Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Chapter 4
Labour Markets and
Unemployment
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Household preferences
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.01
Consumption
A household indifference curve:
utility held constant
gain
pain
More leisure = less work
Leisure
0
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.01
Household preference.
Economic interpretation of the geometry
♦ Slope. (<0) Substitution of leisure for consumption
♦ Curve. Marginal rate of substitution is not constant. The
less leisure you have, the less leisure you are willing to
sacrifice for one more unit of consumption (holding utility
constant).
♦ Shift. Level of economic welfare (utility).
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.01
Consumption
Household preferences
Higher utility
Lower
utility
Leisure
0
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Household budget line and optimal choice
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.02
The household budget (zero non-labour income)
w 
Consumption
B
w  C
We "buy
back" our
leisure time
earnings
if we work
all day
spending
rest on
goods
(  )w  C
actual earnings
slope =-w
0
©EGEA 2006
A
Leisure
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.02
Highest attainable indifference curve is tangent to
this budget constraint for those who work
Consumption
B
We can do
better than this!
Nice but we
can’t afford it!
A
0
©EGEA 2006
Leisure
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.02
Optimal choice
Consumption
B
R
Consumption
slope =-w
0
©EGEA 2006
Leisure
Work
A
Leisure
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Reaction of the household to a wage increase:
Labour supply
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.03
Wage increase chances budget set
Consumption
B
R´
R
A
0
©EGEA 2006
Leisure
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA

w   C ,  
 
Assuming both consumption and leisure
are normal goods and that the substitution
effect for labour supply is greater than the
income effect.
©EGEA 2006
Figure 4.03
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA



Real wage
w 
Figure 4.03
(Upward sloping)
household labour supply curve
Labour supply
0
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
The production function and
the labour demand curve
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.05
Output (Y)
Firm has a production function and it pays
the real wage w1
Real wage
Labour
w1
Labour
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.05
Output (Y)
Wage costs increase with employment
R1 (slope = w1)
Real wage
Labour
w1
Labour
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Output (Y)
Determine L1 so that MPL1=w1
A1
R1 (slope = w1)
Real wage
Labour
©EGEA 2006
w1
L1
Labour
Figure 4.05
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Output (Y)
Now determine L for a lower wage, w2
A1
R1 (slope = w1)
R2 (slope = w2 )
Real wage
Labour
©EGEA 2006
w1
w2
L1
Labour
Figure 4.05
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Output (Y)
Find L2 so that MPL2=w2
A1
A2
R1 (slope = w1)
R2 (slope = w2 )
Real wage
Labour
©EGEA 2006
w1
w2
L1
L2
Labour
Figure 4.05
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.05
Output (Y)
Connect the dots to derive the demand for labour
A1
A2
R1 (slope = w1)
R2 (slope = w2 )
Real wage
Labour
©EGEA 2006
w1
w2
MPL
L1
L2
Labour
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.05
Economic interpretation of geometry of the
demand for labour
♦ Slope. Negative because MPL falls as we move to
the right along the production function.
♦ Curve. Here there is no reason to expect curvature
one way or the other. Note that an absolutely linear
demand for labour implies a quadratic form of the
production function.
♦ Shift. Capital accumulation or productivity change.
(Figure 4.6)
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
An increase in labour productivity
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.06
An increase in labour productivity (A increases)
Output (Y)
Y  F  A  L,K 
Real wage
Labour
F
MPL 
A
  AL 
MPL´
MPL
Labour
©EGEA 2006
Hold L constant
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Equilibrium in the labour market
©EGEA 2006
Figure 4.07
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.07
Real wage
Supply
consumption
Labour market: first blade of scissors
leisure
Labour hours
0
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.07
Real wage
output
Labour market: second blade of scissors
Labour
hours
Demand
Labour hours
0
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.07
Equilibrium in the labour market
Real wage
Supply
A
w
Demand
Labour hours
0
©EGEA 2006
L
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.07
Voluntary unemployment
L
Real wage
Supply
A
w
Demand
Labour hours
0
©EGEA 2006
L
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Shifting labour demand and supply
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.08
Increase in labour demand
(MPL increases because of increase in A or K)
Real wage
Supply
w,L
both
increase
A´
A
Demand
Labour hours
0
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.08
Increase in labour supply
(e.g. new entries through immigration)
Real wage
Supply
w falls,
L rises
A
A´
Demand
Labour hours
0
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Involuntary unemployment
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.09
Wage fixed above market-clearing level
Real wage
Household labour supply
It’s a free market, so
the short-side
determines actual
employment.
B
w
w
A
Labour demand
Involuntary unemployment
0
©EGEA 2006
L
s
L
Labour
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Trade unions’ indifference curves
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.10
Employment
(a) Average
©EGEA 2006
Real wage
Real wage
Real wage
Trade unions’ indifference curves
Employment
Employment
(b) Hard-line
(c) Jobs-first
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
The collective labour supply curve
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.11
Collective labour supply curve
Real wage
Collective
Labour Supply
Labour
Demand
Employment
0
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Labour market equilibrium with a trade union
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.12
Labour market with a trade union
Real
wage
Collective labour supply
Household labour supply
w
B
A
w
Labour demand
0
L
L
s
L
Union-voluntary, individual-involuntary unemployment
©EGEA 2006
Labour
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Minimum wages
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.13
No unions, no minimum wage
Real
wage
Household labour supply
A
w
Labour demand
0
©EGEA 2006
L
Labour
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.13
Add unions, no minimum wage yet
Real
wage
Collective labour supply
Household labour supply
w
B
A
w
Labour demand
0
L
L
s
L
Union-voluntary, individual-involuntary unemployment
©EGEA 2006
Labour
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.13
Adding a minimum wage above union wage
Real
wage
wmin
w
Collective labour supply
Household labour supply
C
B
A
w
Labour demand
0
Lmin L
L
s
s
L Lmin
Unemployment under a minimum wage
©EGEA 2006
Labour
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
A map of labour markets
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.14
All working age people are in one of three states
Employed
Unemployed
Not in
labour force
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.14
Gross flows starting from state of employment
Quits
to
other
jobs
Employed
Layoffs
Quits to
unemployment
Retirements
Not in
labour force
©EGEA 2006
Unemployed
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.14
Gross flows from state of unemployment
Job finds
Quits
to
other
jobs
Employed
Layoffs
Unemployed
Quits to
unemployment
Retirements
Discouraged
Not in
labour force
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.14
Gross flows from out of the labour force
Job finds
Quits
to
other
jobs
Employed
Retirements
Layoffs
Quits to
unemployment
New
Unsuccessful
entries
new entries
Not in
labour force
©EGEA 2006
Unemployed
Discouraged
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Actual and equilibrium employment
©EGEA 2006
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.17
Equilibrium employment
and unemployment
Real
wage
Wage offer curve
w
Individual
labour supply
A
Labour demand
L L
s
0
©EGEA 2006
L
s
L
Labour
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.17
Actual employment when real wage is not equal
to the equilibrium real wage
Real
wage
Wage offer curve
w1
w
w2
A1
Individual
labour supply
A
A2
Labour demand
0
©EGEA 2006
L1
L L2
s
L
Labour
Burda, Wyplosz
MACROECONOMIA: UNA PROSPETTIVA EUROPEA
Figure 4.17
Actual unemployment when real wage is not
equal to the equilibrium real wage
Real
wage
Wage offer curve
w1
w
w2
A1
Individual
labour supply
A
A2
Labour demand
0
©EGEA 2006
L1
L L2
s
L
Labour