CHAPTER 29 The Labor Market In the Macroeconomy

PowerPoint Lectures for

Principles of Economics,
9e
; ;

By
Karl E. Case,
Ray C. Fair &
Sharon M. Oster

2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster

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CHAPTER 29 The Labor Market In the Macroeconomy

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PART V THE CORE OF MACROECONOMIC THEORY

29

The Labor Market In

the Macroeconomy

Prepared by:
Fernando & Yvonn Quijano
2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster

PART V THE CORE OF MACROECONOMIC THEORY

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The Labor Market In

the Macroeconomy

CHAPTER OUTLINE
CHAPTER 29 The Labor Market In the Macroeconomy

The Labor Market: Basic Concepts

The Classical View of the Labor Market
The Classical Labor Market and the Aggregate
Supply Curve
The Unemployment Rate and the Classical View

Explaining the Existence of Unemployment

Sticky Wages
Efficiency Wage Theory
Imperfect Information
Minimum Wage Laws
An Open Question

The Short-Run Relationship Between the

Unemployment Rate and Inflation
The Phillips Curve: A Historical Perspective
Aggregate Supply and Aggregate Demand Analysis
and the Phillips Curve
Expectations and the Phillips Curve
Is There a Short-Run Trade-Off between Inflationand
Unemployment?

The Long-Run Aggregate Supply Curve,

Potential Output, and the Natural Rate of
Unemployment
The Nonaccelerating Inflation Rate of
Unemployment (NAIRU)

Looking Ahead

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The Labor Market: Basic Concepts

The labor force (LF) is the number of employed
plus unemployed:

CHAPTER 29 The Labor Market In the Macroeconomy

LF = E + U
unemployment rate The number of people
unemployed as a percentage of the labor force.
Unemployment rate = U/LF

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CHAPTER 29 The Labor Market In the Macroeconomy

The Labor Market: Basic Concepts

frictional unemployment The portion of

unemployment that is due to the normal working of
the labor market; used to denote short-run job/skill
matching problems.
structural unemployment The portion of
unemployment that is due to changes in the
structure of the economy that result in a significant
loss of jobs in certain industries.
cyclical unemployment The increase in
unemployment that occurs during recessions and
depressions.

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The Classical View of the Labor Market

CHAPTER 29 The Labor Market In the Macroeconomy

labor demand curve A graph that illustrates the

amount of labor that firms want to employ at each
given wage rate.
labor supply curve A graph that illustrates the
amount of labor that households want to supply at
each given wage rate.

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CHAPTER 29 The Labor Market In the Macroeconomy

The Classical View of the Labor Market

FIGURE 29.1 The Classical Labor Market

Classical economists believe that the labor market always clears. If the demand for labor shifts from D0 to D1,
the equilibrium wage will fall from W0 to W1. Anyone who wants a job at W1 will have one.

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The Classical View of the Labor Market

CHAPTER 29 The Labor Market In the Macroeconomy

The Classical Labor Market and the Aggregate Supply Curve

The classical idea that wages adjust to clear the

labor market is consistent with the view that wages
respond quickly to price changes. This means that
the AS curve is vertical.
When the AS curve is vertical, monetary and fiscal
policy cannot affect the level of output and
employment in the economy.

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The Classical View of the Labor Market

CHAPTER 29 The Labor Market In the Macroeconomy

The Unemployment Rate and the Classical View

The unemployment rate is not necessarily an

accurate indicator of whether the labor market is
working properly.
The measured unemployment rate may sometimes
seem high even though the labor market is
working well.

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Explaining the Existence of Unemployment

Sticky Wages

CHAPTER 29 The Labor Market In the Macroeconomy

sticky wages The downward rigidity of wages as

an explanation for the existence of unemployment.
FIGURE 29.2 Sticky Wages
If wages stick at W0 instead of
falling to the new equilibrium wage
of W* following a shift of demand
from D0 to D1, the result will be
unemployment equal to L0 - L1.

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Explaining the Existence of Unemployment

Sticky Wages

CHAPTER 29 The Labor Market In the Macroeconomy

Social, or Implicit, Contracts

social, or implicit, contracts Unspoken
agreements between workers and firms that firms
will not cut wages.
relative-wage explanation of unemployment
An explanation for sticky wages (and therefore
unemployment): If workers are concerned about
their wages relative to other workers in other firms
and industries, they may be unwilling to accept a
wage cut unless they know that all other workers
are receiving similar cuts.

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Explaining the Existence of Unemployment

Sticky Wages

CHAPTER 29 The Labor Market In the Macroeconomy

Explicit Contracts
explicit contracts Employment contracts that
stipulate workers wages, usually for a period of 1
to 3 years.
cost-of-living adjustments (COLAs) Contract
provisions that tie wages to changes in the cost of
living. The greater the inflation rate, the more
wages are raised.

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Explaining the Existence of Unemployment

Sticky Wages

CHAPTER 29 The Labor Market In the Macroeconomy

Explicit Contracts

Graduate School
Applications in
Recessions
Graduate School Offers
Relief During Economic
Recession
Oklahoma Daily
(U. Oklahoma)

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Explaining the Existence of Unemployment

CHAPTER 29 The Labor Market In the Macroeconomy

Efficiency Wage Theory

efficiency wage theory An explanation for

unemployment that holds that the productivity of
workers increases with the wage rate. If this is so,
firms may have an incentive to pay wages above
the market-clearing rate.

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Explaining the Existence of Unemployment

CHAPTER 29 The Labor Market In the Macroeconomy

Imperfect Information

Firms may not have enough information at their

disposal to know what the market-clearing wage is.
In this case, firms are said to have imperfect
information.
If firms have imperfect or incomplete information,
they may set wages wrongwages that do not
clear the labor market.

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Explaining the Existence of Unemployment

CHAPTER 29 The Labor Market In the Macroeconomy

Minimum Wage Laws

minimum wage laws Laws that set a floor for

wage ratesthat is, a minimum hourly rate for any
kind of labor.

An Open Question

The aggregate labor market is very complicated,

and there are no simple answers to why there is
unemployment.

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The Short-Run Relationship Between

the Unemployment Rate and Inflation

CHAPTER 29 The Labor Market In the Macroeconomy

In the short run, the unemployment rate (U) and

aggregate output (income) (Y) are negatively
related.
FIGURE 29.3 The Aggregate
Supply Curve
The AS curve shows a positive
relationship between the price
level (P) and aggregate output
(income) (Y).

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CHAPTER 29 The Labor Market In the Macroeconomy

The Short-Run Relationship Between

the Unemployment Rate and Inflation

FIGURE 29.4 The

Relationship Between the Price
Level and the Unemployment
Rate
This curve shows a negative
relationship between the price
level (P) and the unemployment
rate (U). As the unemployment
rate declines in response to the
economys moving closer and
closer to capacity output, the price
level rises more and more.

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The Short-Run Relationship Between

the Unemployment Rate and Inflation

CHAPTER 29 The Labor Market In the Macroeconomy

inflation rate The percentage change in the price

level.
Phillips Curve A curve showing the relationship
between the inflation rate and the unemployment
rate.

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The Short-Run Relationship Between

the Unemployment Rate and Inflation

CHAPTER 29 The Labor Market In the Macroeconomy

FIGURE 29.5 The Phillips

Curve
The Phillips Curve shows the
relationship between the inflation
rate and the unemployment rate.

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The Short-Run Relationship Between

the Unemployment Rate and Inflation
The Phillips Curve: A Historical Perspective

CHAPTER 29 The Labor Market In the Macroeconomy

FIGURE 29.6 Unemployment

and Inflation, 19601969
During the 1960s, there seemed
to be an obvious trade-off
between inflation and
unemployment. Policy debates
during the period revolved around
this apparent trade-off.

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The Short-Run Relationship Between

the Unemployment Rate and Inflation
The Phillips Curve: A Historical Perspective

CHAPTER 29 The Labor Market In the Macroeconomy

FIGURE 29.7 Unemployment

and Inflation, 19702007
From the 1970s on, it became
clear that the relationship between
unemployment and inflation was
anything but simple.

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The Short-Run Relationship Between

the Unemployment Rate and Inflation

CHAPTER 29 The Labor Market In the Macroeconomy

Aggregate Supply and Aggregate Demand Analysis and the

Phillips Curve

FIGURE 29.8 Changes in the Price Level and Aggregate Output Depend on Shifts in Both
Aggregate Demand and Aggregate Supply

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The Short-Run Relationship Between

the Unemployment Rate and Inflation

CHAPTER 29 The Labor Market In the Macroeconomy

Aggregate Supply and Aggregate Demand Analysis and the

Phillips Curve
The Role of Import Prices

FIGURE 29.9 The Price of Imports, 1960 I2007 IV

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The Short-Run Relationship Between

the Unemployment Rate and Inflation

CHAPTER 29 The Labor Market In the Macroeconomy

Expectations and the Phillips Curve

Expectations are self-fulfilling. This means that

wage inflation is affected by expectations of future
price inflation.
Price expectations that affect wage contracts
eventually affect prices themselves.
Inflationary expectations shift the Phillips Curve to
the right.

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The Short-Run Relationship Between

the Unemployment Rate and Inflation

CHAPTER 29 The Labor Market In the Macroeconomy

Is There a Short-Run Trade-Off between Inflation and

Unemployment?
There is a short-run trade-off between inflation and
unemployment, but other factors besides
unemployment affect inflation. Policy involves
more than simply choosing a point along a nice
smooth curve.

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CHAPTER 29 The Labor Market In the Macroeconomy

The Long-Run Aggregate Supply Curve, Potential Output, and the

Natural Rate of Unemployment

FIGURE 29.10 The Long-Run Phillips Curve: The Natural Rate of Unemployment
If the AS curve is vertical in the long run, so is the Phillips Curve. In the long run, the Phillips Curve
corresponds to the natural rate of unemploymentthat is, the unemployment rate that is consistent
with the notion of a fixed long-run output at potential output. U* is the natural rate of unemployment.

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CHAPTER 29 The Labor Market In the Macroeconomy

The Long-Run Aggregate Supply Curve, Potential Output, and the

Natural Rate of Unemployment

natural rate of unemployment The

unemployment that occurs as a normal part of the
functioning of the economy. Sometimes taken as
the sum of frictional unemployment and structural
unemployment.

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The Long-Run Aggregate Supply Curve, Potential Output, and the

Natural Rate of Unemployment
The Nonaccelerating Inflation Rate of Unemployment (NAIRU)

CHAPTER 29 The Labor Market In the Macroeconomy

NAIRU The nonaccelerating inflation rate of

unemployment.
FIGURE 29.11 The NAIRU
Diagram
To the left of the NAIRU, the price
level is accelerating (positive
changes in the inflation rate); to
the right of the NAIRU, the price
level is decelerating (negative
changes in the inflation rate). Only
when the unemployment rate is
equal to the NAIRU is the price
level changing at a constant rate
(no change in the inflation rate).

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REVIEW TERMS AND CONCEPTS

cost-of-living adjustments
(COLAs)
CHAPTER 29 The Labor Market In the Macroeconomy

cyclical unemployment
efficient wage theory

NAIRU
natural rate of unemployment
Phillips Curve

explicit contracts

relative-wage explanation of
unemployment

frictional unemployment

social, or implicit, contracts

inflation rate

sticky wages

labor demand curve

structural unemployment

labor supply curve

unemployment rate

minimum wage laws

2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster

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