The Labor Market

GSBA549
IBEAR

Module 2
 Module Objectives
• Know the major long-run determinants of total
employment and real wages
• Know how various economic shocks affect
employment and real wages
• Define and know the causes of unemployment
 Real Hourly Compensation

(1987=100)
110

How to explain this?

100

90

80

70

60

50

40
50 55 60 65 70 75 80 85 90 95
 Labor Demand and Supply
• Firms hire labor up to the point where the real
wage rate equals the MPL (i.e., w/p = MPL)
– MPL depends on A and K/L
– MPL declines as the quantity of labor increases
– The MPL curve is the labor demand curve
– Labor demand curve depends on
• TFP (A)
• Capital (K)
• The quantity of labor supplied generally
increases with the real wage rate
 Labor Market Equilibrium

w/p
Ls

w0/p

Ld

L0 L
One-time Population Increase

w/p
L0s
L1s

w0/p
w1/p

Ld

L0 L1 L
Working Age Population and
Employment
240000
200000

160000 Population

120000

80000 Employment

40000
50 55 60 65 70 75 80 85 90 95
Thousands (log scale)
 Other Factors Changing
Supply
• Labor participation
– higher labor participation rate increases labor
supply => reduces real wage and increases
employment
• Wealth
– higher wealth reduces labor supply
• Future Expected Income
– higher future expected income reduces labor
supply
 Employment Ratio
80

76
Age 16-65
72

68

64

60
Age 16+
56

52
1950 1960 1970 1980 1990 2000
Average Weekly Hours
44

42
All Workers
(Household Survey)
40

38

Hourly Workers
36
(Establishment Survey)

34

32
1950 1960 1970 1980 1990 2000
 One-Time Technical
Improvement (A increases)
w/p L1s
L0s
w1/p

w0/p

Ld1
Ld
0

L0 L
 Labor Income Tax
w
Ls
Deadweight loss

Revenue

w(1−τ 
)

Ld

L1 L0 L
 Tax Rates and Revenue
• The amount of the taxed activity is the tax
base.
• Higher tax rates lower the tax base, which
tends to reduce revenue.
• Higher tax rates generate more revenue
from a given tax base.
• The net effect on revenue is unclear; this
leads to the Laffer Curve
 Laffer Curve
Revenue

Tax Rate
 The fraction of total federal income taxes paid
on returns from the top ½% of the distribution of
the adjusted gross income
Civilian Working-Age Population

Employed
129.80

Unemployed
6.68

Not in Labor Force

66.88

August 1997
 Unemployment
• unemployed: looking for a job but can’t
find a job
• employed: has been working full-time or
part-time during the past week.
• labor force = unemployed + employed
• unemployment rate = unemployed as % of
labor force
Participation and Employment
Rate

labor force
participation rate =
total working age population

employed
employment rate = total working age population
Why Some People Unemployed
• Imperfect Information
– prevent instantaneous matching
– leads to job search
• Heterogeneity of workers and jobs
– workers differ in skills
– jobs also differ
– there is a gain from appropriately matching
workers and jobs
 Types of Unemployment
• Frictional unemployment
• Structural unemployment
• Cyclical unemployment
• Natural rate of unemployment:
– if there is no cyclical unemployment
Long-Term Effects on the Natural
Rate of Unemployment
• Demographic changes
– young workers
– female workers
– ethnic differences
• Government policy
– unemployment benefits
– minimum wage
– restrictions on firing workers
• Speed of economic change
Prime-age workers (ages 25-54), in
millions US
Prime-age workers (ages 25-54) with more
than a high school degree US
1,000
 Summary - 1
• The major long-run determinant of total employment is
labor supply, which depends heavily on the size of the
working-age population
• The major long-run determinant of real wages is the
marginal product of labor, which depends heavily on
production technology and labor supply
• A temporary increase in the growth rate of the working-
age population raises employment and lowers real
wages
 Summary - 2
• Technical progress has little long-run effect on total
employment but raises real wages
• A higher labor income tax rate lowers total employment
and may either raise or lower revenue
• The unemployment rate is total unemployment as a
fraction of the labor force
• Unemployment exists because of frictions in the labor
market, which depend on imperfect information and
heterogeneity of workers and jobs
• The natural rate of unemployment depends on
demographic factors, government policy, and the pace of
economic change
 Two: Aging Population
China grows old as it grows
richer…

Source: United Nations