The Labor Market

Persons living in a country constitute the population of that country, but when it comes to the working-age population, the definition is different. The working-age population includes people who are 15 years old or older.

A person who falls under the following categories is considered as employed (E): Persons over a certain age who are in a paid work for at least one hour during the reference period or who have a job but are temporarily absent during the reference week for certain reasons, e.g. parental leave; Persons over a certain age who work for profit or family gain during the reference period.

An unemployed person (U) is one who is not employed during the reference period but has been actively looking for work in the last four weeks and is ready to start work within two weeks.

The labor force (LF) is the sum of people who have a job (E) or are not employed but are actively looking for a job (U). Labor force (LF) = Employed (E) + Unemployed (U)

The unemployment rate is the percentage of unemployed people in the labor force (LF).

Unemployment rate = (U/LF) x 100

Labor force participation rate (LFPR) is the proportion of working-age population (P) that either works (E) or looks for work (U):

Labor force participationrate = (E +U)/P x100

Those who are not employed and give up looking for a job are discouraged workers. Some withdraw from the labor market during a recession and return when the market expands. Since official unemployment statistics do not include discouraged workers as unemployed when calculating the unemployment rate, published statistics may differ from actual statistics.

COVID-19, which began in early December 2019 and quickly spread to other countries, has negatively affected both the economy and social life since the day it broke out. Some industries had to suspend their operations for various reasons, such as travel restrictions and curfews imposed by governments. Supply chains were negatively affected, production was cut and unemployment increased. With the spread of COVID-19, the global economy shrank by 5.2% in 2020, causing mass unemployment. This is the deepest recession since World War II.

The labor market is where workers look for a job and firms look for an employee. In this market, labor is supplied by households and demanded by firms.

Firms demand labor until the value of the marginal product of labor (VMPL), which is the revenue that firms gain by hiring additional workers, is equal to the wage (w) that is being paid. As the number of workers increases, the value of the marginal product of each additional worker diminishes. Profit-maximizing firms hire up to the point where VMPL = w. When wages increase, firms demand a smaller number of workers.

The labor demand curve shows the relationship between the quantity of labor demanded and the wage. The downward sloping part of the value of marginal product value of labor is the labor demand curve. A change in the wage affects the quantity of labor demanded. Ceteris paribus, the quantity of labor demanded moves along labor demand curve when the wage changes. If the wage rises, the quantity of labor demanded decreases, while a decrease in the wage increases the quantity of labor demanded.

Any change in factors other than the wage, such as changes in the goods and services market, changes in productivity or changes in input markets, leads to a shift in the labor demand curve.

The labor supply curve, which indicates the relationship between the quantity of labor supplied and the wage, is upward sloping. Ceteris paribus, the quantity of labor supplied moves along the labor demand curve when the wage changes.

Any change in factors other than the wage, such as changes in tastes and preferences, the use of household appliances, and the population such as immigration, leads to a shift in the labor supply curve. With an increasing number of foreigners, the labor supply curve shifts to the right.

The point at which the labor supply and demand curves intersect shows the equilibrium wage (W*) and employment (L*). In the equilibrium, the quantity of labor supplied is equal to the quantity of labor demanded. In other words, all persons who supply their labor are employed by firms and remunerated at the equilibrium wage. If the is higher than the equilibrium wage, the quantity of labor supplied is higher than the quantity of labor demanded. This exerts pressure to lower the wage. If, on the other hand, the wage is lower than the equilibrium wage, the quantity of labor demanded is greater than the quantity of labor supplied, so that pressure is exerted to increase the wage.

Frictional unemployment occurs because workers spend time finding a job while at the same time firms spend time looking for a suitable worker for that job. Fortunately, frictional unemployment lasts only a short time and is a sign that the economy is in good health.

Structural unemployment is a nuisance for an economy. Structural unemployment results from a serious mismatch between the skills that workers have and those that companies expect from them. There are some specific skills that are prerequisite for being hired by an industry. Some industries terminate contracts and the workers who work for them become unemployed. The skills they have may not be enough to be hired by another industry. For example, the industry you work for stops operating and you become unemployed. The skills you acquired during your time in that industry are useless for other industries. Structural unemployment also arises due to wage rigidity, a situation where the wage is higher than the equilibrium wage.

Firms may want to pay a higher wage than the one where the quantity of labor supplied is equal to the quantity of labor demanded. The reason why firms are willing to pay more than the market equilibrium wage is to increase worker productivity, as it is beneficial for firms to keep worker motivation high and discourage them from quitting. The efficiency wage, however, leads to involuntary unemployment. There are many who are willing to work in the firms that pay the efficiency wage, but the firms are only willing to hire a few. Consequently, there is a gap between the number of those who want to work at the efficiency wage and those who can be hired at the efficiency wage.

The floor wage set by the government is the minimum wage. Firms cannot pay workers a wage that is less than the minimum wage. This law affects the quantity of labor supplied and the quantity of labor demanded differently. The minimum wage encourages more people (the quantity of labor supplied under the minimum wage law) to enter the labor market, while it discourages firms from hiring more people and even induces them to lay off existing workers (the quantity of labor demanded by firms under the minimum wage law). The difference between the quantity of labor demanded and the quantity of labor supplied corresponds to unemployment due to the minimum wage law.

A slowdown in the aggregate economy leads to cyclical unemployment. In good times, we assume that most firms increase their production in such a way that they need more workers; but in the opposite case, firms may have to lay off many workers. Workers who are laid off due to a downturn in the business cycle are cyclically unemployed.

The sum of frictional and structural unemployment corresponds to the natural rate of unemployment. If the actual unemployment rate is higher than the natural unemployment rate, it is due to cyclical unemployment. Actual unemployment rate fluctuates around the natural rate of unemployment. In a recession, more workers are laid off and it is normal that the actual unemployment rate is higher than the natural rate of unemployment.

There is a trade-off between inflation and unemployment in the short run.The Phillips curve illustrating the negative relationship between the inflation rate and the unemployment rate.

The seminal work of Okun (1962) presented the inverse relationship between changes in unemployment and the growth rate of real GNP. Thereafter the deviation of unemployment from the natural rate of unemployment and the deviation of real output from potential output is known as Okun’s law. This law can be presented as follows:

U −UN = − 1/2 (Y −Y p )

where U is the unemployment rate, and UN represents the natural rate of unemployment. Y is the real output in logs and Yp is potential output in logs. According to the equation above , each one percentage point increase in real output leads to a one-half percentage point decrease in the unemployment rate. Broadly speaking, real output greater than its potential output leads to decline in unemployment rate.