Labor Force. Employment and Unemployment. Plan

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Labor Force.

Employment and Unemployment .


  1. Labor is as a main factor of production.

  1. Labor market, demand and supply for labor.

  1. Labor market equilibrium, how wages and employment are determined.

  1. Unemployment: types, costs, rate.

Labor actually means any type of physical or mental exertion. In economic terms, labor is the efforts exerted to produce any goods and services .It includes all types of human efforts – physical exertion, mental exercise,

use of intellect, etc. done in exchange for an economic reward. Let us see the features of labor as a factor of production:

1] Pershible in Nature
Labor is pershible in nature. This simply means that it has to storage capacity, labor cannot be stored. If a worker does not turn up to work for one shift his labor of that shift is lost completely. It cannot be stored and utilized the next day. That labor is lost permanently. A laborer cannot store his labor to use at another time. So we say labor as a factor of production is highly pershible.
2] Labor is inseparable from the laborer
This means physical presence of the laborer is compulsory.

To sell his services the laborer has to be physical present at the palace of production of goods or services. We cannot separate and his labor power. So we cannot expect a welder to do his work from home, he has to present at the site of the work.

3] Human effort
Labor is a unique factor of production in comparison with others. It is directly related to human effort, unlike the others. So there are certain special factors we must take into

consideration when it comes to labor. Fair treatment of workers , rest times, suitable work environment, idle time, etc are just some such factors.

4] Labor is Heterogeneous
We cannot expect labor to be uniform. Every laborer is unique and so his labor power will also differ from the others. The quality and the efficiency of the labor will depend on the skills, work environment, incentives and other inherent qualities of the laborer.
5] Labor has poor bargaining power
Labor as a factor of production has a very week bargaining power with the buyer of the services. It cannot be stored, isn’t very mobile and has no standard or reserve price. So generally laborers are forced to work for whatever wages the employer offers. In comparison to the employer, the

laborers have very little bargaining power. There is also the problem that laborers do not have any other reserves to fall back on. They are usually poor and ignorant. And this labor work is their only source of income. So they accept whatever wages the employer offers.

6] Not easily mobile
Labor as a factor of production is mobile, the laborer can relocate to the site of work. But there are many barriers to the movement of labor from one place to another. So we can say labor is not as mobile as other factors of production like Capital.
Labor can be classified under the following heads:
1 Physical and Mental labor
2 Skilled and Unskilled labor
The Labor Force is the total population of working age people who are willing and able to work. Both those who are employed and those who are unemployed, but actively seeking work.
Labor Market is the place where workers and employees interact with each other. In the labor market employers compete to hire the best and the workers compete for the best satisfying job.
A labor market is a market where people offer their skills to employers in exchange for wage, salaries and other forms compensation. Participants in the labor market include any person who is seeking to work for compensation and any person or organization that is looking

for compensation and any person or organization that is looking for people to perform labor.

Under the labor market theory, labor like any other resource. The market determines the allocation of labor and its costs. In other words, it determines where people will work and how much they will get paid.
Labor market theory is a model and it makes a few

important assumptions:

  1. The most important motivation in the labor market for people is a wage or other monetary compensation.

  1. Workers are pretty much fungible – you can substitute one for another and it makes little difference.

  1. Workers are mobile – they can move to where there is demand for work.

  1. Wages are flexible – they can go up or down

According to assumptions, we can see how sellers

( people seeking employment ) and buyers ( employers )

behave in the labor market under these assumptions. For

example, some people consider the nature of the work more important than the compensation being offered and may actually choose a lower paying offer.
Labor demand is defined as the amount of labor that employers seek to hire during a given time period at a particular wage rate.
Labor supply is defined as the amount labor, measured in person-hours, offered for hire during a given time period.
The demand for labor follows the general economic law of demand. The price for labor is inversely related to the quantity of labor available in the market. This is just a fancy way of saying that employers will hire more people when wages go down and will hire fewer when wages rise.

In other words, demand for labor increases as wages decrease and demand for labor decreases as wages increase.

It is probably not too surprising to find out that the general economic law of supply also applies to the labor market. As wages increase, more people will enter the labor market and compete for the higher-paid jobs, but if wages decline, fewer people will seek to compete.
Labor market equilibrium is just another fancy way of saying that the price of labor and quantity of labor in the market have stabilized and will not change unless something significant happens to change the price or quantity. The labor market will reach equilibrium when the supply of labor equals the demand of labor.
Why does unemployment exist?
If the prevailing real wage is above the equilibrium real wage, then more workers will want jobs than can find

them – unemployment.

But why would the real wage be above equilibrium?
Three frictions that prevent the real wage from adjusting to maintain equilibrium:
­­­­Efficiency wage, labor unions, minimum wage
Efficiency wage A higher than market wage that a firm pays to motivate workers to be more productive and to increase profits.

Efficiency wages:

  • Make workers less likely to do things that lead the firm to fire them

  • Make workers less likely to switch jobs, so firms avoid expensive searches

  • Improve the quality of the pool of job applicants

Measurement of unemployment

We can divide the total population into three groups:

  1. The first group is made up of people under 16 years of age and people who are institutionalized. Such people are not considered potential members of the labor force.

  1. The second group, labeled “not in the labor force” is composed of adults who are potential workers but are not employed and are not seeking work. For example they are stay at home parents, full-time students or retirees.

  1. The third group is the labor force consists of people who are able to work, both employed and unemployed but actively seeking work.

The third group is active labor force.

Both of the second and the third groups are potential labor force.
The unemployment rate is the percentage of the labor force unemployed:
Unemployment rate=unemployed/labor force*100
Types of unemployment
To better understand unemployment, economists have found it useful analyze three categories of unemployment:
Frictional unemployment, structural unemployment, cyclical unemployment
Frictional unemployment Short-term unemployment that arises from the process of matching the job skills of workers to the requirements of jobs.
Frictional unemployment occurs because:

  • Workers have different skills, interests and abilities

  • Employers needs different skills, conditions and wages

  • Workers need time to search for a job, firms need time to find new employees

Frictional unemployment can improve economic efficiency, because of better matching.

There is always some level of frictional unemployment. Seasonal unemployment is a type of frictional unemployment due to factors such as weather, variations in tourism and holidays.

Structural unemployment Unemployment that arises from a persistent mismatch between the job skills or attributes of

workers and the requirements of jobs.

Structural unemployment is typically longer lasting than frictional unemployment. Technological changes are source of structural unemployment.

Cyclical unemployment Unemployment caused by a recession, measured as the difference between the actual level of unemployment and the level of unemployment when the unemployment rate equals the natural rate of unemployment.
Natural rate of unemployment The normal rate of unemployment, consisting of the frictional plus structural unemployment.
Full employment doesn’t mean every worker has a job.

  • The cyclical unemployment rate is zero at full employment

  • The “full-employment rate of unemployment” is also known as the “natural rate of unemployment”

The natural rate of unemployment is around 5% or 6%

Economic costs of unemployment
The basic economic cost of unemployment is forgone output. When the economy fails to create enough jobs for all who are able and willing to work, potential production of goods and services is irretrievably lost.
Unemployment above the natural rate means that society is operating at some point inside its production possibilities curve. Economists call this sacrifice of output a

GDP gap – the difference between actual and potential GDP The GDP gap can be either negative or positive .

In the case of unemployment above the natural rate, it is negative, because actual GDP falls short of potential GDP.
Macroeconomist Arthur Okun was the first to quantify

the relationship between the unemployment rate and the GDP gap. Okun’s law indicates that for every 1 percentage point by which the actual unemployment rate excee1ds the natural rate, a negative GDP gap of about 2 percent occurs.
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