Population is a strong driver of the economy as well as the quality of the labor force.
The Labor Market, Unemployment, and Inflation
(Part B)
by
Charles Lamson
The Classical View of the Labor Market
 FIGURE 1  Each point on the labor supply curve in Figure 1 represents the amount of labor households want to supply at each given wage rate. Each household decision concerning how much labor to supply is part of the overall consumer choice problem of a household. Each household member looks at the market wage rate, the prices of output, and the value of leisure time (including the value of staying at home and working in the yard or raising children) and chooses the amount of labor to supply (if any). A household member not in the labor force has decided his or her time is more valuable and nonmarket activities. It is easy to see why. If you choose to stay out of the labor force, it is because you (a member of society) place a higher value on the use of your time than society is currently placing on the product that you would produce if you were employed. Consider households in less developed countries. In many, the alternative to working for a wage is subsistence farming. If the wage rate in the labor market is very low, many will choose to farm for themselves. In this case, the value of what these people produce in farming must be greater than the value that society currently places on what they would produce if they worked for a wage. If this were not true, wages would rise and more people would join the labor force. Each point on the labor demand curve in Figure 1 represents the amounts of labor firms want to employ at each given wage rate. Each firm's decision about how much labor to demand is part of its overall profit-maximizing decision. A firm makes a profit by selling output to households. It will hire more workers if the value of its output is sufficient to justify the wage that is being paid. Thus, the amount of labor that a firm hires depends on the value of the output that workers produce.  The classical economists saw the workings of the labor market---the behavior of labor supply and labor demand---as optimal from the standpoint of both individual households and firms and from the standpoint of society. If households want more output than is currently being produced, output demand will increase, output prices will rise, the demand for labor will increase, the wage rate will rise, and more workers will be drawn into the labor force. (Some of those who preferred not to be a part of the labor force at the lower wage rate will be lured into the labor force at the higher wage rate.) At equilibrium, prices and wages reflect a trade-off between the value households place on outputs and the value of time spent in leisure and non-market work. At equilibrium, the people who are not working have chosen not to work at the market wage. There is always full employment in this sense. The classical economists believed the market will achieve the optimal result if left to its own devices, and there is nothing the government can do to make things better. The Classical Labor Market and the Aggregate Supply Curve    The Unemployment Rate and the Classical View If, as the classical economists assumed, the labor market works well, how can we account for the fact that the unemployment rate at times seems high? There seem to be times when millions of people who want jobs at prevailing wage rates cannot find them. How can we reconcile this situation with the classical assumption about the labor market?  Some economists answer by arguing that the unemployment rate is not a good measure of whether the labor market is working well. We know the economy is dynamic and that at any given time some industries are expanding and some are contracting. In California the construction industry contracted in the mid-1990s. Consider, for example, a carpenter who is laid off because of the industry's contraction. He had probably developed specific skills related to the construction industry---skills not necessarily useful for jobs in other industries. If he were earning $40,000 per year as a carpenter, it may be that he could earn only $30,000 per year in another industry. He may eventually work his way back up to a salary of $40,000 in the new industry as he develops new skills, but this will take time. Will this carpenter take a job at $30,000? There are at least two reasons he may not. First, he may believe the slump in the construction industry is temporary and he will soon get his job back. Second, he may believe he can earn more than $30,000 in another industry and will continue to look for a better job. If our carpenter decides to continue looking for a job paying more than $30,000 per year, he will be considered unemployed because he is actively looking for work. This does not necessarily mean the labor market is not working properly. The carpenter has chosen not to work for a wage of $30,000 per year, we would not expect him to find a job paying more than $30,000. The unemployment rate as measured by the government is not necessarily an accurate indicator of whether the labor market is working properly. If the degree to which industries are changing in the economy fluctuates over time, there will be more people like our carpenter at some times than at others. this will cause the measured unemployment rate to fluctuate. Some economists argue the measured unemployment rate may sometimes seem high even though the labor market is working well. The quantity of labor supplied at the current wage is equal to the quantity demanded at the current wage. The fact that there are people willing to work at a higher wage than the current wage does not mean the labor market is not working. Whenever there is an upward-sloping supply curve in a market (as is usually the case in the labor market), the quantity supplied at a price higher than the equilibrium price is always greater than the quantity supplied at the equilibrium price.  Economists who view unemployment in this way do not see it as a major problem. Yet the images of the bread lines in the 1930s are still with us, and many find it difficult to believe everything was optimal when over 12 million people were looking for work at the end of 1982. There are other views of unemployment as we will see in the next post. *CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 558-561* end |
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