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 activelysearching 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 labourdiminishes 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