Labor Market [Macro Economics]

Macro Economics 

- Chapter 7. Labor Market, Wage, Unemployment

What is the Labor Market?

The labor market is where workers offer their skills and employers demand them. Just like any market, prices (wages) are set by supply and demand.

• Labor supply: People willing to work
• Labor demand: Businesses needing workers

Where do these two meet? That’s where the wage is set, and employment levels are determined.

### unemployment rate = unemployed / labor force × 100

Key Forces Shaping the Labor Market

1. Demand for Labor

• Employers hire workers based on the marginal product of labor (how much extra output a worker adds).
• Demand is downward-sloping: the more workers available, the less each additional one adds to output.

2. Supply of Labor

• People work when wages are high enough to make giving up leisure time worth it.
• Higher wages pull more people into the workforce.

3. Equilibrium

• The wage where supply equals demand determines employment levels in a frictionless world.

But the real world has frictions. Let’s dive into those.

Wage Rigidity and Labor Market Shocks

What happens when things don’t adjust perfectly?

• Wage rigidity: When wages don’t fall even if labor demand drops.
• This can happen due to contracts, minimum wages, or social expectations.
• The result? Higher unemployment—employers can’t afford to hire as many workers.

Example: If it’s hard to fire employees (due to laws), firms hire fewer to begin with. Labor demand shifts left, and employment falls.

Types of Unemployment

Unemployment isn’t one-size-fits-all. Economists identify different types:

• Cyclical: Caused by recessions or economic slowdowns
• Frictional: People between jobs or new to the labor market
• Structural: Mismatch between skills and job openings
• Natural rate: The sum of frictional and structural unemployment

Governments often aim policies at reducing cyclical or structural unemployment without hurting natural market dynamics.

### actual unemployment = frictional + structural + cyclical

###++ frictional + structural (= Natural rate)

Modeling Unemployment: The Bathtub Model

This model sees unemployment as a stock, with people constantly flowing in (job loss) and out (job finding). The natural rate of unemployment depends on:

• Job separation rate (Ṡ; how often people lose jobs)
• Job finding rate (ḟ; how quickly they get new ones)

Improve either, and you reduce unemployment. But policy tweaks here can have side effects.

Labor Market Differences Around the World

The U.S., Europe, and Japan all show different labor outcomes:
• Europe: Higher unemployment, shorter workweeks
• U.S.: More hours worked, lower unemployment
• Japan: Historically lower unemployment, but with demographic shifts

Why?
• Labor regulations
• Cultural preferences for leisure
• Welfare systems
• Hiring and firing rules

These institutional differences shape labor supply, demand, and outcomes.

The Value of Human Capital

What’s the value of your career in dollar terms? Economists use present discounted value (PDV) to calculate it.

### present discount value = future value / (1 + interest rate)ᵇ

Example:
• A $63,000 salary over 45 years at a 3% discount rate = $1.59 million in today’s money.

**$63,000
**$1,590,000: 1.59 million 

This helps explain why education is such a valuable investment—even if college is expensive now, the lifetime income boost pays off.

Why Education Pays (More Than Ever)

Over the last 40 years, the return to a college degree has skyrocketed. College grads earn far more than high school grads.

Why?

• Technology rewards skilled workers
• Globalization favors knowledge jobs
• Demand for cognitive and social skills has grown

And this change isn’t just about individuals—it’s reshaping the entire income distribution.

Labor Markets and Income Inequality

Here’s the twist: Economic growth raises average incomes, but not always equally.

• In the early 1900s, most inequality came from capital income (wealth, dividends).
• Today, it comes from salaries and business income—especially among the highly educated.

As the return to education rises, so does the gap between workers with different levels of skill and schooling.

Final Thoughts: The Labor Market Affects Everyone

Whether you’re choosing a career, voting on economic policy, or running a business, you’re participating in the labor market. Understanding how it works—from supply and demand to unemployment and inequality—helps you make better decisions.

The labor market isn’t just an abstract economic concept—it’s where your income, job opportunities, and future all take shape.

[Reference]

[1] Charles I. Jones, Macroeconomics, 5th Edition, Norton.