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Frank & Bernanke
Ch. 9: Workers, Wages and
Unemployment
Labor Market Trends





During the last century real wages in the
industrialized world increased substantially.
Since the 70s, the rate of growth of real wages
slowed.
Wage inequality rose substantially in the recent
decades in US.
In the US, recent decades saw substantial job
creation.
Western Europe has experienced high
unemployment rates in recent decades.
Real Wages

Compared to before the Great Depression, an average
American worker earns four times as much.
 Real wages grew at a rate of 2.5% between 1960 and
1973 but at a rate of 1.2% between 1973 and 1999.
 Real wages for unskilled labor declined by one-fourth
since the 70s.
 Real wages for bachelor’s and master’s degree holders
increased substantially; a master’s holder earns twice
the highschool graduate.
(http://www.census.gov/population/socdemo/education/tableA-3.txt)
http://www.census.gov/statab/
www/employ.html
http://www.census.gov/statab/w
ww/govtsoclaw.html
http://www.census.gov/statab/www/edu.html
Employment/Unemployment

In 1970, 57% of over 16 population had
jobs; in 1999, 64% had jobs.
 Between 1980 and 1999, US economy
created more than 34 million new jobs.
 Many of the EU countries experienced very
high (some double digit) unemployment
rates for over ten years; job creation has
been very low.
Explaining The Trends

The labor market trends mentioned will be
explained using the traditional supply-demand
analysis.
 The “product” demanded is the “labor” of the
worker. The horizontal axis can be measured
in terms of number of workers or number of
hours worked.
 The “price” on the vertical axis is the real
wage - what firms pay to acquire labor.
Deriving the Demand for Labor

Demand for labor comes from
employers/firms.
 An employer will have to do the marginal
benefit vs. marginal cost calculation to
determine how many people (or many hours
of work) to hire.
Demand for Labor
BOB'S BICYCLE FACTORY (Problem 2, p. 239)
# of Workers # of Bikes Marginal Product Value of MP
1
10
2
18
3
24
4
28
5
30
Bob has costs of $100/bike other than labor costs.
Each bike sells for $130. (Labor's contribution is $30)
Demand for Labor
BOB'S BICYCLE FACTORY (Problem 2, p. 239)
# of Workers # of Bikes Marginal Product Value of MP
1
10
10
$300
2
18
8
$240
3
24
6
$180
4
28
4
$120
5
30
2
$60
Bob has costs of $100/bike other than labor costs.
Each bike sells for $130.
Bob’s Demand for Labor

How do we define the demand curve?
 At each and every price how much is
demanded in the market.
 Apply this to Bob.
 At each and every real wage, how much
labor will Bob hire?
Bob's Demand for Labor
$350
Real Wage
$300
$250
$200
$150
$100
$50
$0
0
1
2
3
# of Workers
4
5
6
Shifts in Demand
BOB'S BICYCLE FACTORY (Problem 2, p. 239)
# of Workers # of Bikes Marginal Product Value of MP Value of MP(2)
1
10
10
$300
$400
2
18
8
$240
$320
3
24
6
$180
$240
4
28
4
$120
$160
5
30
2
$60
$80
Bob has costs of $100/bike other than labor costs.
Each bike sells for $130.
There is a $10 increase in bike prices.
Shifts in Demand
$500
Real Wage
$400
$300
$200
$100
$0
0
1
2
3
Workers
4
5
6
Value of MP
Value of MP(2)
Shifts in Demand
BOB'S BICYCLE FACTORY (Problem 2, p. 239)
# of Workers # of Bikes Marginal Product MP w/ 50% Value of MP Value of MP(2) VMP(2-50%)
1
10
10
15
$300
$400
$600
2
18
8
12
$240
$320
$480
3
24
6
9
$180
$240
$360
4
28
4
6
$120
$160
$240
5
30
2
3
$60
$80
$120
Bob has costs of $100/bike other than labor costs.
Each bike sells for $130.
There is a $10 increase in bike prices.
Worker productivity increases by 50%.
Shifts in Demand
$700
$600
$500
$400
$300
$200
$100
$0
0
1
2
Value of MP
3
Value of MP(2)
4
5
VMP(2-50%)
6
Supply of Labor

The decision to work or not to work, again,
depends on the cost-benefit principle.
 If your reservation price (how much you
would pay another to do the job) is less than
what you are offered to do the job, you
should take the job.
 In this view, the higher the real wage, the
more hours of work will be offered by
workers.
Shifts in Supply of Labor

Any thing that changes the size of the
working age population.
– Increase in domestic birth rate.
– Immigration.
– Emigration.
– Change in the age a typical person enters the
work force.
– Change in the age a typical person retires.
Explaining Political Stands

Employers usually favor immigration while
labor unions oppose it. Given our simple
Supply and Demand analysis, explain why.
 What happens to real wages due to
immigration?
 Supply curve shifts right, depressing real
wages.
Immigration
Real Wages
Labor
Why Did Real Wages Rise
Fourfold During 20th Century

Average labor productivity rose shifting the
demand for labor to the right.
 The reasons for average labor productivity
growth were
– technological advances;
– increases in capital stock;
– increases in human capital.
Rise in Average Labor
Productivity
Real
wage
L
Why Did Real Wages Rose
Much Slowly After 1973

Average labor productivity slowed down
significantly, eliminating the large
rightward shifts in the demand for labor.
 Labor supply increased (labor participation
rates rose) shifting the supply to the right.
After 1973
Increasing Wage Inequality

Technological changes in services favored
skilled labor against unskilled labor unlike
the technological changes in manufacturing.
 Looking at two labor markets, skilled and
unskilled, the changes in demand would
create the observed gap.
Technological Change
S
S
D
Skilled Labor
D
Unskilled Labor
Increasing Wage Inequality

Trade dependent on comparative advantage,
lowers the demand for labor by importing
industry but raises the demand for labor by
exporting industry.
 Unskilled labor loses in the process.
 However, the bulk of the trade is between
industrialized countries, buying and selling
similar products.
Globalization
Real wage
Furniture Industry
(Importing)
L
Pharmaceutical Industry
(Exporting)
“Outsourcing”

Even at the best of times, the American economy
has a tremendous rate of “churn”—over 2m jobs a
month. ... The process allocates resources—money
and people—to where they can be most
productive, helped by competition, including from
outsourcing, that lowers prices. In the long run,
higher productivity is the only way to create
higher standards of living across an economy.
The Economist, Feb. 19, 2004
Sucking Sound?
Between 1980 and 2002,
America's population grew
by 23.9%. The number of
employed Americans, on the
other hand, grew by 37.4%.
Today, 138.6m Americans
are in work, a near-record,
both in absolute terms and
as a proportion of the
population.
The Economist, Feb. 19, 2004
Should Technology and
Globalization Be Stopped?
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Specialization increases the total amount
produced.
 Free trade increases the total amount available.
 Increasing worker mobility from shrinking to
expanding industries would help.
 Providing government help during transition
should be easy because of the increasing pie.
Churning + Productivity
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In 1960 only one in 25 workers was
employed in the business-services and
health-care industries. Today, one in six is.
In terms of output, manufacturing has risen,
but, thanks to that productivity spurt, these
goods are produced by fewer people—12%
of the workforce, less than half the
proportion of three decades ago.
The Economist, Feb. 19, 2004
The Economist, Feb. 19, 2004
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The best-known report, by Forrester Research, a
consultancy, guesses that 3.3m American service-industry
jobs will have gone overseas by 2015—barely noticeable
when you think about the 7m-8m lost every quarter
through job-churning. And the bulk of these exports will
not be the high-flying jobs of IT consultants, but the mindnumbing functions of code-writing.
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Even at their peak in 2001, the number of all “traderelated” layoffs represented a mere 0.6% of American
unemployment.
Types of Unemployment

Frictional unemployment - the short-term
unemployment when people are searching
for a job that match their wishes.
 Structural unemployment - long-term
mismatch between the skills and jobs.
 Cyclical unemployment - unusually high
rates of unemployment experienced during
recessions.
Unemployment

Total unemployment is the sum of
frictional, structural and cyclical
unemployment.
 Even if the economy is producing at full
employment, there will be structurally and
frictionally unemployed.
Barriers That Create
Structural Unemployment

Minimum wage laws.
 Labor unions.
 Unemployment insurance.
 Other governmental regulations.
Do Minimum Wage Laws
Alleviate Poverty?

Minimum wage laws affect unskilled labor.
 Higher wages should increase the income of
the unskilled labor.
 If the labor market is in equilibrium, a
minimum wage law that sets the wage above
equilibrium will create unemployment and
solve the poverty of some by making other
poor worse off.
Labor Unions

It could work as a minimum wage law.
 It could increase unemployment.
 In a perfectly competitive labor market with
low costs of searching for a job, labor
unions would increase unemployment.
 In monopsony situations labor unions
improve efficiency.
Unemployment Insurance

A state that pays unemployment insurance
for 13 weeks will force the unemployed to
search for a job more vigorously than a state
that pays unemployment insurance for 52
weeks.
Other Regulations

Some health and safety regulations increase
the cost of labor significantly.
 It works similar to minimum wage laws.
 Employment cost index keeps track of the
benefits plus wages.
Why Unemployment Rates
Are Very High in EU?

Structural barriers are very strong in EU
because of political commitment to social
safety laws.
 Higher percentage of workers are unionized.
 Unemployment insurance is very generous.
 Benefits and severance pay provisions are
much higher than US.
Why Did EU Unemployment
Rates Soar the Last 20 Years?

Technological change with skill bias.
 Globalization.
 Both of these forces reduced the demand for
unskilled labor yet social safety laws kept
the wages high.