TUTORIAL 3 (24 28 MARCH) ANSWER KEY

Unemployment and the Labour market

Textbook Reference: Chapter 3
Main Concepts
Demand for labour
Supply of labour
Model of labour demand, supply and the real wage
Unemployment frictional, structural and cyclical
Full employment
Review Questions
Question 1
Go to statistics on the RBA Website at
http://www.rba.gov.au/statistics/tables/index.html#output_labour
Using Table G7, summarise (with graphs) the main labour market trends in Australia over
the last 20 years for:
(i)
The unemployment rate (column I)
You should be able to describe the trends in the data and think about reasons for trends.
Eg previous recession in early 1990s unemployment rate over 10% in 1993. The
unemployment rate fell as the economy entered long period of stable growth in 1990s and
2000s (until 2008). Note relatively modest effect of GFC on unemployment rate.

(ii)
The participation rate (column D)
You should think about the following issues:

what might have led to an increasing trend in the participation rate?

Is there any relationship between the unemployment rate and the participation rate
(think about discouraged workers) etc.

(iii)
The relative proportions of part-time and full-time workers in total employment
(columns E, F & G)
Think about the following broad trends:
Why might share of PT workers in labour force have risen from about 20% to 30% over
time? What might cause firms to offer more jobs on a part-time (or casual) basis rather than
as full-time positions? (Lower costs, greater flexibility). What about worker preferences. Do
you think there is a greater demand by some groups of workers for part-time employment?

(iv)

Hours worked per worker (column J/column G)

Why have average hours worked decreased over the last 20 years? Is it a trade-off between
labour and leisure? Is it the increasing level of technology, increasing female participation,
or lower fertility rates?

Question 2
List three types of unemployment and their causes. Discuss the likely economic and social
costs of each form of unemployment. What is the natural rate of unemployment? In each
of the following cases explain which type of unemployment is the best description.
(i)
John lost his job when the aluminium plant in Geelong closed. He has worked in
the steel plant since leaving high-school and owns a house in Geelong.
Structural. Johns skills are mismatched with existing employment opportunities.
(ii)
Jan was made redundant from her job in the real estate industry because the
recession reduced the sales of houses.
Cyclical. Jans unemployment is temporary and associated with a recession.

(iii)
Ian is an unskilled worker who does seasonal work picking fruit in the Riverina.
When there is no fruit to pick he is unemployed.
Structural. Ian lacks the skills to land a long-term, stable job.
(iv)
Janet, a software engineer, lost her job when the start-up company she was
working in went bankrupt. She interviewed for a position with five firms, before
eventually accepting a new job in a firm in the same industry.
Frictional. The delay in taking a new job arises because Janet is trying to find the best opportunity,
not because work is unavailable.

(v)
Jonathan worked in an automobile manufacturing plant in Adelaide but lost his job
when the company decided to close the plant in 2008. He has been unemployed since
that time but is still searching for employment in automobile manufacturing.
Structural. Jonathan may have initially lost his job due to a recession so his unemployment
might be classified as cyclical. However one consequence of the recession in 2008 in
Australia has been a large decline in the manufacturing sectors, so it is likely that the
decision of the company to close the Adelaide operations are permanent and hence
structural, so that Jonathans unemployment is structural. This is particularly so if he does
not have the necessary skills to find employment in other industries.

Discussion Questions
Question 3
(i)
Draw the demand and supply model of the aggregate labour market. Explain why
the demand curve is downward sloping and why the supply curve is upward sloping.
Explain the factors that would cause each of these curves to shift.

See BOF Section 3.1

Labour Demand Curve:
The aggregate labour demand curve represents the marginal productivity of workers, since
it is optimal for a firm to employ a quantity of labour where the real wage is equal to the
marginal product of labour. Since there are diminishing returns to labour, aggregate labour
demand is downward sloping.
Since the aggregate labour demand curve represents the marginal productivity of workers,
anything that determines this level of productivity, such as technological change,
determines the position of the curve. Note that section 3.1 explains the determinants of
labour demand from the perspective of a firm and hence an increase in the relative price of
the firms output would shift labour demand. The same is not necessary for aggregate
labour demand, since increases in prices of aggregate output would also tend to decrease
the real wage.
Labour Supply Curve
Positive slope reflects fact that higher real wages are required to induce an increased supply
of labour. Higher real wage will lead to a higher number of hours supplied by existing
workers and would also lead to entry into the labour market (higher participation rate) by
those whose reservation wage now exceeds the new real wage.
Position of curve is primarily affected by size of working age population and participation
rate.

(ii)
Suppose the government introduces a carbon tax which is a levy on the use of
energy by firms. Use the model in part (i) to explain the effect on employment and
unemployment if we assume that real wages are fixed.

Other things equal, the carbon tax increases the price of one of the inputs into production,
the price of energy. Labour and other inputs into production are complementary, and
hence the marginal product of labour decreases. Labour demand shifts leftwards,
decreasing employment and opening up a gap between labour demand and labour supply if
the real wage does not adjust, increasing unemployment. A sticky or unchanging real wage
is plausible if nominal wages are indexed to changes in the price level or inflation.

(iv)
Suppose the government introduces a minimum wage. Use the model to analyse
the effect on employment, unemployment, the labour force, and the quantity of labour
demanded. Who are the winners and who are the losers?

See BOF Section 3.4.1

If the minimum wage is binding, employment falls from the labour market equilibrium L* to
the quantity of labour demanded at the minimum wage, L D. The quantity of labour supplied
increases from L* to Ls, since the higher wage induces entry into the labour market (larger
labour force) and a willingness to work more hours. Unemployment is LD - Ls, since there is
an excess supply of labour at the higher wage. The winners are those that retain their
employment at the higher minimum wage. Losers are those that lose their employment
due to the higher wage, or that cannot find employment at the higher wage.
Note that the text examines a market for low-skill workers. It is not true that only low-skill
workers are losers, since low-skill workers with protection from labour cartels would benefit
from such a policy.