ECO2103

Macroeconomics

© 2022 Singapore Institute of Management

 Lecture 3
Workers, Wages and Unemployment

Ref:
Tan Khay Boon, Macroeconomics,
SIM Global Education, 2016
Session 3
2
Learning Objectives

1. Define unemployment and discouraged workers

2. Calculate labour force, unemployment rate and
participation rate
3. Analyse the demand and supply of labour in the
labour market
4. Explain the types of unemployment, the costs of
unemployment and the methods to reduce
unemployment

6-3
Definition of Unemployment
3 conditions that defines unemployment
• Willingness to work
– Those who don’t work because they do not
want to work or do not need to work for a living
are not considered unemployed

• Ability to work
– Posses relevant skills
– People with mental or physical disability who
cannot work are not unemployed
4
Definition of Unemployement

• Active job search

– The person must be actively searching for
a job
– 6 weeks of job search needed to qualify
– Long and unsuccessful job search results
in chronic unemployment

5
Discouraged Worker
• Key criteria to being considered as
unemployed is: Active job search
• If job search is long and unsuccessful,
the job seeker may be discouraged and
stop efforts to look for a job
• Voluntarily not working
• No longer considered as unemployed

6
Labour Force Statistics
Total Population

Under 15 Working Age Population (>15 yrs)

Labour Force Out of Labour Force

Employed + • Physical/Mental disability

Unemployed • Housewives
• Students
• Discouraged workers
7
Labour Force Statistics
• Labour Force
– Comprises of those with a job or looking for a job
– Employed comprises of part time and full time workers
– Part time workers who wish to work full time but cannot
are considered under-employed
Labour Force = Employed + Unemployed

• Labour Force Participation Rate

– Potential labour resource
– Labour force participation rate can be different based on
age group or gender
Labour Force Participation Rate = Labour Force X100%

Working Age Population

8
Labour Force Statistics
• Unemployment Rate
– Percentage of labour force without a job
– This only includes workers who are willing and
able to work; and actively searching for a job
– Excludes discouraged workers (masks extent
of true unemployment)
– Various factors affect unemployment, including
health of economy
Unemployment Rate = Unemployed x 100%
Labour Force
9
Calculating Labour Force Statistics
An economy consists of 100 persons. 10 persons
are below 15 years old (legal working age). Among
those above 15 years, 50 are full time workers, 10
part time workers, 5 retirees, 5 housewives and 8
full time students. Out of the 12 remaining
persons, 8 are actively searching for a job. Find
the
a) Labour force
b) Labour force participation rate
c) Unemployment rate

10
Calculating Labour Force Statistics

• Working age population = (100 – 10) = 90

• Employed = 50 + 10 = 60
• Unemployed = 8

a) Labour Force = 60 + 8 = 68
b) Labour Force Participation Rate = (68/90) x100%
= 75.56%
c) Unemployment rate = (8/68)x100% = 11.75%

11
Duration of Unemployment

• Costs of unemployment are directly related to

the length of time a person has been
unemployed
– Unemployment spell is the period during which
an individual is continuously unemployed
– Duration of unemployment is the length of the
unemployment spell
• The unemployed population in April 2011:

Duration (weeks) 5 or less 5 – 14 More than 14

% of unemployed 20% 22% 58%

6-12
Duration of Unemployment
• Long-term unemployed refer to those out of work
for 6 months or longer
• Short-term unemployed have several possible
outcomes
– Find a permanent job after searching for a few weeks
• Economic costs are low

– Leave the labor force

– Short-term or temporary job that leads to
unemployment again
• These chronically unemployed have costs similar to the long-
term unemployed

6-13
Other Unemployment Issues
• Discouraged workers would like to have a job but
they have not looked for work in the past four
weeks because they believe there are no jobs
available
– Counted as out of the labor force
• Involuntary part-time workers are people who
like to work full-time but cannot find a full-time job
– Counted as employed
• August 2014 unemployment rate was 6.1%
– Including discouraged workers and involuntary part-
time workers would make the rate 12%
6-14
Costs of Unemployment
• Economic costs
– Lost wages and production
– Decreased taxes and increased transfers
(unemployment benefits)
• Psychological costs
– Individual self-esteem
– Family stress of decreased income and increased
uncertainty
• Social costs
– Potential increases in crime and social problems
• Social resources spent to address these
6-15
The Labor Market
• Supply and demand analysis can be used to
find the price of labor (real wages) and the
quantity (employment)
– Analysis will consider the number of workers
employed, not work-hours per year
• Labor market is an input market
– Firms buy labor to produce goods and services
• Macroeconomics look at aggregate levels of
employment and real wages
– Microeconomics looks at wage determination for a
category of workers
6-16
 Wages and Demand for Labor
• The demand for labor:
– A derived demand
– Firms demand for labour based on consumers
demand for the output produced by the labour
– Households supply the labour effort
• Diminishing returns to labor
– Assumes non-labor inputs are held constant
– Adding one worker increases output but by less
than the previous worker added
6-17
Wages and Demand for Labor
• Value of Marginal Product (VMP) is the extra
revenue that an added worker generates:
VMP = MPL x P
– VMP is the marginal benefit of a worker
– MPL is the marginal product of labour
– P is the price of each output
• Wage is the marginal cost of employing the
worker
• Optimal number of workers to employ:
Wage = VMP
18
Smart Phones Inc
Smart Phones Inc can sell its phones for $500 each
Smart Marginal Product Value of Marginal
Number
Phones Product ($)
of
(TP) MPL = ∆TP/∆L
Workers
VMP = MPL x P
1 20 20 20x$500 = $10,000
2 38 18 18x$500 = $9,000
3 54 16 16x$500 = $8,000
4 68 14 14x$500 = $7,000
5 80 12 12x$500 = $6,000
6 90 10 10x$500 = $5,000
7 98 8 8x$500 = $4,000
8 104 6 6x$500 = $3,000
6-19
 Demand Curve for Labor
• Hire an extra worker if
and only if the VMP
exceeds the wage paid
• If wage is $9,000, firm

Wage ($000s)
only hire 2 workers
9
• If wage falls to $6,000, firm
will hire 5 workers 6 Labor
• The lower the wage, the Demand
more workers employed
• Inverse relationship between
wages and demand for 2 5
labour Employment

6-20
Determinants of Labour Demand
• Demand shifts when the value of the marginal
product of a worker changes
• Two factors determine the demand (VMP) for
labor
– The price of the company’s output (P)
• An increase in market demand
– The productivity of the workers (MPL)
• Greater quantity of non-labor inputs
• Organizational change
• Training and education
6-21
Smart Phones Inc
Smart Phones Inc can sell all its phones for $500 each
Assume a 50% increase in productivity (MPL)
Smart Marginal Product Value of Marginal
Number
Phones Product ($)
of
(TP) MPL = ∆TP/∆L
Workers
VMP = MPL x P
1 30 30 30x$500 = $15,000
2 57 27 27x$500 = $13,500
3 81 24 24x$500 = $12,000
4 102 21 21x$500 = $10,500
5 120 18 18x$500 = $9,000
6 135 15 15x$500 = $7,500
7 147 2 12x$500 = $6,000
8 156 9 9x$500 = $4,500
6-22
 Increase in Worker Productivity (MPL)
• If the productivity of
workers increase, more
profitable to hire more
workers at given wage

Real Wage ($000s)

• At wage of $9,000, firm 9
hires 5 workers
• At wage of $6,000, firm Labor Demand (2)
6
hires 7 workers
• An increase in the Labor Demand (1)
productivity of workers’ 2 5 7
increases the demand Employment
for labor
6-23
Smart Phones Inc
Smart Phones Inc can increase the price of its phones
from $500 to $1,000 each
Smart Marginal Product Value of Marginal
Number
Phones Product ($)
of
(TP) MPL = ∆TP/∆L
Workers
VMP = MPL x P
1 20 20 20x$1000 = $20,000
2 38 18 18x$1000 = $18,000
3 54 16 16x$1000 = $16,000
4 68 14 14x$1000 = $14,000
5 80 12 12x$1000 = $12,000
6 90 10 10x$1000 = $10,000
7 98 8 8x$1000 = $8,000
8 104 6 6x$1000 = $6,000
6-24
 Increase in Price of Output (P)

• Again more profitable

to hire more workers
at given wage

Real Wage ($000s)

• At wage of $8,000, 8
firm hires 7 workers
• At wage of $6,000, 6 Labor Demand (2)
firm hires 8 workers
• An increase in the Labor Demand (1)
price of output
3 5 7 8
increases the demand
Employment
for labor
6-25
Individual Labor Supply
• Reservation wage is the lowest wage a
worker would accept for a given job
– Opportunity cost of working is your leisure
activity
– Work compensates you for lost leisure
• If working conditions are unpleasant or
dangerous, a premium for that would be
included in the wage
– Cost – Benefit Principle at work

6-26
The Supply of Labor

Labor
Supply
Real Wage

The labor supply curve

slopes up because at a
higher real wage, more
people are willing to
work

Employment

6-27
Aggregate Labor Supply
• Macroeconomic determinants of labor
supply
– Size of the working age population
• Domestic birthrate
• Immigration and emigration
• Legal working age: When people can enter and
retire from the workforce
– Share of working-age population willing to
work
6-28
Shifts in Labor Supply
• A shift in labor supply is caused by any
change in the number of workers willing to
work at each wage
– Increase in the working-age population
• Baby boom
• Higher net immigration
• Increasing age at retirement
– Increase in the share of working-age
population willing to work
• Women's participation in the labor force has
increased in the last 50 years
6-29
Labour Market Analysis

• Combining the labour demand curve

and labour supply curve, analysis can
be made about equilibrium wage and
employment
• Identify wage inequality arising from
globalisation

30
Effects of Increase in Productivity
• Industrialized countries Real Wage
have had sustained
growth in productivity in S
the 20th century
– Increases demand for W1
labor
W
– Both real wages and
employment increased D'
D
• Productivity increases
were due to N N'
– Technological progress Employment

– Increases in capital

6-31
Effects of Globalisation

• Globalization results in an expansion of many

markets to worldwide supply
– Increasing ease of goods and services crossing
national borders
• Benefit of globalization is increased
specialization and efficiency
– Principle of Comparative Advantage
• Globalization also means that some goods
produced domestically are no longer competitive
– Some domestic sectors shrink
6-32
Globalisation and Wage Inequality
Agriculture Manufacturing
Real Wage Real Wage
SM
SA

W‘M
W
W’A D‘M
DA DM
D‘A
N‘A NA NM N‘M

Employment Employment

6-33
Globalisation and Wage Inequality
• When wages in importing industries fall and wages in
exporting industries rise, wage inequality increases
– Low-skill industries face the toughest international
competition
– Political resistance to free trade grows
• Worker mobility is the movement of workers
between jobs, firms, and industries
– Market incentives move workers out of agriculture and
into manufacturing
– Transition aid by government can assist workers to make
the change
6-34
Effects of Technological Change
• Technological change can be a source of increasing
wage inequality
– Occurs if technical change favors higher-skilled or better-
educated workers
• Some innovation renders old skills less valuable
– Calculator vs computer in statistics
• Skill-biased technological change affects the marginal
products of higher skilled workers differently from those
of lower-skilled workers
– Recent changes favor higher skilled workers
– Automobile production lines increasingly use robots

6-35
Skill-Biased Technological Change
Unskilled Workers Skilled Workers
Real Wage
SU SS

W'S
WS
WS D'S
W'S

DU DS
D'U
N'U NU NS N'S
Employment Employment

6-36
Types of Unemployment
• Frictional unemployment occurs when there is
imperfect information
• Workers with the relevant skills do not know which
company offers the best prospects
• Firms in turn need time to select and interview before
finding the most suitable candidate
• Friction unemployment is typically
– Short in duration

– Low in economic cost

– May increase economic efficiency as right job fit reduces

future turnover
6-37
Frictional Unemployment
• Less serious in nature
• All healthy economies will have some
level of frictional unemployment
• May be reduced by improving
information flow
– Career exhibitions
– Job agencies
– Job posting through internet and apps
38
Structural Unemployment
• Structural unemployment arises due to
mismatch of skills and job opportunities
• Arises due to changes in the economy
– Technological advances that leads to certain jobs
being replaced by machines e.g. invention of the
ATM reduces the need for bank tellers
– Change in consumer taste e.g. use of computers
replace typewriters
– Operational cost e.g. manufacturing companies
relocate to low cost countries like China and India

6-39
Structural Unemployment
• More serious and long lasting in nature
• Jobs that are displaced are unlikely to
return to the economy
• For displaced workers to find employment
in other industries, they would need to
acquire new skills
• Firms/government provide financial and
other incentives to encourage workers to
go for re-training 40
Cyclical Unemployment

• Cyclical unemployment is the

increase in unemployment during
fluctuations in the business cycle
– Recession: Falling income leads to less
spending and production =>Leads to
retrenchment
– Individual worker and firms are unable to
alleviate this problem

41
Cyclical Unemployment

– Government has to take the lead to raise

spending and production
• Fiscal policy: Government raises its spending
or decrease taxes
• Monetary policy: Central bank to reduce
interest rates and raise demand for output

42
Classical Unemployment

• Classical unemployment arises when

wage is deliberately maintained above
equilibrium level
• Usually takes place by an imposition of
a minimum wage law
– Strong labour union
– Government policy to assist workers

43
 Classical Unemployment
Real Wage
Minimum Wage Laws
S
• Minimum wage (Wmin)
above equilibrium (W)
Wmin
A B creates (NB – N A)
unemployment
W
D • Workers who find a
minimum-wage job get a
higher wage
NA NB
N
Employment
• Others are unemployed

6-44
Classical Unemployment
• Health and safety regulations or rigid
labour laws can reduce the demand for
labor by
– Increasing employer costs
– Reducing worker productivity
• The reduction in demand will increase
unemployment and/or lower wages

6-45
 Classical Unemployment

• Labor union benefits • Labor union costs

– Reduced worker – Introduces inefficiency
into competitive
exploitation markets
– Support progressive – May keep companies
labor legislation from competing
– Increase productivity globally
– Increase labor supply
– Promote democracy in non-union sector
in the workplace – Decreases wages for
non-union workers
6-46
Seasonal Unemployment
• Seasonal unemployment arises due to change in
the season
– Fisherman cannot fish during the monsoon season
– Ski resorts close during summer

• Temporary in nature but occurs on a regular

basis throughout the year
• Similar to structural unemployment
– Workers affected need to acquire new skills relevant
to different seasons

6-47
SUMMARY

• Unemployment is defined by
– Willingness to work
– Ability to work
– Actively searching for a job
SUMMARY
• The labour force is the sum of employed
and unemployed workers
• The labour force participation rate is the
percentage of the working age population
that is in the labour force
• The unemployment rate is calculated as
the number of unemployed workers
divided by the labour force
SUMMARY
• Wages and employment levels can be
studied using a supply and demand model
of the labour market
• Demand for labour is determined by the
value of marginal product
– VMP = MPL x P
– Optimal employment occurs where W = VMP
SUMMARY
• Supply of labour is determined based on
reservation wage
– Higher wage lead to higher supply of labour
– Labour supply affected by size of working age
population and share of working age
population willing to work
SUMMARY
• Trends in wages and employment levels
are affected by:
– Improvement in productivity
– Globalisation and international trade
– Technological advances

• Rising wage inequality especially between

skilled/educated and unskilled/uneducated
workers
SUMMARY
• There are 5 types of unemployment –
– Frictional: Short and transitory due to imperfect
information
– Structural: Longer and potentially more serious.
Arises due to changing economic structure
– Cyclical: Follows business cycle and needs
government intervention
– Classical: Minimum wages imposed above
equilibrium level. Benefits may be outweighed by
job losses
– Seasonal: A type of structural unemployment
arising from change in seasons
Question 1
Who of the following is counted as unemployed?
A. Ray wants to work forty hours per week, but is only
working for twenty hours per week.
B. Anna Marie spends all of her time taking care of her
children at home.
C. Frank would like to work, but has not looked for work
because he believes no jobs are available.
D. Melissa has a Ph.D. in physics, but is currently
employed full time driving a taxi.
E. Martin has been offered several jobs in the past four
weeks, but has chosen not to accept any of the
offers and is still sending out job applications.
54
Answer to Question 1

55
Question 2
In a small town of 100 people there are 10 children under
16, 10 retired people, 60 people with full-time jobs, 3
people with part-time jobs, 3 full-time students over 16,
and 4 full-time homemakers. The remaining people did
not have jobs, but wanted them. All but one of these had
actively looked for a job in the previous four weeks. What
is the participation rate in this town?

(A) 63.0%
(B) 71.1%
(C) 72.0%
(D) 80.0%
(E) 87.5%
56
Answer Question 2

57
Question 3
In a small town of 100 people there are 10 children
under 16, 10 retired people, 60 people with full-time
jobs, 3 people with part-time jobs, 3 full-time students
over 16, and 4 full-time homemakers. The remaining
people did not have jobs, but wanted them. All but one
of these had actively looked for a job in the previous four
weeks. What is the unemployment rate in this town?

(A) 10.0%
(B) 11.0%
(C) 12.5 %
(D) 14.3%
(E) 20.0%

58
Answer to Question 3

59
Question 4
The demand for labor depends on ______ and
_______.

A. the supply of labor; the marginal product of

labor
B. the supply of labor; the price of output
produced
C. the rate of price inflation; the price of the output
produced
D. the rate of price inflation; the marginal product
of labor
E. the marginal product of labor; the price of
output produced 60
Answer to Question 4

61
Question 5
High Tech, Inc. produces plastic chairs that sell for
$10 each. The following table provides information
about how many plastic chairs can be produced per
hour. For simplicity assume that labor is the only
input. Number of Chairs Produced
Workers per Hour
0 0
1 10
2 18
3 24
4 28
5 30
How many workers will be hired, if the hourly wage
for workers is $70?
(A) 1 (B) 2 (C) 3 (D) 4 (E) 5
62
Answer to Question 5

63
Question 6
The demand for labor in a certain industry is ND = 45 -
5w, where ND is the number of workers employers
want to hire and w is the real wage measured in dollars
per hour. The supply of labor in the same industry is NS
= 10 + 5w, where NS is the number of people willing to
work. If the minimum wage is $5 per hour, how many
workers will be unemployed?

(A) 5
(B) 10
(C) 15
(D) 20
(E) 25
64
Answer to Question 6

65
Question 7
State the type of unemployment for the following
scenarios:
a) The high wage expectation of a school leaver is
causing him to take a longer time to find a job.
b) A well-qualified civil engineer is retrenched from
the declining construction sector and is unable
to find any other work over the last 3 years.
c) The recession causes a worker to be laid off and
he is unable to find another job in the weak
economy.

66
Answer to Question 7

67