Faced with collapsing demand, the mining company cut production, and also sought to drastically reduce costs. As part of this process, they replaced human labour by machines wherever possible. Figure 9. The boom in ore prices in the top figure made mining highly profitable, leading to strong demand for labour, which eventually dried up the pool of unemployed riggers and truck-drivers. Mining companies had no choice but to pay extraordinarily high salaries, and while the mining boom lasted, the companies remained highly profitable.
The downturn in commodity prices began in mid and unemployment began to rise.
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Note: Unemployment rates are seasonally adjusted. The chart shows real weekly earnings for males in Western Australia, together with the world price of iron-ore in the top panel and the unemployment rate in Australia in the bottom panel. Following the peak in iron-ore prices, real wage growth slowed and unemployment began to rise. In this unit, we describe how the labour market works and why even in equilibrium, the supply of labour number of people seeking jobs exceeds the demand for labour number of jobs offered. Those without work in this situation are termed the involuntary unemployed to distinguish them from those who are unemployed by choice, but are looking for a job.
In previous units we have looked at particular markets—buying and selling bread, for example—and sometimes at a single firm. Here we model the labour market of an entire economy, which determines the amount of unemployment in the population as a whole. We look at price-setting firms, selling differentiated products as described in Unit 7 , and a large number of identical workers who may be employed by the firms for the same wage set by the firm as studied in Unit 6.
We consider the simple case in which the only input to production is labour, so that the only cost is the wage, and profits are determined by just three things: the nominal wage the actual amount received in a particular currency , the price at which the firm sells its goods, and the average output produced by a worker in an hour. The labour market brings together two earlier themes: the firm and its employees Unit 6 and the firm and its customers Unit 7. Two things you have learned will be essential to seeing how the labour market functions. In order to motivate employees to work hard and well, firms must set the wage sufficiently high so that the worker receives an employment rent.
This means there is a cost of job loss: she is better off being employed than being fired due to inadequate effort. If the worker is very likely to find alternative work if she is fired, which will be the case if the employment level in the economy is high, she will need a higher wage to work hard. Think of wage-setting as the business of the human resources HR department of the firm. In setting the price of the good they sell, firms face a trade-off between selling more goods and setting a higher price, due to the demand curve they face.
To determine the price to set, the firm finds the markup over their production cost that balances the gains from a higher price against the losses from lower sales so as to maximize its profits. Think of price-setting as the business of the marketing department of the firm. We want to know how the real wage and the level of employment in the economy as a whole are determined.
Keep in mind that the real wage is the nominal wage divided by the price level of a standard bundle of consumer goods, so it is determined both by the nominal wages paid by the firms and the prices they each set. Think about this in two stages:. But the key idea is simple. Once all firms in the economy have made their wage and price markup decisions, the output per worker in the economy is divided into the real wage that a worker receives, and the real profits that the owner receives.
To understand how the real wage and employment are jointly determined in the labour market, we need two basic concepts:. In the next section we look at how employment and unemployment are measured. After that, we introduce the wage-setting curve using the model of wage-setting from Unit 6. Then we describe how a single firm determines its employment level using the model of price-setting from Unit 7.
This will provide a reason why the price-setting curve is essential to understanding the labour market in the economy as a whole. We then show how the two curves together determine the equilibrium level of employment, the real wage, and the distribution of income between wages and profits. According to the standardized definition of the International Labour Organization ILO , the unemployed are the people who:. We begin on the left-hand side with the population.
The next box shows the population of working age. This is the total population, minus children and those over It is divided into two parts: the labour force and those out of the labour force known as inactive. People out of the labour force are not employed or actively looking for work, for example, people unable to work due to sickness or disability, or parents who stay at home to raise children. Only members of the labour force can be considered as employed or unemployed. There are a number of statistics that are useful for evaluating labour market performance in a country and for comparing labour markets across countries.
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The statistics depend on the relative sizes of the boxes shown in Figure 9. The first is the participation rate , which shows the proportion of the working age population that is in the labour force. It is calculated as follows:. Next is the most commonly cited labour market statistic: the unemployment rate.
This shows the proportion of the labour force that is unemployed. Lastly, we come to the employment rate , which shows the proportion of the population of working age that are in paid work or self-employed. It is important to note that the denominator the statistic on the bottom of the fraction is different for the unemployment and the employment rate. Hence, two countries with the same unemployment rate can differ in their employment rates if one has a high participation rate and the other has a low one.
The table in Figure 9. It also shows that the structure of the labour market differs widely across countries. Norway also had a higher participation rate, which is a reflection of the higher proportion of women in the labour force.
International Labour Association. Norway and Spain are illustrations of two common cases. Norway is a low-unemployment, high-employment economy the other Scandinavian countries—Sweden, Denmark, and Finland—are similar and Spain is a high-unemployment, low-employment economy the other southern European economies—Portugal, Italy and Greece—are other examples.
We now build a model of the labour market that can help to explain differences in unemployment rates across countries, and changes over time within a country. To do this, we broaden the perspective from the single firm in Unit 6 to the whole economy, and we ask how changes in the unemployment rate affect the wage set by employers.
In Figure 9. The vertical axis is the economy-wide wage. The wage-setting curve: Labour discipline and unemployment in the economy as a whole. The upward-sloping line is called the wage-setting curve. This means that at the employment rate x , the wage w is the result of both employers and employees doing the best they can in setting wages and responding to the wage with a given amount of effort, respectively. We show how to do this in Figure 9. The top panel of Figure 9. As we saw in Unit 6, a higher unemployment rate reduces the reservation wage, because a worker faces a longer expected period of unemployment if he or she loses a job.
Deriving the wage-setting curve: Varying the unemployment rate in the economy. In the lower panel, we plot point A. We now assume a fixed size for the labour force and the horizontal axis gives the number of workers employed, N.
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Both the reservation wage and the wage set by the employer are higher, as shown by point B. This gives the second point on the wage-setting curve in the lower panel.
We derived the wage-setting curve as part of the labour discipline model, which was designed to illustrate how employees and firm owners and their managers interact when setting wages and determining the level of work effort. We will use the same model later when we describe policies to alter the level of unemployment in the entire economy.
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Later in this unit and in Units 16 and 17 we will look at the ways in which labour unions can affect the wage-setting process and so alter the workings of the labour market. Wage-setting curves have been estimated for many economies. Read how it is done in an article by David Blanchflower and Andrew Oswald. Note that in Figure 9. By using data on unemployment rates and wages in local areas, economists can estimate and plot the wage-setting curve for an economy. The amount produced depends on the amount that the firm is able to sell, which in turn depends on the price that it charges.
Recall in our model they are human resources HR , the marketing department, and the production department PD. Remember this firm has only one input—labour—so the wage is the only cost. So the wage the firm pays W is the cost of a unit of output in the relevant currency unit. Note that W is the nominal wage and w is the real wage. Once HR has set the wage at a level sufficient to motivate the workforce, the marketing department proceeds in two steps.
So first, as in Unit 7, the marketing department asks: which combinations of p and q are feasible? These combinations are shown by the demand curve, which will depend on the amounts that other firms are producing, the prices they are setting, the wages they are paying, and other influences on the total level of demand for goods in the economy.
Step two is to pick a point on the demand curve, so the marketing department looks at Figure 9. Using the value of W chosen by HR, the marketing department constructs the isoprofit curves shown. Recall that each curve is the collection of all combinations of price and quantity that will yield the firm the same level of profit, given the wage.
Curves further out from the origin higher price and quantity indicate higher profits. Recall that:.
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As in Unit 7, maximum profits occur at point B, where the demand curve is tangent to an isoprofit curve. This determines the division of the total revenue between profits and wages. Notice from the figure that once the firm has set a price, it has determined the division of the total revenue between profits and wages.