Estimation of a Disequilibrium Aggregate Labour Market - Example

Name : xxxxxxxxxxx Institution : xxxxxxxxxxx Title : xxxxxxxxxxx Tutor : xxxxxxxxxxx Course : xxxxxxxxxxx @2010 Introduction The labour market mainly operates through the interaction between employers and workers. Economists assume that every household supplies a particular fixed quantity of labour to the labour market, which is also refereed to as the aggregate or market supply of labour. According to Günter &Straub (2005) , the labour market is in equilibrium when the labour services demanded by employers is equal to the differentiated labour services that can be supplied by house households essentially at wage rates acceptable by unions. This particular situation is referred to a market clearing. The big question concerning the appropriateness of regarding the labour market as a clearing market has been a focus of interest among many economists. This particular paper seeks to evaluate whether or not it’s appropriate to regard the aggregate labour market as a clearing market. According to Smith (2010), the classical theory supports the assumption that it is appropriate to regard the aggregate labour market as a clearing market. Smith (2010) argues that the critical feature of this theory is that labour market force of supply and demand act in response to various changes in real wages. Labour supply increases with rise in real wages and declines as they go down. Labour demand is therefore directly related to labour marginal productivity as an input in the production process. Bringing various market forces together, Smith (2001) argues that the classical theory of the labour market clearly states that real wages ought to and would with the lack of impediments, adjust to bring market clearing. Figure 1: Supply and Demand for Labour within an Industry As shown in Figure 1, above represents labour price whereas quantity demanded (number of labor-hours employed) is shown by N. The demand for labour is represented by pMP, the output price times the marginal productivity of labour in output units. Naturally, the equilibrium price (wage) and the equilibrium quantity demanded and supplied (employment) are at the point where the supply and demand curve intersects. Figure 2, above provides an analysis of the effects of minimum wage law. In the figure, minimum wage is represented by W, above the equilibrium wage. Consequently, employers will demand as well as hire only Nd labour-hours, below which could be hired at the equilibrium wage. In contrast, Ns labour hours are supplied, and there is an excess supply. The supply and demand approach as illustrated above assumes that marginal productivity curve stays unchanged even as wages and conditions of working change. Nevertheless, there is little evidence that change in wages or the conditions of working can change the marginal productivity curve upward or downward, therefore impacting change on the relationship between the unit number of labour employed and that of marginal productivity of labour. In particular, a slash on wages may possibly shift the marginal productivity downward. On the other hand, Schlicht (2002) argues that it is sufficient to establish that the equilibrium exists under certain plausible conditions and not any general claim can be made. Schlicht (2002) argues further that for any given set of firms, there will be an equilibrium employment level that may be somewhere ranging between zero and full employment, all the limits inclusive. If taken for granted that the heterogeneity problem stops to be of any significance at the very low employment levels since only best employees will be taken in any case, the elasticity of productivity can be assumed to be small. Schlicht (2002) however argues that as long as there is satisfactory demand enabling profitable production, a positive equilibrium level of employment will materialize. And assuming there is a short-run equilibrium bringing in positive profits then market entry will be induced. On the other hand, the number of firms cannot increase without limits. Thus, for an adequately large number of firms, losses will arise, stirring up market exit. For continuity purposes there has to be equilibrium for a given number of firms in addition to a certain employment level. A study carried out by Martyn Andrews (1987) on the empirical investigation into market clearing in the UK has led to a great number of economists rejecting the assumption that the aggregate labour market constantly clears. One of the facts against this assumption is the pro-cyclical real wage movement, or equally the positive link between employment and real wage. When evaluated on its own, this means that fluctuations occurring from aggregate demand have to stimulate shifts within the labour demand schedule. On the other hand, when added on to the second fact against this assumption which is referred to as short-run labour supply, it turns out to be relatively inelastic. One clear proposition is that same source of shock will hint a locus of points in the real wage-employment space and whereby the real wage fluctuations are large compared to fluctuations in employment (Martyn, 1987). The third fact against the assumption that the aggregate labour market constantly clears according this study carried out by Martyn Andrews on the empirical investigation into market clearing in the UK argues that real wage fluctuates a little over the cycle implying that market clearing is not consistent with the evidence. Rosen & Quandt (1987) however argues that the issue of whether or not it’s appropriate to regard the aggregate labour market as a clearing market has an impact on varied issues such as unemployment, the effectiveness of monetary policies in addition to the rate of income taxes. Rosen & Quandt (1987) argues further that the consensus as regards the correct answer is unfortunately lacking. According to Barro & Grossman (2001), various contributions brought forward by Patinkin & Clower (1956) have represented significant efforts towards reconstructing a macroeconomic theory within a clearly disequilibrium context. Barro & Grossman (2001) combined and extended Patinkin (1956) & Clower’s (1965) models drawing various insights to attain a general equilibrium model of a closed economy. Providing facts against the assumption that the aggregate labour market constantly clears, Patinkin & Cowler (1956) gave out an analysis of involuntary unemployment in a context of clear market disequilibrium and illustrated that the confusing implications of the conventional analysis as concern the real wage are clear results of its general equilibrium character. According to Barro & Grossman (2001), Patikin & Cowler (1956) offered a theory to prove that involuntary unemployment in the context of a clear market disequilibrium can come up as a result of disequilibrium, particularly, when there is excess supply within the market for the existing output. In his theory Patikin (1956) argues that the incapacity of various firms to put on the market the quantity of output provided by their supply schedules sets them off to demand smaller labour quantity as compared to that offered by their usual demand schedhule.Barro & Grossman (2001) however argues that fundamental nature of Patinkin’s theory was a causality coming from the excessive supply of current output within the market to a state of excess supply within the labour market. According to Barro & Grossman (2001), Patinkin’s theory in so doing, explained the probable cause of recurring unemployment, though his analysis involved only partial disequilibrium rather than the general equilibrium. Barro & Grossman (2001) argues that a general disequilibrium, ought to integrate the likelihood of a reverse influence the excess supply level within the labour market upon the state of surplus supply within the market for existing output. Another argument against the assumption that the aggregate labour market is a clearing market is revealed through Keyne’s attribution regarding full employment assumption. According to Iakhpor (2003), Keynes describes full employment as a labour market condition in which only frictional and voluntary employment exists. Iakhpor (2003) argues further that Keynes validation of the definition of involuntary unemployment invoked the classical theory applied to the labour market. According to the argument, the real wage at which a given individual agrees to be employed has to be at least equal to the marginal disutility of the work that is to be done. As a result, there can only be involuntary unemployment in cases where the rise in real wages stimulates more individuals to agree to employment. According to Iakhpor (2003), Keynes also links full employment with the condition under which output supply ceases to be elastic implying that any further rise in the value of effective demand can no longer go along with by any rise in the output. According to Iakhpor (2003),Keynes argues that there is also full employment in cases where the output rises to a level in which the marginal return coming out of the representative unit of the various factors of production falls to a minimum figure upon which a quantity of the various factors adequate to produce this available output. According to Barro (2008), the rejection of the assumption that the aggregate labour market is a clearing market is a significant feature of deviating theories of income distribution and wage determination. Labour-intensity models highlight the unpredictability of labour effort, as a result linking wages not only to the socio-economic institutions governing the labour market but also to the nature of technology. Barro (2008)argues further that the heterodox literature has not arrived at consensus as regards the significance of labour costs in determining trade and other patterns of investment patterns and therefore the eventual effect of globalization on labour markets. Schlicht (2002) on the other hand reflecting a labour market having heterogeneous workers argues that firms employs by putting in place a given hiring standard as well as a simultaneous wage offer. Schlicht (2002) argues further that a more demanding standard of hiring employees calls for better wage offers so as to attract adequate as well as qualified applicants. As a result, an efficient wage effect is obtained. Equilibrium materializes but it does not clear the labour market. Wage levels normally depend on various structural characteristics of labour supply, for instance heterogeneity and the mobility of employees. According Schlicht (2002), such explanations presents the wage formation theory within a labour market where the emerging wage steadily fails to clear market. According to Schlicht (2002), the labour market is set apart by indistinguishable firms seeking employees who differ in their efficiencies with each firm making a wage offer and in which given numbers of employees’ apply. The firms therefore test their efficiencies and decide on the best employees to fill various vacancies. If all these firms provide a similar wage offer, each firm will receive the same mixture of candidates and so may end up with a labour force having similar average qualification as all firms do. If one of the firms gives an offer of a higher wage, however, it will be able to draw more candidates and, more particularly, a larger number of candidates who are better qualified. This brings in the possibility of employing better employees and may turn out to be worthwhile for the firm provide a wage offer higher than the available wage rate. Schlicht (2002) however argues that in equilibrium such possibilities are excluded. As a result, all the firms have to provide similar wage rates and no firm has a reason to deviate from the available market wage. This condition therefore fixes concurrently an equilibrium wage rate as well as an equilibrium employment level. Conclusion It is without a doubt that the size of contemporaneous relationship between employment and real wage has really fascinated a great deal of economists’ interest. It is however difficult to justify whether or not it’s appropriate to regard the aggregate labour market as a clearing market as majority evidences seems fairly ambiguous. Moreover, not every economist would be on familiar terms with the supply and demand analysis of the labour markets, employments and wages. In addition to this, there are numerous criticisms regarding the supply and demand model of the labour markets with each of the criticisms having the possibility of leading to a different analysis of the labour markets. Some of the critics for instance stress the significance of bargaining power to be having a great influence on wages and employment, as a result shifting them away from the supply and demand equilibrium or still reinstating completely supply and demand as wage determinants. References Ahiakpor, C.W, 2003, Classical Macroeconomics: Some Modern Variations and Distortions Volume 61 of Routledge Studies in the History of Economics, Routledge. Barro, R & Grossman, H, 2001, General Disequilibrium Model of Income and Employment, The American Economic Review, Volume 61, Issue 1 (Mar., 1971), 82-93. Barro, R.J, 2008, Macroeconomics: A Modern Approach, Cengage Learning. Günter, C & Straub, R, 2005, Does Government Spending Crowd in Private Consumption? Theory and Empirical Evidence for the Euro Area, Issues, International Monetary Fund. Martyn Andrews, 1987, The Aggregate Labour Market: An Empirical Investigation into Market-Clearing for the UK, The Economical Journal, Blackwell Publishing, 97,157-176. Rosen, H.S & Quandt, R.E, 1987, Estimation of a Disequilibrium Aggregate Labour Market. Smith, W, 2003, Labour Economics, Edition 2, Illustrated, Routledge. Schlicht, E, 2002, Hiring Standards and Market Clearing. http://www.jstor.org/pss/2233328 http://www.jstor.org/pss/1924162 Read More