Labour Market

• Total population = potential workers + the rest
• Potential workers = labour force + the rest
• Labour force = unemployed + employed
• Potential workers are divided into three categories:

  • Employed persons hold a paid full-time or part-time job.
  • Unemployed persons are without a job and are actively searching for a job.
  • “Not in the labour force” people are those without a paid job and not actively searching for one (hysteresis).
• Unemployment rate = Unemployed / Labour Force * 100
• Participation rate = Labour Force / Potential Workers * 100
• The labour demand curve is the value of the marginal product of labour because profit-maximising firms hire workers until that value equals the wage.
• A firm will hire if the marginal benefit is greater than or equal to the additional cost.

  • The marginal benefit is the value of the marginal product of labour - the increase in revenue resulting from hiring an additional worker.
  • The marginal cost is the market wage.
• The labour demand curve slopes downward because the marginal product of labour diminishes as more labour is used.
• The labour demand curve shifts when a change in any of the following occurs:

  • Derived demand
  • Technological progress and high productivity
  • Input prices of capital and land
• The labour supply curve is derived from “Household Behaviour” - the choice between consumption and leisure (or non-market work).
• An increase in real wage (relative price of leisure to consumption) induces substitution and income effects.
• The labour supply curve is upward-sloping when the substitution effect is stronger than the income effect.
• The labour supply curve shifts when a change in any of the following occurs:

  • Tastes or preferences
  • The opportunity cost of time
  • Population and demographics
• Frictions are obstacles, or barriers, to the clearing of markets.
• Wage rigidity is caused by

  • Minimum wage laws
  • Unions negotiating higher wages.
  • Firms paying higher wages to raise worker productivity
  • Workers resisting wage reductions
• Workers are highly averse to reductions in wages, resulting in what economists call downward wage rigidity. As a result, most firms would rather fire some workers than cut the wages of all or many workers.
• Similar to decomposing GDP into trends and business cycles, the actual unemployment rate can also be decomposed into:

  • The natural rate of unemployment – the average unemployment rate over an extended period
  • Cyclical unemployment – deviation of the unemployment rate from its natural rate