EC114 Introductory Macroeconomics Core Lecture 3

Introduction

• Introductory Macroeconomics:
  • Week 1: National income measurement
  • Week 2: Total factor productivity and human capital.
  • Week 3: Unemployment and the labour market.
  • Week 4: Trade and Globalisation.
  • Week 5: Revision (Thursday) and midterm exam (Friday).
    • Sample paper: http://rpubs.com/jjreade/ec114_sample_ex

But first: Enhancement Week

• Come and play Settlers, 11:30am-2pm Monday, 12-2pm Tuesday.

Talking

• I don’t particularly like being grumpy.
• I simply would like that if you come to the lecture, you come for the lecture.
  • A time slot in which a lecture on introductory macroeconomics will be given.
  • A lecture is given by the lecturer to those willing to listen.
• If you want to socialise, there are plenty of other places for that.
• If you plan on talking during this lecture please leave now.
  • If you do talk, I will ask you to leave during the lecture.
• You have a responsibility to me and to your fellow students.

Forecast Competition - Week 3

• Oil prices on Friday February 6.
  • Submit here: http://goo.gl/forms/iE2IyYp8mQ

## [1] 46.11373

Breakdown of Labour Market

Cross-Country Comparisons

Youth Unemployment

Long Run Labour (Demand)

• Firms employ until marginal product of labour equal to real wage.
  • MPL curve also labour demand curve.

Long Run Labour (Demand)

Long Run Labour (Demand)

Labour Supply

• Income and substitution effects cancel eachother out.
  • Real wages go up without any effect on employment (rate).

• Equilibrium sometimes referred to as natural rate of unemployment.

Long Run Labour Demand and Supply

Natural Rate of Unemployment Across Countries

Diagrammatic Natural Rate of Unemployment

• Assumption: Labour and product markets not perfectly competitive.
  • Firms and workers may have some market power (potentially monopoly).
• Firms mark up prices above wages.
• Labour unions push wages above market rates.
• Unemployment reconciles these monopoly demands:
  • Unemployment forces wages demanded by workers down to equilibrium.

Diagrammatic Natural Rate of Unemployment

• Firm’s real wage demands consistent with desired profits, not unemployment.

Determinants of Natural Rate

• Firms set prices by rule (where \(x\) is % desired mark-up): \[ \frac{W}{P} = \frac{1}{1+\frac{x}{100}}. \]

r x <- 0:100 plot(x,1/(1+x/100),main="Resulting W/P ratio for value of x",xlab="x",ylab="W/P")

- Characterise union behaviour as, where \(b<0\) and \(u\) is unemployment: \[ \frac{W}{P} = A + bu. \] - Setting equal to each other: \[ u^* = \frac{1}{b}\left(A - \frac{1}{1+\frac{x}{100}}\right). \]

Determinants of Natural Rate

\[ u^* = \frac{1}{b}\left(A - \frac{1}{1+\frac{x}{100}}\right). \]

• Three separate influences on natural rate:

  • Product market power (\(x\)).
  • Sensitivity of wage demands to unemployment (\(b\)).
  • Monopoly power of labour unions (\(A\)).

Determinants of Natural Rate: \(x\)

Determinants of Natural Rate: \(A\)

Determinants of Natural Rate: \(A\)

Benefits Strengthen Position of Unions

• Higher benefits, unions demand higher wages.

Long Term Unemployed Weaken Position of Unions?

• Conversely, long-term unemployed less competition for employed.

Mobility Weakens Position of Employed

Beveridge Curve

Beveridge Curve, Updated

## [1] "JTSJOR"

## [1] "UNRATE"

• Find data: Job openings (goo.gl/ClhZKm), unemployment rate (goo.gl/ZGMup).

For the UK…

• Data from ONS: http://www.ons.gov.uk/ons/rel/lms/labour-market-statistics/january-2015/dataset--claimant-count-and-vacancies.html

What Lowers Unemployment?

• Active labour market spending:
  • Assist job search, re-training.
  • Subsidised job creation, apprenticeship schemes.
• Coordinated wage bargaining:
  • Numerous disparate unions may bid wages higher than small number of large unions.
  • Many continental European countries have strong unions but low unemployment.

What Lowers Unemployment?

What Lowers Unemployment?

7.7 A Flow Approach to Natural Rate of Unemployment

• Each month, many who are employed lose their jobs. Inflows into unemployment.
• Equivalently, many also cease to be unemployed in a given month.
• Natural rate of unemployment: Steady state for unemployment.
  • Implies inflows and outflows must equal each other.
• Implies \(pL=sU\), where \(L\) is total employment, U total unemployment.
  • \(p\) is probability person loses job, \(s\) probability person finds job.
• By definition employment (\(L\)) plus unemployment (\(U\)) is labour force (\(LF\)) hence \(LF=L+U\).
  • Hence \(pL=sU\) becomes \(p(LF-U)=sU\).

Flow Approach

• From \(p(LF-U)=sU\), use that unemployment rate, \(u\), is \(U/LF\). Note that: \[ p(LF - U)=sU \qquad \Rightarrow \qquad p\left(\frac{LF}{LF} - \frac{U}{LF}\right) = s\frac{U}{LF} \qquad \Rightarrow \qquad p(1-u)=su. \]
• Rearranging gives: \[ u^* = \frac{p}{p+s}. \]
• Natural rate of unemployment depends on:
  • \(p\): Probability of losing your job.
  • \(s\): Probability of finding a job.

Employment Protection Legislation

• Employment Protection Legislation (EPL): Measures to protect employed from dismissal.
  • Aim: Reduce \(p\).
  • Laws on dismissal practice, severance pay, notice periods, warnings, regulatory approval, etc.
• Consequence: EPL affects \(s\) also:
  • If firms aware of difficulties terminating employment, may employ fewer.

Whither Labour Market Reform?

• Flexible labour markets cause inequality, social dislocation andmore crime?

  • Relative cost of higher prison population to social security systems?

Both Approaches Work?

Finishing Up

• Ch 7: The labour market: Unemployment, employment (and growth).

• Material for week 4 classes: http://rpubs.com/jjreade/ec114_class2.
• Forecast oil price next week: <>

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