3.
The Labour Market
The Labour Market
• Introduction to Labour Market
• Movements in Unemployment
• Wage Determination
• Price Determination
• The Natural Rate of Unemployment
The Labour Market
• Firms responds to increasing demand by increasing production
• Higher production leads to higher employment
• High employment leads to low unemployment – buy Zambia
• Lower unemployment leads to higher wages
• Higher wages increases production costs leading to firms increasing
prices etc..
Medium Run
• So far we assumed a constant price level where IS – LM models
assumed firms would supply an amount of output at a given price
level. Our focus was on on the short-run
• Now we shift our focus on Medium Run
• Explore how prices and wages affects output over time.
Labour Market
• What do we understand by Labour Market?
Zambia labour market
• Labour force
• Unemployment rate
Zambiastats (central stats-2022)
• Popu==19.5
• Labour force==3.7m. 36.1%
• Employment==3.3m 31.3%
• Unemployed==474,000. 12.6%
• Formal employment==776,000
• Informal employment==2.5m
Movement in unemployment rate, statista 2024
Too high unemployment
When unemployment is high, workers are worse off in two ways:
• Employed workers face a higher probability of losing their job.
• Unemployed workers face a lower probability of finding a job;
• equivalently, they can expect to remain unemployed for a longer
time.
Wage Determination
• Wages are set in many ways. Sometimes they are collective
bargaining
• Collective bargaining is bargaining between a union (or a set of
unions) and a firm (or a set of firms).
• How is it done in Zambia?
Two sets of facts
• Workers are typically paid a wage that exceeds their reservation
wage, the wage that would make them just indifferent between
working or not.
• Wages typically depend on labour market conditions.
• The lower the rate of unemployment, the higher the wages will be.
Bargaining power
• The nature of the job determines how costly it is for a firm to replace
a work. The higher the cost of replacing a worker, the more bargaining
power will have and higher wages will be.
• Labour market conditions also determine the cost of replacing a
worker. Low unemployment means that it will be more difficult to find
replacement, so workers have more bargaining power, and wages are
higher
Efficiency Wage Theory
• Efficiency wage theories suggest that wages depend on:
• the nature of the job
• labour-market conditions.
• Firms, such as high-tech firms, that see employee morale
and commitment as essential to the quality of their work will
pay more than firms in sectors where workers ’activities are
more routine.
• Labour-market conditions will affect the wage. A low
unemployment rate makes it more attractive for employed
workers to quit.
The wage setting equation
• Wage determination:
W = P F ( u, z )
e
Aggregate nominal wage W depends on the factors:
• The expected price level, Pe
• The unemployment rate, u
• A catch-all variable, z, that stands for all other variables that may affect the
outcome of wage setting.
Price determination
• Prices are set by profit-maximizing firms.
• The ability of setting prices requires market power, so the market is
not perfectly competitive.
• In such a case, firms charge prices above their marginal costs.
Price determination
• The price setting equation is given by
• P = (1+m)W
• Where m is the markup of the price over the cost.
• M is positive and p, will exceed the cost, W, by the factor equal to (1 +
m).
The natural rate of unemployment
• What are the implications of wage & price determination for
employment?
• we assume that Pe = P.
• nominal wages depends on actual price, P rather than expected Pe.
• Under this assumption we also assume that, wage setting and price
setting determine the equilibrium (also called natural) rate of
unemployment:
Wage-setting relation
• Wage determination
• W = P F(u,z)
• Dividing both by p, we get:
• W/P = F (u,z). (wage-setting relation)
• Wage determination implies a negative relation between the real
wage and unemployment. The higher the unemployment rate, the
lower the real wage chosen by wage setters.
Graphically…
Price-setting relation
Price determination
• P/W = 1 + m
• Invert both sides we get:
• W/P = 1/1 + m
• Price-setting decisions determine the real wage paid by firms.
• An increase in markup leads to increase their prices given the wage
they have to pay – which leads to a decrease in real wage.
graphically
Equilibrium Real Wage and Unemployment
• Equilibrium in the labor market requires that the real wage chosen in
wage setting be equal to the real wage implied by price setting.
• F (u ,z) = 1/(1+m)
• Labour market equilibrium requires consistency of wage setting and
price setting.
Labour Market Equilibrium
The Natural Rate of unemployment
Now we look at the implications of wage and price determination for
employment.
Unemployment benefits & natural rate of
unemployment
Markups & natural rate of unemployment
summary
it is clear, for a given labor force,
• the unemployment rate determines the level of employment,
and that, given the production function, the
• level of employment determines the level of output.
• Associated with the natural rate of unemployment is a natural level of
output.
• Equilibrium in the labor market: It characterizes the natural rate of
unemployment, which is the rate of unemployment to which the
economy tends to return in the medium run.
