Chapter Thirty The Labor Market, Unemployment, and Inflation.

Chapter ThirtyChapter Thirty

The Labor Market, The Labor Market, Unemployment, and Unemployment, and

InflationInflation

The Labor MarketThe Labor Market

Demand for laborDemand for labor: quantity of labor hired by firms at various wage rates

Supply of laborSupply of labor: quantity of labor provided by households at various wage rates

The Classical Labor MarketThe Classical Labor Market

In the long run, the labor market must be in equilibrium.

QuantitySupplied

QuantityDemanded

The Classical Labor MarketThe Classical Labor MarketWage Rate

L0

Demand

Supply

W0

Units of labor

The Classical Labor MarketThe Classical Labor MarketWage Rate

L1

D0

Supply

W1

Units of labor

D1

L0

W0

Deriving the AS CurveDeriving the AS Curve

P Ld Y

P Ld Y

Explaining the Existence of Explaining the Existence of UnemploymentUnemployment

Sticky wages Efficiency wage theory Imperfect information Minimum wage laws

Sticky WagesSticky WagesWage Rate

L1

D0

S

W1

Units of labor

D1

L0

W0

L*

New equilibrium wage

UnemploymeUnemploymentnt

Efficiency Wage TheoryEfficiency Wage Theory

The efficiency wage theoryefficiency wage theory 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.

Minimum Wage Laws & Minimum Wage Laws & UnemploymentUnemployment

Wage Rate

L0

Demand

Supply

W0

Units of labor

WMin

UnemploymntUnemploymnt

Relationship between the price level Relationship between the price level and the unemployment rate...and the unemployment rate...

Price Level, P

Unemployment Rate, U

Phillips CurvePhillips Curve

The Phillips CurvePhillips Curve is a graph showing the relationship between the inflation rate and the unemployment rate.A negative relationship between unemployment and inflationAn empirical relationship that held during the 1960s

The Phillips CurveThe Phillips Curve

Unemployment Rate, U (%)

Inflation rate (%)

0

UnemploymentRate

InflationRate

1%

2%

3%

1%

4% 10%

Phillips curvePhillips curve

Explaining the Phillips CurveExplaining the Phillips Curve --Rightward Shift in AD-Rightward Shift in AD-

Price level and output riseEmployment increasesUnemployment decreasesPrice level and unemployment move in opposite directions.

Explaining the Phillips CurveExplaining the Phillips Curve -Leftward Shift in AD- -Leftward Shift in AD-

Price level and output fallEmployment decreasesUnemployment increasesPrice level and unemployment move in opposite directions.

0

1

2

3

4

5

6

7

8

9

10

2 4 6 8 10

1960s

1970s

1980s

Unemployment

Inflation

The Phillips Curve: U.S. ExperienceThe Phillips Curve: U.S. Experience

The Natural Rate of UnemploymentThe Natural Rate of Unemployment

The natural rate of unemploymentnatural rate of unemployment is a concept consistent with the notion of a fixed long-run output at potential GDP. Generally considered the sum of the frictional and structural unemployment rates.

The The NNon-on-AAccelerating ccelerating IInflation nflation RRate of ate of UUnemployment (NAIRU)nemployment (NAIRU)change in the inflation rate

Unemployment Rate, UU1 U2NAIRU

0

-1

1

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Review Terms & ConceptsReview Terms & Concepts

Cost-of-living adjustments (COLA’s)

Cyclical unemployment Efficiency wage theory Explicit contracts Frictional

Unemployment Inflation rate

Labor demand curve Labor supply curve Minimum wage laws NAIRU Natural rate of

unemployment Phillips Curve

Review Terms & Concepts Review Terms & Concepts (cont.)(cont.)

Relative-wage explanation of unemployment

Social, or implicit, contracts Structural unemployment Unemployment rate