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2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Labor Market: Basic Concepts
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Labor Market: Basic Concepts
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Classical View of the Labor Market
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Classical View of the Labor Market
Classical economists
believe that the labor
market always clears.
If labor demand
decreases, the
equilibrium wage will
fall. Everyone who
wants a job at W* will
have one. There is
always full employment
in this sense.
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Classical Labor Market and
the Aggregate Supply Curve
The classical idea that wages adjust to
clear the labor market is consistent with
the view that wages respond quickly to
price changes.
This means that the AS curve is vertical.
Therefore, monetary and fiscal policy
cannot affect the level of output and
employment in the economy.
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Unemployment Rate and the
Classical View
The unemployment rate as measured by the
government is not necessarily an accurate
indicator of whether the labor market is
working properly.
The unemployment rate may sometimes
seem high even though the labor market is
working well.
The fact that people are willing to work at a
wage higher than the current wage does not
mean that the labor market is not working.
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Explaining the Existence
of Unemployment
The term sticky wages refers to the
downward rigidity of wages as an explanation
for the existence of unemployment.
If wages stick at W0
rather than fall to the
new equilibrium wage
of W* following a shift
of demand, the result
will be unemployment
equal to L0 L1.
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Explaining the Existence
of Unemployment
One explanation for downwardly
sticky wages is that firms enter into
social, or implicit, contracts.
These contracts are unspoken
agreements between workers and
firms that firms will not cut wages.
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Explaining the Existence
of Unemployment
The relative-wage explanation of
unemployment holds that workers
are concerned about their wages
relative to the wages of other
workers in other firms and industries.
They may be unwilling to accept
wage cuts unless they know other
workers are receiving similar cuts.
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Explaining the Existence
of Unemployment
Explicit contracts are employment
contracts that stipulate workers
wages, usually for a period of one to
three years. Wages set in this way
do not fluctuate with economic
conditions.
Cost of living adjustments
(COLAs) are contract provisions that
tie wages to changes in the cost of
living. The greater the inflation rate,
the more wages are raised.
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Explaining the Existence
of Unemployment
The efficiency wage theory is an
explanation for unemployment that
holds that the productivity of workers
increases with the wage rate. If this
is so, firms may have an incentive to
pay wages above the market-
clearing rate.
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Explaining the Existence
of Unemployment
If firms have imperfect information,
they may simply set wages wrong
wages that do not clear the labor
market.
Minimum wage laws set a floor for
wage rates, and explain at least a
fraction of unemployment.
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Short-Run Relationship Between
the Unemployment Rate and Inflation
The unemployment rate (U) and aggregate output
(income) (Y) are negatively related.
The relationship between Y and
the price level (P) is positive, as
depicted by the AS curve.
This macroeconomic
relationship has been
widely studied.
It shows that there is a
trade-off between inflation
and unemployment. To
lower the inflation rate,
we must accept a higher
unemployment rate.
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Phillips Curve:
A Historical Perspective
In the 1960s and
early 1970s,
inflation appeared
to respond in a
fairly predictable
way to changes in
the unemployment
rate.
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Phillips Curve:
A Historical Perspective
But in the 1970s
and 1980s, the
Phillips Curve broke
down.
The points on this
figure show no
particular
relationship
between inflation
and unemployment.
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Aggregate Supply and Aggregate Demand
Analysis and the Phillips Curve
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Aggregate Supply and Aggregate Demand
Analysis and the Phillips Curve
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Role of Import Prices
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Role of Import Prices
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Long-Run AS curve, Potential GDP, and
the Natural Rate of Unemployment
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The NAIRUThe Nonaccelerating
Inflation Rate of Unemployment
Many economists
believe the relationship
between the change in
the inflation rate and
the unemployment rate
is as depicted by the
PP curve in this figure.
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The NAIRUThe Nonaccelerating
Inflation Rate of Unemployment
To the left of the
NAIRU the price level
is accelerating
(positive changes in
the inflation rate).
To the right of the
NAIRU the price level
is decelerating
(negative changes in
the inflation rate).
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The NAIRUThe Nonaccelerating
Inflation Rate of Unemployment
A favorable shift of the
PP curve is to the left
because the PP curve
crosses zero at a lower
unemployment rate.
A possible recent source of
favorable shifts is
increased foreign
competition, which may
have kept both wage costs
and other input costs down.
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Inflation and Unemployment
Around the World, 1997 to 2000
Inflation and Unemployment Around the World, 1997 to 2000
UNEMPLOYMENT RATE INFLATION RATE
1997 2000 1997 2000
Canada 9.5 6.6 0.3 3.6
Australia 8.8 6.7 0.7 3.6
France 12.5 9.8 1.4 2.5
United Kingdom 5.8 5.7 4.2 6.4
Italy 12.2 10.7 1.5 2.9
United States 4.8 4.1 1.3 4.6
Netherlands 5.8 2.9 3.6 6.2
Sweden 7.8 4.1 0.1 1.4
Germany 11.4 9.1 1.7 1.5
Japan 3.5 4.6 5.4 0.8
Sources:
Sources: Economic Indicators, The Economist,
Economist, July 5 11, 1997; July 8 14, 2000. Reprinted by permission.
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair