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Currently, most economists describe the labor market by the wage-setting. (WS) curve. The WS curve is an increasing function in the (N, W /P). ( ...
Typology: Schemes and Mind Maps
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Based on the textbook by Karlin and Soskice: Macroeconomics: Institutions, Instability, and the Financial System
Robert M. Kunst robert.kunst@univie.ac.at
University of Vienna and Institute for Advanced Studies Vienna
October 22, 2017
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Unemployment
1950 1960 1970 1980 1990 2000 2010
2
4
6
8
10
12
14
%
Austrian unemployment rate according to national definition, monthly since 1950.
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Unemployment
The Austrian definition of the unemployment rate is the simple ratio
unemployment rate = unemployed labor force
unemployed unemployed + employed
with employment excluding self-employment (lawyers, farmers, entrepreneurs), and all numbers taken from registers. The international definition (EU, OECD) is based on questionnaires. It includes self-employment. It can be larger (Spain) or smaller (Austria) than the ‘registered rate’.
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Unemployment
Contrary to the goods and financial market, the labor market does not clear. There is unsatisfied supply of labor (unemployment) and unsatisfied demand for labor (vacancies). Involuntary unemployment can be a matter of strong concern. Unemployed persons are often unhappy or tend to be unhealthy. Employers can use the fear of losing one’s job to discipline workers.
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Wage and price setting
W/P
N
wage setting labor supply WS
res.w.
A
B
If workers receive more than their reservation wage, they supply a fixed amount of labor N. With low unemployment as in B, they get higher wage offers than in A. Unemployment is the difference between the green line and the red vertical.
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Wage and price setting
The reservation wage is the wage that workers require to compensate the disutility of work and the unemployment benefit. A minimum wage is a legal minimum for wages. An efficiency wage is a wage paid in excess of the reservation or minimum wage, in order to discourage shirking and layoffs by workers and generally to boost workers’ morale. The vertical distance between the WS curve and the reservation wage represents the cost of losing one’s job. Labor supply need not be vertical, but it is typically quite ‘inelastic’. There is little empirical evidence on a dependence between labor supply and real wages.
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Wage and price setting
W/P
N
labor supply WS PS unemployment
labor force
The vertical labor supply line (gray) separates involuntary and voluntary unemployment.
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Wage and price setting
W/P
N
WS 1 WS PS unemployment
labor force
More generous unemployment benefits increase the reservation wage and shift up the WS curve. This results in more unemployment. The additional bargaining power will not yield higher real wages.
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Wage and price setting
W/P
N
WS PS unemployment
labor force A
B
A sudden positive demand shock requires more employment than at the intersection of PS and WS. This situation is in line with the short-run IS world, but not with the labor market. The short-run point will be somewhere between PS and WS, between A and B.
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Wage and price setting
If there is more employment than at the WS-PS intersection, real wages negotiated in the wage rounds are higher than the real revenues for the producer. Producers tend to increase prices. There will be more inflation than anticipated. The economy will move back to its ‘medium-run equilibrium’ at the WS-PS intersection. If there is a negative demand shock, there will be deflationary tendencies. Falling or unexpectedly slowly rising prices push the economy back to its equilibrium.
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Wage and price setting
The price-setting equation can be formalized as
P = (1 + μ)
where μ is the markup and ΠN is the marginal productivity of labor. This property follows from economic theory: with competition, the production factors are paid their marginal product. With imperfect competition, there is a markup. The equation is re-written as
w PS^ =
1 + μ
which for a linear production function is a horizontal line in the (N, w ) diagram.
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Wage and price setting
Suppose price setting can be described more generally by a function of price push variables, such as a tax ‘wedge’: w PS^ = ΠN F (μ, zp ), with F (., ) some function that decreases in its first argument μ (as in F (μ, .) = 1/(1 + μ)). Equilibrium in the labor market holds iff w PS^ = w WS^ ⇒ ΠN F (μ, zp ) = B(N, zw ). With these assumptions, labor-saving technological progress yields profits that are directly distributed to workers. Some economists maintain that productivity affects the wage-setting function. The equilibrium defined by this condition can be expressed as the equilibrium employment Ne , the ‘natural’ unemployment rate ue , or as the equilibrium or natural output ye.
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The Phillips curve
The original Phillips curve from 1958 (after A.W. Phillips) was an inverse relation between wage inflation and the unemployment rate: episodes with high unemployment typically have less inflation. The curve was also presented for price inflation and for changes in the unemployment rate. Its validity was often debated on theoretical and empirical grounds. Current Phillips curves often substitute output or the output gap for unemployment. Output and unemployment are inversely related, such Phillips curves are usually upward sloping.
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The Phillips curve
π
y
PC(πE=2%)
PC(πE=4%)
2%
4%
6%
y 0 yH
A
B
C C 0
In A, the economy is in its medium-run equilibrium, WS=PS. A demand shock moves the economy to B, with more output and 4% inflation. In the next wage round, the 4% are expected and the Phillips curve shifts up. If the higher output yH is targeted again, it comes with an inflation of 6% in C.
