quantity of labor supplied falls. An upward sloping labor supply curve implies that the substitution effect outweighs the income effect. 15 III. The Perfectly Competitive Labor Market Real wage Ls0 Equilibrium Real Wage Ld0 Equilibrium Employment Quantity of Labor 16 8 5/5/2011 III. The Perfectly Competitive Labor Market Labor supply shift variables: Labor supply shift variables: Changes in the workingage population (due to changes in fertility, mortality, immigration, and emigration rates). Changes in the share of the workingage population seeking work (due to changes in social norms and complementary technologies that save time to allow complementary technologies that save time to allow more time for work, and leisure). 17 IV. Wage Inequality Since the 1970s, income and wage inequality have Since the 1970s, income and wage inequality have increased dramatically in the United States. Relative shifts in labor demand and labor supply can help us understand many of the reasons for the growing wage gap between rich and poor. However, we have to move beyond the model, however, to fully explain the changes in the last 40 years. the changes in the last 40 years 18 9 5/5/2011 19 IV. Wage Inequality Why Has the CollegeWage Premium Increased in y g g the Last Thirty Years? SkillBiased Technological Change: Technological innovation has increased the relative demand for workers with high levels of human capital, while it has reduced the labor demand for workers with low levels of human capital as automation has replaced many lowskilled jobs. low skilled jobs International Trade: Increased international trade has increased labor demand in exporting industries (which tend to be higher skilled) and reduced labor demand in lowskilled domestic industries. 20 10 5/5/2011 IV. Wage Inequality Why Has the College Wage Premium Increased in Why Has the CollegeWage Premium Increased in the Last Thirty Years? Immigration: The United States has experienced a large increase in immigration, beginning with the 1965 Amendments to the 1952 WalterMcCarran Act, which abolished nationality quotas, and established family unification as the highest priority. Most of these first unification as the highest priority. Most of these first immigration immigrants had very little human capital, so this increased the relative labor supply of low skilled workers. 21 Foreign Born Percent of Total U.S. Population 16 14.7% 12 11.5% Percent 8 4.7% 4 0 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2002 22 11 5/5/2011 IV. Wage Inequality Why Has the CollegeWage Premium Increased in y g g the Last Thirty Years? Institutional Changes: Decreases in the real minimum wage and unionization rates, particularly for lowerskilled workers has reduced their relative pay. Globalization has accelerated these institutional changes. In the 1950s and 1960s, unionization rates in the U.S. exceeded 30 percent. Last year, unionization the U S exceeded 30 percent Last year unionization rates were the lowest in 70 years, at 11.9 percent. In 2010, only 6.9 percent of private sector workers are unionized, compared to 36.2 percent of public sector workers. 23 IV. Wage Inequality While skill biased technological change, While skillbiased technological change, globalization (increased international trade and immigration), and institutional changes may be able to explain why collegeeducated workers, on average, now make relatively more today (compared with workers with only a high school degree), most of the increases in inequality in recent decades have of the increases in inequality in recent decades have occurred in the top 10 percent of the distribution, where almost all of the workers are already college educated. 24 12 5/5/2011 Increases in Income Inequality at the Very Top Income Shares Bottom Bottom 90% 90 to 95% 95 to 99 % 99 to 99.5% 99.5 to 99.9% 99.9 to 99.99% Top 0.01% 1970 $32,580 $32 580 $96,498 $139,028 $244,162 $382,369 $869,866 2007 $32,421 $32 421 $128,560 $220,105 $486,393 $1,021,643 $4,024,583 Percentage Change 0.005% 0 005% 33.2% 58.3% 99.2% 167.2% 362.7% 789.3% $4,384,107 $35,042,705 Source: Based on Thomas Piketty and Emmanuel Saez (2003), "Income Inequality in the United States, 19131998." Quarterly Journal of Economics 108 (1), pp. 139. See http://www.econ.berkeley.edu/~saez/TabFig2007.xls, for updated data through 2007 as used in most of the figures above. Pretax income in 2007 dollars, including capital gains, adjusted for inflation. 25 IV. Wage Inequality Can marginal productivity theory explain this? Some economists believe so by emphasizing the rising y p g g importance of "winnertakeall" labor markets and the "superstar" phenomenon. Other economists say no, arguing that the high pay for those at the very top of the wage and income distribution do not reflect a higher value of their marginal products. For example, there is no evidence that higher CEO pay is associated with better that higher CEO pay is associated with better performance of their company. In fact, high pay may encourage a shortsighted, excessiverisktaking strategy, which results in worse company performance. Political factors and changing social norms likely explain what has happened at the very top. 26 13 5/5/2011 Question 11.1 Which of the following best explains how employment can increase at the same time the real wage is decreasing? A) The labor supply and demand curves both shift to The labor supply and demand curves both shift to the right; however, the shift in the labor demand curve is greater than the shift in the labor supply curve. B) A rightward shift of the labor demand curve and a movement along the labor supply curve. C) The labor supply and demand curves both shift to the right; however, the shift in the labor supply curve is greater than the shift in the labor demand curve. greater than the shift in the labor demand curve D) The labor supply and demand curves both shift to the left; however, the shift in the labor demand curve is greater than the shift in the labor supply curve. Answer: C 27 V. The Natural Rate of Unemployment A problem with the perfectly competitive labor A problem with the perfectly competitive labor market model is that it predicts an unemployment rate of zero (since labor supply equals labor demand in equilibrium). However, even when the economy is at potential output, the unemployment rate is not zero, but it is around 5 percent. d5 t How can we modify the model to account for the natural rate of unemployment (the unemployment rate when the economy is at potential GDP)? 28 14 5/5/2011 29 V. The Natural Rate of Unemployment Types of Unemployment Frictional Unemployment occurs because of the normal turnover in the labor market, such as when people change jobs or locations, or are new entrants into the labor market. Some job search is optimal from a personal and economywide perspective so that workers and firms are wellmatched. Structural Unemployment is due to structural Structural Unemployment is due to structural problems like skillmismatch, insufficient work incentives, and longerterm changes in labor demand. Cyclical Unemployment occurs because of fluctuations around potential output (i.e., the business cycle). 30 15 5/5/2011 V. The Natural Rate of Unemployment The natural rate of unemployment consists of p y frictional unemployment and structural unemployment (when cyclical unemployment is zero since the economy is at potential GDP). There are two main types of theories to explain the natural rate of unemployment: J Job rationing theories. g Job search theories. These two main types of theories are complementary and modify the standard labor demand, labor supply model. 31 V. The Natural Rate of Unemployment Job Rationing occurs when the real wage stays Job Rationing occurs when the real wage stays above the real wage that would equate labor supply and labor demand. The high real wage leads to an excess supply of labor and unemployment. 32 16 5/5/2011 Job Rationing And there is this much unemployment or l t excess supply Real wage When the real wage persistently stays above the intersection of supply and demand Ls0 Ld0 Firms only hire this many workers Quantity of Labor 33 V. The Natural Rate of Unemployment Explanations for Job Rationing Explanations for Job Rationing Minimum wage laws Insiders versus outsiders (labor unions, credentialing, licensing, etc.) Efficiency wages. In some jobs, it may be profit maximizing to pay more than the competitive equilibrium wage if higher wages lead to greater equilibrium wage if higher wages lead to greater efficiency and profits. There can be impacts on worker health, worker turnover, worker quality, and worker effort. Henry Ford and a $5/day wage in 1914, which was twice the going wage. 34 17 5/5/2011 V. The Natural Rate of Unemployment J Job Search occurs when there is uncertainty, insufficient y information, and/or poor incentives which increase the time potential workers spend looking (searching) for a job. Job Search explanations emphasize the random or stochastic nature of the labor market, with the labor demand and labor supply curves in perpetual motion. In a stochastic equilibrium there will always be people In a stochastic equilibrium there will always be people who lose their jobs, quit their jobs, and enter the labor market. There may also be institutional policies that prolong job search (unemployment insurance, hiring costs, lack of job retraining, etc.) 35 Question 11.2 The natural rate of unemployment is caused by a The natural rate of unemployment is caused by a combination of: A) frictional and structural unemployment. B) cyclical and frictional unemployment. C) seasonal and structural unemployment. D) job finding and job leaving. job finding and job leaving. E) real and nominal unemployment. Answer: A 36 18 5/5/2011 Question 11.3 Assuming all else equal, suppose the nominal wage Assuming all else equal, suppose the nominal wage rate decreases by 5 percent, and the aggregate price level decreases by 7 percent. As a result, A) the real wage rate increases by about 12 percent. B) the real wage rate decreases by about 2 percent. ) g y p C) the real wage rate increases by about 2 percent. D) the real wage rate decreases by about 12 percent. Answer: C. 37 Question 11.4 Suppose a labor union is able to effectively negotiate pp y g higher wages for its members and is able to prevent the firm from hiring new workers at a lower wage. The best explanation for this is: A) the jobsearch explanation. B) the efficiencywage explanation. C) the insideroutsider explanation the insider outsider explanation. D) the discouragedworker explanation. E) the stochasticequilibrium explanation. Answer: C 38 19 5/5/2011 VI. Measuring the Labor Market Current Population Survey each month asks about Current Population Survey each month asks about 60,000 U.S. households about the labor market status of each person 16 years of age and over. A person is categorized as "employed" if they work one or more hours for pay (inside or outside the home) during the week that includes the 12th of the month. th A person is categorized as "unemployed" must not have a job, but must be "actively seeking employment." 39 VI. Measuring the Labor Market 40 20 5/5/2011 VI. Measuring the Labor Market The "Official" Unemployment Rate (U3) p y Does not include "discouraged workers" (those who have given up looking for work). Does not include involuntary parttime workers. As a result, it underestimates the "true" unemployment rate. It is important to consider the employmenttopopulation ratio instead. ratio instead Also look at U6 (under "Alternative Measures of Labor Underutilization"), a measure of unemployment which includes involuntary parttime workers and discouraged workers (15.7% for March 2011 vs. 8.8% `official' unemployment rate). 41 VI. Measuring the Labor Market Duration of Unemployment Less than 5 weeks 5 to 14 weeks 15 to 26 15 to 26 weeks 27 weeks or longer Percent March 2011 18.2% 21.7% 14.6% 45.5% ( vs. 16% in 2006) 42 21 5/5/2011 VI. Measuring the Labor Market Unemployment Rates for Different Groups Overall White White Men, Age 20 and over White Women, Age 20 and over Black Asian Latino Teenagers Black Teenagers Bachelor's Degree and Higher March 2011 Not Seasonally Adjusted (Percent) (P t) 8.8% 8.3% 8.7% 6.8% 15.5% 7.1% 11.9% 20.9% 39.3% 4.3% 43 Question 11.5 Consider an economy with a workingage population of twenty people. In April 2011, eight of these people have j jobs and four people are actively seeking work. In May p p y g y 2011, eight people still have jobs, but only two people are actively seeking work. As a result, from April to May, the unemployment rate ___________ from _______ to ________ because of the discouragedworker phenomenon. A) decreased; 50 percent; 25 percent. B) decreased; 33 percent; 20 percent. C) increased; 20 percent; 25 percent. d D) increased; 25 percent; 33 percent. Answer: B. In April the unemployment rate is 4/12 or 33 percent, while in May it's 2/10 or 20 percent. 44 22 ...
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