Week 3

Lectures 5 & 6
Unemployment and the Labour Market

Reference: Bernanke, Olekalns and Frank - Chapter 3

Key Issues
Demand for labour
Supply and demand model of the labour market
Types of unemployment
Impediments to full employment

Demand for Labour

Marginal Product of Labour (Table 3.1 (Textbook
Chapter 3))
A firm combines workers with a given amount of capital
(machines and buildings) to produce computers.
As the firm employs more labour its output rises.
But we can look at the additional output that is
generated by each additional worker. This is the
marginal product of labour.
2

No. of
Workers
0
1
2
3
4
5
6
7
8

Banana Computer Company

Output
Marginal Value of MP
(computers)
Product ($3000/com)
0
25
25
$75,000
48
23
69,000
69
21
63,000
88
19
57,000
105
17
51,000
120
15
45,000
133
13
39,000
144
11
33,000
3

Production Function
160
140

Total Product

120
100
80
60
40
20
0
0

No of Workers

Marginal Product of Labour

Marginal Product of Labour

30
25
20
15
10
5
0
0

No. of Workers

Value of Marginal Product

80000
70000

Value of MPL ($)

60000
50000
40000
30000
20000
10000
0
0

No. of Workers

Diminishing marginal product

The nature of the production technology is such that
each additional worker produces less output than the
existing workers.
Common assumption in economics
Notation:

Y
Marginal Product of Labour = MPL = L

Value of Marginal Product = PriceMPL

Firms Demand for Labour

In deciding the number of workers to employ a firm will
compare the benefit of an additional worker with the
cost of that worker.
Benefit to the firm of employing an additional worker
Value of Marginal Product = PMPL
Cost to the firm of employing an additional worker
Wage = W

Competitive Markets
Assume that firm operates in a competitive market
It cannot set the wage it pays workers
It cannot set the price it receives for its product
Firm (i) will be willing to employ labour until:
Pi MPLi Wi

Value of MPL = money wage

or
MPLi

Wi
Pi

Marginal product of labour = real wage

9

Fundamental Point
Since the MPL decreases as the firm employs more
workers, it must be the case that the real wage also has
to fall (as more workers are employed)
This implies that a firms demand for labour is a
decreasing function of the real wage.

10

Demand Curve for Labour (Version 1)

Pi MPLi Wi

Wi

Money
Wage

LDi = VMP

No. of Workers
11

Demand Curve for Labour (Version 2)

Pi MPLi Wi

Divide both sides by general price level P

Pi MPLi Wi

P
P

12

Demand Curve for Labour (Version 2)

Wi
P

Real
Wage
LDi MP

No. of Workers
13

Demand for Labour at Different Real Wages

Real
Wage
High

Low
LDi

N1

N2
No. of Workers
14

Shifts in the Firms Labour Demand Curve

Higher relative price for firms output
Wi
P

Real
Wage

Pi MPLi
L
P

D
i

LDi

Pi MPLi
P

No. of Workers

15

 Higher marginal productivity of labour

Wi
P

Real
Wage

Pi MPLi
L
P

D
i

LDi

Pi MPLi
P

No. of Workers

16

What are MPL and Real Wage in the following Economy?

No. Workers Output
MPL
Real Wage
(per hour) (per hour)
(per hour)
0
0
1
10
2
18
3
24
4
28
5
30
Money Wage = $10 per hour
Price Index = 2.0
17

How many workers will be employed?

No. Workers Output
MPL
(per hour) (per hour)
0
0
1
10
10
2
18
8
3
24
6
4
28
4
5
30
2

Real Wage
(per hour)
5
5
5
5
5

Money Wage = $10 per hour

Price Index = 2.0
18

How many workers will be employed? (3 workers)

No. Workers Output
MPL
Real Wage
(per hour) (per hour)
(per hour)
0
0
1
10
10
5
2
18
8
5
3
24
6
5
4
28
4
5
5
30
2
5
Money Wage = $10 per hour
Price Index = 2.0
19

What is the Aggregate Labour Demand Curve?

12

10

MPL and W/P

0
0

No. of Workers
MPL or Labour Demand Curve

Real Wage (W/P)

20

Supply of Labour
Suppliers of labour are workers and potential workers.
At any given wage people have to decide if they are willing to
work.
Supply of labour is the total number of people willing to
Wi
work at each real wage: P

Labour supply is generally assumed to be an increasing

function of the real wage.
21

Labour Supply Curve

Real
Wage

LS

Wi
P

No. of Workers
22

Labour Supply Response to Higher Real Wage

Real
Wage

LS

High

Low

N1

N2
No. of Workers
23

Factors that Shift Labour Supply

Size of working-age population (influenced by birth
rate, retirement ages, immigration rates)
Participation rate percentage of working age
population who seek employment

24

Equilibrium in the (Aggregate) Labour Market

LS

Real
Wage
W

P

LD

N*

Employment
25

Effect of Higher Productivity on Real Wage and

Employment
LS

Real
Wage

LD

LD

Employment
26

Real Wages and Employment in Australia

Growth Rates (%)
Real
Real Unit
Employment Change in
Earnings Labour Costs
Unemployment
1970s
1980s
1990s
2000s

38.1
1.0
14.8
6.7

6.7
-9.2
-0.2
-5.2

16.1
25.7
12.5
15.4

+4.5
-0.2
+1.0
-1.9

Real average labour cost

Real Unit Labour Costs =
Average labour productivity
27

Increasing Wage Inequality: Technological Change

Technological change increases worker productivity and is
the basic source of rising living standards
However a given technological innovation can affect
different workers in different ways.
Skill-biased technical change:
Raises the marginal product of high-skill workers
Reduces the marginal product of low-skill workers
28

Ds
real
wage

Su

real
wage

Ss

Ds
Du Du
Employment
Unskilled workers
Fall in wages and
employment

Employment
Skilled workers
Rise in wages and
employment
29

Unemployment
Definitions
Labour Force equals the total number of people
available for work.
Labour Force = Employed + Unemployed

30

ABS Definitions
Employed: Person worked full-time or part-time during the
past week (or was on leave from a regular job)
Unemployed: Person did not work during the preceding week
and made some effort to find work.
Not in Labour Force: Person did not work in the past week
and was not actively seeking work (e.g. retirees, unpaid
homemakers, full-time student).
Discouraged Workers: People who have given up looking for
work (and so are not counted as unemployed)
31

Important Ratios
Unemployment Rate =
(Unemployment/Labour Force)*100

Participation Rate =
(Labour Force/Working-age (15+) Population)*100

32

Labour Force:Data:Australia,Apr-2009,Jun-12,Jun-2015
Thousands (000)
Employed
10,799 11,500 11,769
- Part-time
3,126
3,435
3,612
- Full-time
7,673
8,066
8,156
+Unemployed
615
631(5.2) 756
=Labour Force
11,414 12,132 12,525
+Not in Labour Force
6,045
6,464
6,815
=Working-age (15+) Pop. 17,458 18,596 19,340
(65.2)
Unemployment Rate
100*(756/12,525) = 6.04%
Participation Rate
100*(12,525/19,340) = 64.8%
33

Participation rate
Dec-2014

Nov-2013

Oct-2012

Sep-2011

Aug-2010

Jul-2009

Jun-2008

May-2007

Apr-2006

Mar-2005

Feb-2004

Jan-2003

Dec-2001

Nov-2000

Oct-1999

Sep-1998

Aug-1997

Jul-1996

Jun-1995

May-1994

Apr-1993

Mar-1992

Feb-1991

Jan-1990

Dec-1988

Nov-1987

Oct-1986

Sep-1985

Aug-1984

Jul-1983

Jun-1982

May-1981

Apr-1980

Mar-1979

Feb-1978

% participation
67.0

65.0

64.0

63.0

62.0
6.0

61.0

60.0

59.0

57.0
% unemployed

Monthly Unemployment and Participation Rates

12.0

66.0

10.0

8.0

4.0

2.0

58.0

0.0

Unemployment rate

34

Types of Unemployment
Frictional/Search
Short-term unemployment that is associated with
people searching for the right job.
Will be a feature of any dynamic economy
Tends to be beneficial rather than costly to an economy

35

Structural
Longer-term unemployment that can arise when the
distribution of skills of some workers does not match the
available jobs in the economy
Some workers may have a lack of skills or be subject to
discrimination and this prevents them from finding
stable long-term employment
Structural change in the economy may result in a loss of
jobs for certain types of specialised workers
36

Cyclical
Associated with periods of slowdowns in economic
activity, called recessions

37

Costs of Unemployment
Economic costs
output that is foregone since workforce is not fully
utilised
Psychological costs
long periods of unemployment can lead to loss of selfesteem, unhappiness and depression
Social costs
high unemployment can lead to increased crime and
associated social problems
38

Australia
Feb-2014

Feb-2013

Feb-2012

Feb-2011

Feb-2010

Feb-2009

Feb-2008

Feb-2007

Feb-2006

Feb-2005

Feb-2004

Feb-2003

Feb-2002

Feb-2001

Feb-2000

Feb-1999

Feb-1998

Feb-1997

Feb-1996

Feb-1995

Feb-1994

Feb-1993

Feb-1992

Feb-1991

Feb-1990

Feb-1989

Feb-1988

Feb-1987

Feb-1986

Feb-1985

Feb-1984

Feb-1983

Feb-1982

Feb-1981

Feb-1980

Feb-1979

Feb-1978

Australian and US Unemployment Rates

12.0

10.0

8.0

6.0

4.0

2.0

0.0

US

39

Jan-2014

Oct-2013

Jul-2013

Apr-2013

Jan-2013

Oct-2012

Jul-2012

Apr-2012

Jan-2012

Oct-2011

Jul-2011

Apr-2011

Jan-2011

Oct-2010

Jul-2010

Apr-2010

Jan-2010

Oct-2009

Jul-2009

Apr-2009

Jan-2009

Oct-2008

Jul-2008

Apr-2008

Jan-2008

Oct-2007

Jul-2007

Apr-2007

Jan-2007

Unemployment Rates and the Global Financial Crisis

14.0

12.0

10.0
US

8.0

Japan

Euro Area

6.0
UK

South Korea

Taiwan

4.0
Hong Kong

Australia

2.0

0.0

40

Factors that affect the rate of unemployment

Minimum Wage Laws
Legal minimum hourly wage that business must pay
workers
Known as award wages in Australia
Standard labour demand and supply model predicts that
setting too high a minimum wage will produce
unemployment.
41

Binding Minimum Wage

Real
Wage

LS

wmin

we

LD

ND Ne NS

Employment

42

 Those workers
who are employed at the
minimum wage are better-off than at the marketclearing wage
D
0

N
(
)

There is still debate in economics about the actual

impact of minimum wage laws on the level of
employment. The empirical evidence is not clear-cut.
A famous study by Card and Krueger (1995) finds
little negative employment effects from a 19% rise in
the New Jersey minimum wage. For a review see
http://en.wikipedia.org/wiki/Minimum_wage
43

Labour Unions
Workers may negotiate on an individual basis with a firm
over wages and conditions
Alternatively workers may form labour unions to bargain
collectively with a firm.
Presence of unions tends to produce a wage outcome that is
above the market-clearing wage.
The figure for a minimum wage can be re-interpreted as the
outcome for a unionised industry, where wmin = wunion
44

Unemployment Benefits
Government transfer payment paid to the unemployed.
Provides a basic income to workers who are unemployed
and searching for work.
Can have a disincentive effect on a workers search effort.
Australia: Newstart Allowance (single, 22+, looking for work)
2010 payment is $456 per fortnight
2012 payment is $490 per fortnight
2014 payment is $519 per fortnight
45