Today we're going to look at the we're
going to start looking into the labor
market. Now the labor market
is very interesting for a wide variety
of reasons that we will not discuss in
this course because it's not about labor
economics, it's about macroeconomics.
But there are at least two reasons
why labor markets are very important in
in macro.
One is because things like an employment
rate
is an very important indicator of the
macroeconomic health
of a country or an an economy.
And the second one
which is quite relevant these days is
that the inflation rate
is
one of the main drivers of the inflation
rate is what is going on in the in the
in the labor market. And and we will try
to understand this this mechanism
in the next couple of lectures.
What you have there is the is the
inflation rate in the US and I'm I'm
showing you this picture several times.
You know, after going through a long
period in which the
inflation rate hovered around 2%, you
know, with cycles
we are experiencing an episode of very
high inflation.
Things are coming down, but they're
still at extremely high levels, 6% or
so. And actually very recently these
numbers have picked up again a little.
So that's very high
very high inflation rate, way too high
for an economy like the US to feel
comfortable with. And
whenever you know
some member of the FOMC comes out and
explains why interest rates are so high
at this moment it says and and and and
explains why they are likely to remain
high for quite a while. They say, "Well,
look, inflation is uncomfortably
uncomfortably high at the high levels
and and labor market conditions are very
tight."
And that suggests that the inflation
problem is not likely to go away in in
in in the near future. Okay? So that's
something we need to understand in
macro. Why is it that the labor market
being tight says anything about the
inflation rate, for example. Okay? And
that's the kind of things we're going to
discuss
in particular in the on on the Monday
lecture.
Now today we're going to start with sort
of more basics of the of of of the
of the labor market.
And
and at the same time we're going to
begin a transition in the course in
which we have been focusing on things
that are
in the very short run into things that
take more time. Okay? Because many of
the things that we we're going to
discuss today are things that you're not
likely to see in in every single
quarter, but they are things that you're
likely to see over averages over, you
know, several quarters, several months.
That's what we're going to look at
today.
So remember let me just recap a little
bit what we have been doing up to now.
We have been looking at this ISLM model
which is a great model.
It's it's a very good model
to build on, but it's a very nice model
starting point to understand what
happens in a recession and what are the
what are what are the likely
what are the likely impact of the
different macroeconomic policies,
monetary policy, fiscal policy and so
on.
It is not such a great model
once
the aggregate supply side of the
economy, something we have completely
ignored
starts becoming binding.
Okay? Remember that till now in the ISLM
model we had basically ISLM model we had
two assumptions.
Related assumptions. One, prices were
fully sticky. They didn't move at all.
Second, that output was aggregate demand
determined. So whatever aggregate demand
wanted
producers found a way to produce it at
some given price.
That's that
that combination is unlikely to happen
when for example, when
firms are finding trouble finding new
workers because, you know, there may be
more demand, more demand for these
goods, but but the firm may find it hard
to expand production.
And it's also highly likely that in a
situation like that firms are going to
want to keep prices constant. At some
point they will kill you. Look, you you
want to have lots of meals in my
restaurant. I cannot find people to work
in my restaurant. I'll
I'll I'll hide the prices so at least,
you know, fewer tables and I can manage
one way or the other.
So
we're going to start building a model
that
makes those takes those things into
consideration. What what is the impact
of
of a tight supply side of the economy on
on prices and and and how that starts
affecting feeds back into equilibrium
output eventually.
So the main thing I would say we're
going to do really
relative to ISLM model in the next two
three lectures is endogenize the
inflation rate. Okay? We have kept
prices fixed.
But now we want to endogenize.
And and the story of that endogenization
of
of of inflation starts from the labor
market. And that's the reason we're
going to start looking at the labor
market today. Okay?
Now let me remind you a few things that
I think we discussed in the first
lecture or so or maybe second, I don't
remember.
Let me give you a picture of the labor
market and some variables
important statistics of the labor market
that are
that that
that that matter for for understanding
inflation and so on.
So this is a picture that's this is the
one that you have in the book of
the labor the the labor market. It's a
picture of the labor market at some
point in 2018. I don't know when. It's
it's a picture at one point.
And that's at the time the US had about
330 million people.
That the non-institutional civilian
population, that is those people that in
principle could work
were about 260 million.
That excludes people under 16 years old,
people that are incarcerated, people
that are in the in the armed forces.
Those are excluded from
that's the difference. That's the reason
you have such a big gap between these
two numbers. Okay?
Now out of these people that potentially
could work some of them
want to work and that's what we call the
civilian labor force
and then some of them are out of the
labor force.
Again, at one point in time doesn't mean
that these people are permanently out of
the labor force. They may be temporarily
out of the labor force and so on.
But but about, you know, we started with
about 330 million and by the time that
we look at the people that really want
to work
at that point when the picture was taken
was about half of that, 162 million
people. Okay?
Now these 162 million people
the the great majority of them are
typically employed. They have a job.
Okay?
And then there's a group of people that
would want to have a job. That's the
reason they're part of the civilian
labor force, but do not have one.
And that's about 6 million in that
picture there. Okay?
So when you hear unemployment or the
unemployment rate you're really talking
about these people here. And when you
talk hear about the unemployment rate is
these people not divided over total
population, but it's these people
divided by the civilian labor force.
Okay? So that's the picture.
The US.
The most recent numbers we have about
that kind of statistics is
here you have them. I mean, the
unemployment rate in the US today is
about 3.4%. That's very low. I'll show
you
historical data in a minute and I have
shown you historical data in the recent
past. But this number is very very low.
And
the change in the employment level
in in this is for January
was a reduction. This is this is not
rate. It's number of people that are
that are that were no it's not number of
people that were employed that are no
longer so. You look at the total stock
of unemployed in December and then you
look at the total stock of unemployed in
January 2023. The difference between
these two is 28,000 workers. So 28,000
less workers are in the unemployment
pool.
Now notice that how this number is made.
It's it's not it's not that that, you
know, 25 28,000 people just gained a
job. That's not what happened.
What happens is
first
employment 895,000
and 84,000 people got a job.
Much bigger number.
But also the civilian labor force went
up by 866
and
thousand people. Okay? So if you go back
to
this picture, what you have in in
January
or the numbers reported in January, I do
not know which month they correspond to
exactly is that yes, this this decline
but that decline was made of
a big increase in employment
together with a big increase in the
civilian labor force. Okay?
So that must have been mostly movement
out of the labor force and probably had
that something to Well, I'm not going to
get into that here, but
All these numbers are seasonally
adjusted, so they're corrected relative
to what happens normally in January and
so on.
And COVID and weather can sort of derail
a lot
what happens in January, February.
Numbers tend to be very noisy. Since
COVID, they have been very noisy because
the seasonal adjustments are different.
And and also weather matters a lot in
January, February and so on. So, you can
get pretty large fluctuations which are
really not that interesting to
macroeconomists, but anyways, those are
the numbers.
You look at the civilian labor force
participation, then it was about 62%,
62.5%.
And the employment population ratio is
of the order of 60%, okay? So, the
employment population ratio is is just
this
uh divided by total population, okay?
Um
Those are the averages. The number of
unemployed in 2022, about 6 million
people. That's that's unemployed.
Okay.
So, there you have the unemployment
rate, you know, and it moves as you
would expect it. It typically goes up in
recessions. Uh
the last sort of large recession we had
big swings.
Uh one thing that was interesting and we
couldn't quite understand what was going
on is as you notice right before COVID,
the unemployment rate had already
declined to very low levels.
And so, people were wondering whether
something we're going to talk about
later in the this lecture, whether the
natural rate of unemployment had changed
for some reason.
We'll come back to that. Then we got we
got COVID, obviously a very
recessionary shock initially, massive
unemployment and so on.
But then it came back very quickly and
today we have record low levels of
unemployment. We hadn't seen numbers
like this since, you know, the '60s,
uh really. Very low levels of
unemployment. So, when when uh one of
the things that that
when you hear the FOMC members talking
about the labor market being very tight,
well, one of the things they're looking
at is this. One, there are other
statistics I'll show you, but but but
this is one of them. The unemployment
rate is really, really low.
Sometimes again, especially post-COVID
because of movements in and out of the
labor force, uh
the unemployment rate is not such a
great statistic, not as reliable because
many people left the labor force. So,
people look a lot at the
employment rate, uh which is this is
this is um this is
not the employment population ratio,
it's employment rate. So, employed over
uh
uh the non-civilian
population, no?
And that number, you can see we have
discussed this before,
was trending up here because of the
increase in the labor participation of
women, then it came down, had a lot to
do with the students and things like
that, uh systematically, but then it was
climbing up enormously, it collapsed
during COVID. That's mostly unemployment
and and and and and people out of the
labor force.
Uh
and then recovery, but the recovery has
not picked up to back to the trend. See,
we are back to sort of more or less the
levels we had before COVID, but we're
certainly off the trend.
And one of the reasons the labor markets
are very tight is that is that we
haven't recovered sort of uh
the employment uh um
rate that that we used to have, okay?
This has to do with migration flows,
with a variety of things, uh but that's
that's the issue.
Okay. So, that's that's sort of
those are very static pictures of the
labor market. What is the stock of
unemployment at one point? What is the
unemployment rate and so on and so
forth?
But the truth is that labor markets are
very dynamic,
especially in an economy like the US.
The flows are very large. So, what I
have there, and I don't know for which
date, this is in the book, but the
pictures look more or less the same for
the point I want to make.
This is monthly labor flow flows. And
this
this happened in some month, I don't
care, 2018 at some point.
Look at what happened there.
You have this is we were talking about
the stocks recently. So, employment in
that month was of the order of 132
million uh dollars, 132 million people,
okay?
Out of the labor force, about 79 million
people. Unemployed, about 8.6 million.
That's those were the stocks. Those were
the type of numbers I was showing you
before, okay?
But look at these arrows.
These are flows. So, in every single
month, you see in the US about 3 million
people that move from one job to
another. So, employment to employment.
You see about 1.8 million that move from
employment to unemployment.
And about 2 million people that move
from unemployment to employment. Large
flows.
Not only so, not everything goes from
unemployment to employment. There are
people that are also moving out of the
labor force and into the labor force,
into unemployment, into employment. Here
in this particular case, out the flow
out of the labor force into employment
is 3.4 million.
Flows from employment without going
through unemployment to out of the labor
force, 3.7 million.
Okay. During COVID, there was a this
must have been a very thick arrow.
Lots of people move out from employment
to out of the labor force, okay?
And and one of the problems the economy
has had in the recovery on the on the
labor market side is that this arrow
hasn't been as strong as we would want
it.
Okay.
This arrow, or this arrow for that
matter of fact, people coming coming out
of the labor force into unemployment,
that's also big flow.
Sometimes people are not working and
then they decide that, you know, they
run out of unemployment insurance or
something like that, and so they decide
to start looking, you know, and they
move
into unemployment here,
okay?
Or or they run out of savings and and
they have to come back and they may not
find a job initially. They have to go
through unemployment,
okay?
So, the point is that these flows are
very large.
And and the
and these flows matter a lot
uh
for for the kind of things we want to
talk about in in this course.
Look at what we have here.
Uh
the red line is the unemployment rate
and it's measured on the left axis.
And what we have here in the blue line
is measured in a in an inverse scale.
Look at this this goes up
as you go down.
Is is the
percentage of employed unemployed
workers becoming employed.
Okay.
So, it's the job finding rate from
unemployment. So, you have unemployed
people
and they will be finding jobs. They will
be looking for jobs and they will be
finding jobs.
This number here, this blue line here,
shows you
uh the likelihood that they'll find a
job
in inverted scale,
okay? So,
what do you what correlation do you
notice there?
It's very tight.
Yeah. As the percent of people
um that get a job each month is smaller,
there's more people without a job.
Exactly. That means when the
unemployment rate is high,
it is harder for unemployed workers to
find a job.
Or another way of an direct implication
of that is that a typical unemployed
worker will spend more time in
unemployment because they're going to be
looking for jobs and it's more
it's harder to get a job, so you're
going to be looking for a job for a
longer period of time.
Why are we talking about these things?
Well,
because of this type of
uh
reasons. Well, this means that when
unemployment is high, workers are worse
off in at least two ways.
And there are two ways that are going to
be important for what I'll say next.
One
is that the employed workers face a
higher probability of losing a job.
That's what happens when unemployment is
the reason unemployment gets to be high
is because
firms are firing workers and so on and
so forth, no? And so
so so when unemployment is high, the
first thing the workers know is that
it's very likely they'll lose their job,
more likely that they'll lose their job.
But the second channel, which is what
this picture highlights here, is that is
that if you fall on employment, it's
going to take a it's going to be a lot
harder to get out of unemployment,
okay? So, when unemployment is high is
high, it's scary for workers for two
reasons. Once, you're more likely to
lose a job because it's capturing
recessionary conditions and so on in the
economy, but second, if you end up in
unemployment, it's going to be hard to
get out of it,
okay?
And and later on this unemployment rate
is going to show up in wage bargaining
and the main reason it's going to show
up is of this kind.
And also think about the other side.
When there's bargaining, there's two
There's going to be firm and workers.
From the firm point of view,
if there's a lot of unemployment, do you
think it's hard or or or or or easy to
find a worker?
If you replace a worker that decides to
leave for whatever reason,
Easy, no? You have lots of people to
choose from, so it becomes easy. So,
unemployment is high, workers are more
scared.
If they get out, it it is they're scared
of losing their job. If they get out,
it's it it's it's hard to get a job. And
on the other side, the firms for the
firms, it's not that they're scared to
lose a worker because it's pretty fairly
easy to replace that worker.
Today, firms are very worried about
losing their workers. In some sectors,
no, in some sectors are getting rid of
workers, but but if you run a
restaurant, you're very scared of losing
your your your workers, you know,
because it's going to be very difficult
to find a replacement for that worker.
So, surprise, surprise, wages in that
industry are going up a lot, okay?
We're going to get there.
So, that's what comes in wage
determination. Look at the what I'm what
I'm trying to build here. I'm starting
from telling you stories about the labor
market, what things are important for
workers, and so on.
Now, I'm going to get into wage
determination, and obviously this
variables I talked about are going to be
important in this wage determination,
but my ultimate goal is to talk about
inflation. So, the next step, so I'm
going to talk about wage determination
here, and then we're going to talk about
prices, and there we're going to be one
step closer to talking about inflation,
okay? So, let's go through the
intermediate step, wage determination.
Uh
So, just to give you a little
background, you know, sometimes
uh wages are set by collective
bargaining, unions
in particular.
Now, in the US, unions are not a big
thing.
Okay? They were a much bigger thing many
years back.
They aren't today.
Um
in other economies, they are a big
thing, okay? Japan, in Europe.
Uh
and the unions can happen at different
levels of aggregation, at the level of
the firm, at the level of the sector,
and and and and
and you name it.
In general, regardless of the level you
of unionization you have
uh in a country or in a sector,
the higher the skill needed to a job,
the more likely this other bargaining
takes place between an individual
between an employer and an individual
rather than a union, okay? Because it's
sort of much more idiosyncratic
and customized, and so on.
But, either way, regardless of whether
uh whether uh uh wages are set
at a collective level or at at the
individual level,
the main macroeconomic drivers
of uh wages are similar across both of
them.
Of course, the particulars are going to
be different, even the dynamics can be
different, and so on. But, the big
drivers, the big macro drivers
are similar, regardless of the
bargaining mode you have at the level at
which it happens, and so on. And those
are the things we're going to highlight
here.
So,
a fact of life is that workers' wages
typically exceed the reservation wage.
Now, what does it mean the reservation
wage? The reservation wage is a wage
that would leave you indifferent between
employed or unemployed. Doesn't mean
there's a nice wage, anything. But,
I mean, that's and certainly doesn't
mean that you wouldn't prefer to have to
have a higher wage.
But, it tells you that, look, at that
wage, you'd rather be employed than
unemployed.
Okay? And there's a wait long list of
reasons why
that ends up being the equilibrium type
wage, and I'm not going to discuss them
here,
but
take it as a fact for now.
Okay? So, that is
workers prefer to be employed.
They may take the risk of becoming
unemployed, but they typically prefer to
be employed.
Um
Now, wages, and this is where it becomes
uh
uh important for interesting for us in
macro, is
the wages that are finally set depend
on labor market conditions.
So, very clearly, the lower is the
unemployment rate, the higher the wages
will tend to be. Okay? And you're seeing
it now. The unemployment rate is very
low, wages are rising a lot.
Okay?
And workers' bargaining power depends on
this again. There's a huge literature on
these things, I'm just compressing it
into
as the very minimums.
Uh the bargaining power of a worker is a
thing that we already discussed.
Well, it depends on how costly for the
firm to find a worker. So, obviously, if
unemployment is very high, it's very
easy for firms to buy a work find a
worker. That's not good for the
bargaining for of a work If you want to
bargain with your employer,
and there's lots of people like you out
there,
uh you're not going to have a lot of
bargaining power. So, it's unlikely that
you're going to come up with a very high
wage, okay?
Uh
and it's also the other side of it is
how hard it is for workers to find
another job if they were to leave the
firms. I mean, if you know that there
are lots of jobs like the one you
currently have out there which are not
occupied, so there's empty vacant jobs,
then you're probably going to have a
much stronger hand with your employer
because you can say, "Okay, if you don't
pay me what I want, I move to the next
door." Okay?
And in terms of the macroeconomic
variables we care about,
a situation like that is very likely to
happen when unemployment is very low.
Okay?
Because that means that other
jobs
are are unlikely to be filled
because, you know, there there are lots
of people looking for things, but it's
difficult for the firms to find
the workers, and therefore
you're going to be a lot more attractive
to that
labor market.
So, in summary,
at the aggregate level,
we can write a wage-setting equation
of this form.
So, the wage, and this is the nominal
wage,
uh
can be written as an increasing function
of expected price.
Meaning, wages are not set in most
professions, they're not set second
second by second. You set them you know,
you bargain for a wage, and so on, and
that thing it sticks for a year or so,
at least.
Some Okay?
Well, obviously, if you expect this
inflation is zero,
you know, you're going to demand a wage
that is more or less
what you need today.
If inflation is 10%,
you you say, "Well, I'm going to have to
demand a higher wage because I have to
live with this wage for a year, and
prices are going to be rising while
while I have this wage." And so so, if
they expect lots of inflation, if they
expect prices to be high in the future,
they're going to ask for a higher
nominal wage today because I'm going to
have to live with that wage on average
for the next uh
year or so, okay? So, that's the first
thing, and it's going to play an
important role. It says wages are an
increasing function on the price level
workers expect. They expect a high price
level in the future or during the life
of the wage contract, then they
obviously going to demand a higher wage.
Other things equal.
What are other things? Well, the the
arguments of this function here.
Unemployment.
If I'm employed for any given expected
price, if the unemployment rate is high,
workers are going to demand a lower
wage.
Why is that?
Because it's going to be um harder for
them to find a job, so they have less
bargaining power. They have less
bargaining power, exactly, okay?
Um so, they're going to like they're
going to demand a lower wage.
This variable Z here
is a catch-all variable for
a a strength workers' strength in the
bargaining position situation, something
like that. So,
uh
for example, uh
this is things like uh employment
protection laws.
Okay?
Firing costs. If it is difficult to fire
someone, the Z will tend to be high. So,
this only tells you that given the level
of unemployment, if it is very hard to
fire someone, wages workers are going to
be willing to they're going to they're
very likely to demand a higher wage. No,
it's hard
it's hard for you to fire me,
I'm going to bargain harder for my wage,
and this type of institutions
institutional factors play a huge role
in Europe, much more than in the US.
Okay?
Good.
But, as a matter of a definition, we're
going to say
an increase in Z is Z is something that
increases the bargaining power of
workers. Okay?
And therefore, for any given level of
unemployment and expected prices,
they're going to lead to a higher wage
demand. This is the wage This is the
workers' demand in a wage.
We have to figure out what happens in
equilibrium, but this is what the
workers are demanding. Okay?
Is it clear what we have here?
Good.
So, let's now move to the other side.
Okay? So, that's one side of the
scissor. We have the workers, and they
given certain
macroeconomic conditions summarized by
the unemployment rate and expected
prices, they demand certain wages.
Now, we can't find equilibrium wage
until we don't see the other side, what
firms are willing to pay, and so on. So,
we need to explore this other side.
And the starting point of that other
side
is the production function, meaning
you know,
uh
firms are going to end up setting prices
for goods,
but producing those goods will take
factors of production. They're going to
have to use something
uh to produce that.
And the cost of that something will
determine, importantly, what is the
price they end up charging.
I'm going to simplify things a lot here.
Uh I'm going to assume the production
function is first linear and linear only
on labor, so no other factors of
production.
Meaning,
this says that to produce one unit of
the aggregate good,
uh
you need well,
this says that if you have if you add an
extra worker
uh uh,
to the big production function of the
economy,
then you're going to get a more units of
output.
Okay?
That's what this says.
So, Y is output, the output we've been
talking about, measured in the way we
have been talking about and so on.
N is employment, and A is labor
productivity. That is the output per
worker.
Okay?
I want to make things very simple. We're
going to talk a lot about in the next
part of the course, in the part of
growth, about this A, what moves this A
over time, what it does, and so on.
But, but,
I'm going to simplify things a lot here
for now, and I'm going to set A equal to
1.
So, it doesn't get any simpler than this
as a production function. This
production function says, you want to
produce one more good, you need one more
worker.
Okay?
This is what this says.
If you have 10 workers, you produce 10
units of good.
If you have 11 workers, you produce 11
units of goods. Okay, so to produce one
more unit of good, you need
one
worker more.
Now, why do you think I'm
I'm simplifying it so much and I'm right
I'm even repeating this idea that one
more worker, one more unit of good.
That tells you that how much does it
cost to the firm
to the firm that has this production
function
to produce
one extra unit of workers or
one extra unit of goods?
Well, you have to ask the question,
well, what will the firm have to do?
Well,
the first So, suppose a firm wants to
produce one more units of goods. What is
it that it needs to do?
It needs to hire another worker. How
much will that cost?
The wage. The wage. Exactly, no? So, now
we're beginning to So, so this is the
wage in this case is the cost per unit
of production for this guy. So,
the marginal cost of production for this
firm is the wage.
All the rest, intermediate inputs, is
all summarized. This is value added.
Built on something else.
So, this production function, as simple
as it is, says exactly that. The
marginal cost of production is equal to
the wage.
So, assume that the wage that I'm going
to So, now I'm going to come up with a
pricing model, a price setting rule. So,
firms that understand how much more it
costs to produce an
an extra unit of good, now have to
decide the price they want to charge for
that extra unit of the good.
There's a lot that that comes into in
that decision, but but we're going to
summarize it with a markup. Very simple.
We're going to say, "Look,
the the firm will do the following.
We'll say, "It cost me one worker to
produce one one unit of
extra of good. A worker cost me W, so my
the price I want to charge is 1 + M, M
is a positive number, times W."
Okay? So, M is a number like 0.2.
So, you pay 100 in in in the in the
wage, then you're going to charge the
And suppose the wage is 100,
uh, if the markup is 20%, you're going
to set a price of 120.
Okay? That's the price setting rule
that we're going to adopt, and again,
it's not that crazy.
Simple, but not that crazy.
So, that's we call this the price
setting equation.
The firm takes the wage, because that's
the marginal cost of production,
and and then,
uh, adds a markup, and that's the final
price.
Now, we can
rewrite this price setting equation
as a as a wage equation in the following
sense. It's still a price setting
equation, but this All that I've done
here, no, is I divided by P and by one
by P and 1 + M, and I get that the wage
the the real wage the firm is willing to
pay
is equal to 1 over 1 + the markup.
That's another way of saying it. It's
the same, huh? I took this price setting
equation, and I just rewrote it.
I rewrote it this way because then, you
know, I had when I look at the wage
setting equation, I also wrote it that
that way, W over something. I want to
write the price setting equation in the
same sort of units as as my wage setting
equation, so then I can use that one
diagram, put them together easily,
and and find an
an equilibrium of something.
Okay?
So, what you see here is, for example,
is that the higher is the markup,
the lower is the real wage the firm is
willing to offer.
You see that?
They have And this is an equilibrium at
the level of the economy. It's not you
individually, but on average, that's
what ends up happening. If firms on
average end up charging a higher markup,
it has to be the case
that in equilibrium, the real wage
offered by the firms is lower.
That's what this says.
Okay?
So, if we're in a situation where the
markup was zero,
and now all of the sudden, because of
imperfect competition or perhaps the
some price of a key input went up and
it's not really measuring value added or
whatever,
uh,
if the markup goes to to to one,
then the real wage in equilibrium will
fall
to half what it used to be.
That's what this question That's what
the firms will offer.
Whether that's an equilibrium or not, we
shall see.
Or how do we get to that to be an
equilibrium, we shall see.
But that's what the firms will offer.
That's what the price setting equation
says.
In fact,
you already know from this equation that
that's what the real wage will be,
because there's no variable here that
can adjust to that.
What happens is something else will have
to give in the economy, so this ends up
being the equilibrium wage. Okay? But
you'll understand that a little later.
Or you'll understand it better a little
later.
Okay. So, now we're almost ready to come
up with to discuss a very important
concept in macroeconomics.
And that's the concept of the natural
rate of unemployment.
Now, the first warning is that there's
nothing natural about the natural rate
of unemployment. It's not sort of, you
know, something that God gave us or
anything like that.
Okay?
I'll say, for us,
and and what typically means the natural
rate of unemployment,
simply means what I wrote there,
which is that employment that takes
place when the
expected price is equal to actual
prices.
Okay?
That's what we'll define for this
class, for this course, we'll define the
natural rate of unemployment. The
natural rate of unemployment is when the
expected price is equal to P.
That's what we mean. If I we ask you any
question about the natural rate of
unemployment,
we don't mean that that's what is good,
that that's what is bad, that that's
what God decided or someone else decided
or whatever. This is all that it means
is that in any equation where you have
P, you can stick in P, and then solve
for equilibrium, and that the employment
rate that comes from that is what we
call the natural rate of unemployment.
Because of this, you can also think of
that unemployment rate as a sort of
as a good
proxy for what is likely to be the
average rate of unemployment of an
economy over a longer period of time.
You know, because people are unlikely to
be fooled all the time in the same
direction. So, sometimes they're going
to expect a higher price than it is,
sometimes it's a lower, and so on. On
average, unless there's something very
weird going on, they're going to get it
right. But because you know what more or
less what the level of inflation of the
economy is, sometimes you'll miss up,
sometimes you'll miss down, but on
average, you're going to be right if you
if you take an average over a long
period of time.
So, for that reason, you can also
interpret this natural rate of
unemployment as an employment rate of
the medium run, if you will. So, when
you have collected enough data,
positive errors are balanced with
negative errors, and so on.
Okay?
But that's all that we mean by the
natural rate of unemployment.
Okay?
Now, notice that with this assumption
that PE is equal to P, I can go back to
my wage setting equation, which was W
over PE equal to F dot. I think it I
don't remember where I divided by P, but
I had PE there.
I'm going to divide by P both sides,
and then I'm going to set PE equal to P,
and now I have that my wage setting
equation can be written this way, and
notice that that employment rate I put
here is the N.
And it's the natural rate of
unemployment.
Because once I get in a model in which
you assume that P is equal to P, that
employment rate that comes out of that
is a natural rate of unemployment.
Okay? That's That's all that it just
means. It says, "Okay,
you allow me to to replace PE by P,
well, then I can call my unemployment
rate here the natural rate of
unemployment."
And it has lots of names. It's the
natural rate, the structural rate of
unemployment, and so on.
Now, what this tells you,
I mean, you can see the slope of this
function.
If the natural rate of unemployment is
higher in this economy,
what is the real wage that comes from
the wage setting equation?
Lower.
curve in the space of wages to real
wages to unemployment.
to the natural rate of unemployment.
It's a downward sloping curve for the
reasons we discussed before, bargaining
power, and so on. Okay?
So, I can put together, remember the the
price setting equation led me to also an
equation of the real wage, which was not
a function of anything. It was only a
function of parameters. So, that's a
horizontal
curve in the space of real wages and
unemployment, natural rate of
unemployment. Here, we have a downward
sloping curve,
and the intersection of these two curves
is the natural rate of unemployment.
Okay?
So, this was the price setting relation.
Remember, it's 1 over 1 plus M.
This is the wage setting equation.
Uh
with the assumption that PE is equal to
P.
And that's the natural rate of
unemployment.
And here you can understand what I said
before is that
you see, in this economy
the real wage, because this price
setting equation is flat in the simple
economy, the real wage is pinned down by
the firm.
By the firms collectively.
And not collectively in an oligopolistic
way. It's, you know, it's what happens
in equilibrium.
Uh
it's set by that, but the equilibrium
unemployment natural rate of
unemployment is intersection of that
real wage set by the firms
and the wage setting relationship.
So, what happens
in a to a point say to the right?
What happens in this point here?
What is the situation we have?
Well,
at that high level of unemployment
workers are willing to work for much
lower real wages than the firms are
offering.
Okay?
This is what workers at this level of
unemployment, very high level of
unemployment
workers would be fine with this.
Firms are paying that.
Okay?
So,
unemployment is very likely to be
falling because workers are not
demanding a lot and and and firms, you
know, are going to hire all these
workers back.
The opposite here.
If here workers are demanding a wage
that is much higher than firms are
willing to pay.
Well, that's likely to lead to more
unemployment because firms are going to
be very reluctant to hire
uh these very expensive workers.
Okay? So, that's going to build
unemployment in this direction.
Good. So, that's
that's the natural rate of unemployment.
Again, nothing natural about it. It's
the equilibrium when you assume the
expected price is equal to
uh price. So, there are some important
parameters in this diagram here.
One is this M.
The markup. That's a parameter, very
important markup here. To So, see,
if the markup changes the natural rate
of unemployment will change.
There's another set of parameters here
which is
Z. We took as given the institution that
protect
the bargaining power of workers
institutions, supporting institutions.
The Z. That's a parameter here. If that
changes, the natural rate of
unemployment will change.
Which is again something that confirms
there's nothing natural about the
natural rate of unemployment.
So, let me just do it in equations very
quickly and then and then
uh
I'll do a
a couple of important shifts.
Uh so, in terms of equation, all that I
did is say, "Look, the wage wage setting
equation the price setting equation
gives us that.
The wage setting equation gives us that.
Therefore, that equal to that. That's
the point we found. That's the natural
rate of unemployment." Okay?
So, from here
that's when the two are equal. This is
what's the flat curve. This is what's
the downward sloping curve. Well, these
two are equal
uh
when these two things are equal. Okay?
And that's where you get there. So, from
there you solve the natural rate of
unemployment.
What do you think happens to the natural
rate of unemployment if Z goes up?
Let's just be very mechanical at this
point. Just math.
If Z goes up
what what happens to F?
Goes up, no? If Z was positive.
Well, the right hand side hasn't gone
up.
So, this went up.
Something has to give, so F comes back
down.
And the only thing that can give, the
only thing is endogenous in that picture
there is the natural rate of
unemployment.
So, if Z goes up, F goes up. Well, I
need to bring F back down because the
right hand side hasn't given an inch.
So, what do I have to do to natural rate
of unemployment for F to come back down?
Price, no? Because that's what will
weaken bargaining power.
Workers bargaining power got stronger
because increasing Z, well, I have to
weaken it some. I don't have to
Equilibrium will weaken it somehow
so that we end up in the same situation
with the same real wage that we had
before, which was equal to 1 over 1 plus
M.
What happens if M goes up?
Well, if M goes up markups go up. That
means firms real wage
uh
the real wage firms offer drops.
So, I need If this right hand side
drops, then I need the left hand side to
drop drop as well.
And the only thing that is endogenous
here is the natural rate of
unemployment.
So, I know that I need to but to drop F,
what do I need to do to UN?
So, I need to bring F down. And the only
tool you have, it's not a tool, but in
equilibrium everything that will
can change here is UN.
It will
It will increase UN.
Because that will reduce bargaining
power of workers and that will reduce
their their real wage demand and
therefore you restore equilibrium that
way.
So, this environment is a very nasty
environment for workers in a sense, no?
Because
it's always the the scapegoat is is the
natural rate of unemployment.
So, here you have what I just said in in
pictures. So, that's the example of Z
going up.
Bargaining power of workers going up.
So, suppose you start at an at an
equilibrium like this.
And now and now Z goes up.
Well, that means that workers for any
given level of unemployment natural rate
of unemployment want a higher wage.
Because they have more bargaining power.
Well, that higher wage is inconsistent
with the wage that firms want to pay.
What restores equilibrium is
unemployment the natural rate of
unemployment goes up
enough so that the wage demand sort of
comes down to the same original level
because this this price setting equation
is completely flat.
Okay?
So, there you have a a situation where
bargaining power of workers went up.
And all that ended up happening is is
that in the medium run at least
that the natural rate of unemployment
went up.
That's very much the story of Europe, by
the way.
In the '80s, France in particular. In
France they sort of made your labor
reforms
Z boosting, if you will, in the 1980s.
Initially it was a great deal for
workers. Real wages went up and so on.
It was wonderful.
But eventually with the passage of time
they end up just with a much higher real
not a much higher real wage, but a much
higher real
unemployment rate. Okay? They went from
uh single digit lows in the digits to,
you know, 15% unemployment rates and
things like that. And since then they
have been sort of
reforming the labor market to fix some
of that. But
but that's that's that was very much
what happened in continental Europe
in the '80s.
This is the case of a markup increase.
It's the other one I described, no? So,
uh if if markups go up
then initially that means firms in
equilibrium are not willing to pay real
wages uh
they they want to pay a lower real wage.
Well, at this level of unemployment
workers are not going to take it.
The only thing that will restore
equilibrium is that the natural rate of
unemployment goes up. That weakens
the hand of workers.
And you end up
uh with this. And again, there's nothing
natural about this. I'm not saying this
is good, bad. I have no idea why the
markups went up. If it is just imperfect
competition going up, that's clearly not
a good thing.
Uh but it may have been something else.
The price of oil went up a lot. I don't
know. Uh was a war somewhere and then
productivity came down. So, something of
that kind.
So, I don't know what did it. But but
the only thing I'm describing here is
the mechanics.
Okay?
Good.
So,
uh
the quiz is up to here.
Right? So, the the quiz ends here.
Okay?
Uh in the next lecture we're going to
learn I'm going to start the Phillips
curve, which is now
using this model, but looking at
deviations, situations where the price
is not equal to expected price or
expected price is not equal to to
to the actual price. And and that's
going to lead to interesting situations.
Uh
and there we're going to be talking
about inflation. Here this is not a
model to talk about inflation. I'm
talking about what happens in the medium
run. I haven't told you whether
adjustment happens through the nominal
wage, through the prices, or what. I
mean, there are many ways of
reaching the same real wage.
You know, you could have it
uh you could you could lower real real
wages by increasing
wages by 50% and prices by 60, say.
No?
Or you could do it by, you know,
lowering nominal wages by 10 and not
moving prices. So, there are many ways
of doing it. The Phillips curve doesn't
allow us to
to get into that part. But it's not
going to be part of your quiz. The quiz
that's going to be part of of the second
quiz. So, in the next lecture we're
going to talk about the Phillips curve
and then on Wednesday a review and
and then you have your quiz. Okay?