unemployment gavin cameron university of oxford oubep 2006

Unemployment

Gavin Cameron University of Oxford

OUBEP 2006

OXFORD UNIVERSITY BUSINESS ECONOMICS PROGRAMME

2

introduction• “When in any country the

demand for those who live by wages… is continually increasing; when every year furnishes employment for a greater number than had been employed the year before, the workmen have no occasion to combine to raise their wages. The scarcity of hands occasions competition among masters, who bid against one another, in order to get workmen…” Adam Smith (1776)


3

job separation and job finding• The workforce= employed + unemployed

• L=E+U• When unemployment is stable, the number of job

separations must equal the number of jobs found.• sE=fU

• but since E=L-U• s(L-U)=fU, divide both sides by L to obtain• s(1-U/L)=fU/L and solve for U/L to find• (U/L)*= s/(s+f)

• The steady-state unemployment rate is an increasing function of the job separation rate and a decreasing function of the job finding rate.


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labour supply

When real wages rise, the budget line rotates around point A (the endowment of time remains unchanged) and becomes steeper. This allows both consumption and leisure to increase at the same time (income effect). Because leisure is more expensive, however, some is given up (substitution effect). In the case depicted here, the substitution effect dominates at first, but not in the extreme.


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the supply of labour

employment

Individual

Aggregate

The aggregate curve is less steep than for an individual since new workers enter the workforce as wages rise.

real wage


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the demand for labour

employment

labour demand, Ld

A competitive firm demands labour up until the point where MC=MR, that is W=MPL*P, which is the same as W/P=MPL

As more workers are added into the workforce, for a given level of capital and technology, the marginal product of labour, and hence the demand for labour, falls.

real wage


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the natural rate of unemployment

employment

labour demand, Ld

labour supply, Ls workforce

natural rate

equilibrium employment

equilibrium wage

real wage


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the natural rate and the NAIRU• The natural rate model assumes that markets clear and that

there is competition in all markets.• In fact, the labour market may be dominated by unions.• If so, there is bargaining between unions and firms. • Other things being equal, this will raise the level of

unemployment for any given real wage.• Also, goods markets may be dominated by a few large

sellers (imperfect competition) in which case the labour demand curve may be less steep, possibly even horizontal.


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wage bargaining• Unemployment is the means by which the competing claims

of employers and unions are reconciled.• Unions bargain over wages relative to prices (the wage-

setting curve) and reduce their demands when unemployment is high.

• Unions care about the employed (insiders) without caring too much about the unemployed (outsiders).

• Employers set prices relative to wages: this leads to a relatively flat labour demand schedule (the price-setting curve).


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wage-setting and price-setting

employment

price-setting: firms set a constant mark-up of prices over costs, PS

labour supply, Lsworkforce

wage-setting, WSreal wage


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two views of the labour market• The natural rate model suggests that most equilibrium

unemployment is voluntary in the sense that workers could find jobs at the current real wage, but choose not to.

• The NAIRU model suggests that some equilibrium unemployment is involuntary in the sense that workers would like to work at the current real wage but cannot find jobs.


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the NRU and the NAIRU

employment

labour supply, Ls

workforce

voluntary

NAIRU

wage-setting, WS

price-setting: firms set a constant mark-up of prices over costs, PS

real wage

labour demand, Ld

involuntary


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unemployment equilibrium• Unions claim real wages that rise with employment:

target wage = base + aggression (employment)• Firms offer real wages as a proportion of labour

productivity:feasible wage = productivity * (100%-markup)

• In equilibrium, the target wage equals the feasible wage when:employment= productivity * (100%-markup) – base

aggression• If productivity and the markup don’t vary with employment,

then we have the horizontal price-setting curve from the NAIRU diagram.


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minimum wages in a secondary labour market

employment

labour demand, Ld

labour supply, Lsworkforce

equilibrium employment

equilibrium wage

real wage

The secondary labour market (typically for unskilled, young workers) is potentially vulnerable to the effect of a minimum wage.

minimum wage


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a monopsony labour market

employment

labour demand Ld

labour supply Ls

marginal cost of labour

A monopsonist who pays all workers the same equates its demand for labour with its marginal cost, Wm, when setting employment at Em.

equilibrium wage

competitive wage

Em Ec

real wage


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why pay above the going rate?• In 1914, the Ford Motor Company

paid its workers $5 per day when the going rate was between $2 and $3. Why?

• “A low wage business is always insecure… The payment of five dollars a day for an eight hour day was one of the finest cost-cutting moves we ever made”, Henry Ford

• Why would this policy reduce costs?• Workers might work harder and staff

turnover might be reduced because workers don’t want to run the risk of a big cut in wages (moral hazard). The firm may also attract better quality workers.

• If many firms pay efficiency wages, it will be harder for the unemployed to find jobs, and so unemployment will be higher.


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how to reduce unemployment• Active Labour Market Policies: training and work

experience schemes for long-term unemployed, unskilled, youths, women, older workers;

• Reform of the benefit system, especially duration;• Limitations on union power – no closed shops, no secondary

picketing, secret ballots; • Changes to wage bargaining, especially increased employer

coordination;• Tax reform (lower payroll taxes for the unskilled etc);• Increased labour mobility.• Flexicurity: Cuts to employment protection, coupled with

active labour market policies;


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how not to reduce unemployment• Cunning demand-side policies (unlikely to have much effect

in the long-run, plus very expensive);• Job-sharing or cuts in working hours;• Increased investment by firms (although this will raise

wages);• Protectionism (any benefit to workers massively outweighed

by costs to consumers).


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Source: Faggio and Nickell (2006)

unemployment around the world


20

Source: BIS (2006)


21

Source: O’Mahony and Van Ark (2003), table I.1.

Source: OECD (2005)


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summary• “When large numbers of

people are out of work…. unemployment invariably follows”, Calvin Coolidge (US President, 1923-1929).


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syndicate topics• What is the effect on unemployment of (a) a fall in union

strength or (b) a fall in real benefits?• Would unemployment fall if working hours were cut?• Do firms pay workers their marginal product?• Is competition from the South a cause of unemployment in

the North?• Why has the relative pay of the unskilled fallen since 1980?• What are the current trends in unemployment around the

world?

unemployment gavin cameron university of oxford oubep 2006

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