Download Lecture #15: Wages and Unemployment in the Labor Market and more Study notes Economics in PDF only on Docsity! Lecture #15 ECON 3133-02 October 13, 2005 Reading assignment: Chapter 6. 1. The labor market. a. Use the fact the wages tend to be inversely related to the unemployment rate, write down an equation that characterizes the setting of wages in the United States. Describe how each of the variables likely impacts wages. The equation below is the wage setting or labor supply condition. Wt=Ptef(ut,zt) 1. There is a positive relationship between the expected price level and wages (most important thing to remember about our model). Here, we assume that workers care about their real wages, that is, the amount they can purchase with their nominal wages. If prices are expected to increase in the future (e.g. suppose you suspect your land lord is about to double your rent), then you will ask for a higher nominal wage, Wt. 2. As the unemployment rate rises, for all of the reasons we discussed above, the nominal wage rate, Wt, falls. 3. We use the term zt to refer to all other variables other than the expected price level and unemployment rate that affect wages. We assume that we can express zt such that it is positively related to the wage rate. For example, we often use zt to capture unemployment compensation. If unemployment compensation increases in a country, wages are expected to increase. In a sense, workers have increased bargaining power since the negative prospects affiliated with unemployment have declined. b. We will see that your answer on 1(a) above actually reflects labor supply. We now turn to labor demand. From microeconomics, what is the profit maximizing wage rate a firm will pay an employee. From microeconomic theory, we know firms will continue to hire workers as long as the extra revenue generated from hiring one extra worker exceeds the wage rate. We stop once the two are equal. In economics parlance, we say the firms will stop hiring once the marginal revenue product of the worker (MRPL) is equal to the wage rate. Note that marginal revenue product is simply equal to marginal revenue multiplied by marginal product. Suppressing the time subscripts yields: W=MPRL=MR*MPL. c. List the three assumptions made about the demand for labor. 1. Firms only use labor to produce goods and services. 2. Technology is constant. 3. All firms are monopolistically competitive such that they may be expected to charge a price slightly above their marginal cost. d. Define the natural rate of unemployment. The natural rate of unemployment is the unemployment rate that results when the actual price level observed in the economy is equal to the price level workers expected (Pe). e. You are given the following information: f(ut,zt)=1-ut, λ=.5, Pte=Pt. Write down the function that represents labor demand and labor supply, and use this information to calculate the equilibrium unemployment rate and real wage rate. From above, our labor supply (or wage setting condition) is given as: )1( ),( Ntt tt e tt uPW zufPW −==> = The second line follows because we know that if actual and expected prices are equal, then the unemployment rate at time t is the natural rate of unemployment. If we convert into base year prices, then the real value of any number is simply the nominal value divided by the current price level. Thus, the real wage rate is simply equal to the nominal wage rate at time t divided by the price level at time t. Dividing both sides of the above wage setting/labor supply equation by Pt yields: N t t u P W −=1 LABOR SUPPLY Labor demand is much simpler. From above, we have:
