Macroeconomic Stabilisation Theory and Policy - Essay Example

Labour markets are highly essential in any given economy as Zanetti puts it. It serves in the determination of the performance of the overall economy. Its mere structure affects the equilibrium of such an economy in the long-run and moreso it predicts the process by which the macroeconomics factors behave over a given time period. Therefore, the institutions of the labour market are very important in the economic trend studies. (Zanetti, 2007) This study is going to have a look at the issue of labour market macro economy and more specifically it is going to focus on giving an answer to the study question, “Is it appropriate to regard the aggregate labour market as a clearing market?” A labour market is generally a market where the services of labour factors of production exchange hands. From a macroeconomics’ point of view, it is a very critical factor that impacts on the overall markets of factors of production. In line with the same definition, it should be noted that in the short-run wages remain rigid and this is among other predicaments in the same short-run. In the short-run, therefore, equilibrium remains an illusion. Over-employment and under-employment remain the order of the day in the short-run. (econguru.com, 2008) Castles, in his book, states that aggregate supply of labour is usually a function of the trade-off between leisure and income. It involves the effects of substitution and the income offsetting. (Castles, 1998 p198) On the other hand aggregate demand of labour happens where there is measurement of employment levels and it serves as a rate of growth determinant with wages and inflationary impacts on wage levels in the spotlight. (O’Hara, 2001 p511) These two functions of any given labour market are the major aspects of this market clearing topic. They are going to be considered in detail further on in the study. The expression “Market clearing” refers to that process through which markets move to a scenario where the quantity of demand is equal to that of supply. This means that the forces of the economy ensure that supply and demand are at par. This process of achieving a market clearing position usually involves various adjustments in the market up to the point of getting a price of market clearing. This concept of market clearing is highly related to that of equilibrium in the market. (Black, et al, 2009 p282) Issues of a labour market may be with the inclusion of wages, rates of participation as well as unemployment. A typical labour market, thus, provides a systematic structure that creates an environment of employers’ and workers’ interaction with regards to the conditions of work, jobs and pay. The outcomes of a given labour market are dependent upon the processes as well as institutions of the overall bargaining besides the part played by unions of trade and organisations of employers. (eurofound.europa.cu, 2011) An equilibrium in a market of labour may be the putting together of demand for labour and labour supply. In such a case the price, with labour in focus, is the wage equivalent to a given labour level and the demanded quantity of labour is the amount of labour-hours that are employed. Labour demand is the output price multiplied by the extra labour productivity in output units. Equilibrium, therefore, occurs where the demand and supply curves intersect. Figure 1; shows the demand and supply of labour in a given industrial case. Note: D is demand for labour S is supply for labour W is real wage levels Wage S W D Labour hours D,S One can look at a given labour market where there is a law of minimum wage. The most essential factor here is to make an analysis of the effects of the law of minimum wage. Minimum wage (W1) is set above the wage at equilibrium level. The resultant effect is that of employers’ demand as well as hire (N1) labour-hours, which is lower than would be the amount of labour hours that are hired at the point of equilibrium wage. The other outcome is an excess supply of labour as seen in the diagrammatical illustration that follows. Figure2; a labour market with minimum wage laws Wage S W1 W* D N* NS D,S The assumption is that those employees working under the law of minimum wage are better off since there are other workers willing to give more labour hours but are not able to find jobs in such an industry. (Drexel.edu, 2011) This aforementioned scenario of a labour market is so generic, though. Thus, it is very vital to have a look at a labour market with more emphasis focused on the aggregate issue and market clearing point alike. Prior to this analysis, it is however good to note that there can be a situation of a flexible or a rigid labour market as McGinnity writes. Differentiating the two market types can be possible under an economics’ approach. This distinguishing will aid in the analysis of the institution of labour markets and the state of welfare. Setting out in this disambiguation, a rigid labour market is defined as one which negates the condition of a labour market that clears freely. Therefore, from an economics’ discipline point of view, rigidity in a labour market reflects on the obstacles or hurdles that hinder efficience in a labour market’s functioning. Hurdles mentioned above maybe the likes of protection measures of employment, such as expensive and difficult firing procedures, highly infested market with unions of labour, an overall high level taxes as well as very high minimum wage levels. A labour market that is faced with rigidities may face a hard time in responding to shocks emanating from externally, with the likes of stiff competition in the world economy and changes in technology giving good examples of external shocks. On the other hand, a labour market that is flexible has an example of the US market of labour which was characterised by various reforms in the 1980s. It (the US labour market) got a significantly different system of welfare while compared to a rigid market. However, levels of rigidity in a labour market are different with various economies put in question. The main argument brought about by the flexible albour market is that welfare systems, despite their being seen as a positive move to reduce the deprivation of finances due to unemployment they have big contributions to the unemployment levels. Welfare systems are synonymous with rigid markets. (McGinnity, 2004 pp14,15) Furher, it is good to note that participation in a labour market is called employment and it also involves both the selling and the buying of labour as a resource. To this argument, it therefore, follows that the demand and supply of labour both impacts and is impacted by the prices in such a market. Taking other factors as remaining equal a rise or fall in the number of workers seeking to be employed raise or reduce wages. The change in the prices of the services of labour is the prime determinants of demand and supply of labour. Self-regulating markets of labour are usually flexible and free. Wages fluctuate upwards and downwards in such markets in an uncontrolled manner thus may achieve a point of balance in both demand and supply. In a free market of labour, the movement of wages will eventually terminate employments and surpluses. In reality, freedom in contracting and mobility of labour, however, bring about hinderances to this automatic balancing of labour demand and supply. Rarely can there be a market clearing point in reality and as such, governments have to come in and intervene to ensure sanity in the labour markets. (Abbott, 2010 p1) In order to explain this concept of aggregate labour market, it is very important to have a look at it from different perspectives. Before embarking on the various scenarios to explain whether an aggregate labour market means a market clearing point, one should note that the case is not always like that. That is, only in very few situations will the aggregate market of labour reflect a position of market clearing. Making an assumption that jobs in entirety are similar with regards to the work effort disutility, benefits and worked hours as well as considering all other factors which are not included in real wages take the number of employees working in the labour force are (E) and real wage levels are (W) where W= Wo/P and Wo= nominal wages and P the level of prices. At this juncture, all employees will be having their reservation wage, which is in other words that wage level which employees must atleast earn so as to accept a job as opposed to remaining jobless. Employees exhibit different behaviours and preferences and thus their reservation wages are also not the same. As levels of real wages increase, more job seekers will be aiming at getting into the job market. From this, an upward sloping curve of labour supply (S) is obtained. Also, there is the assumption that various firms in the market are characterised by perfect competition and this results in their selling all their commodities at the marginal cost rate. The end of this is that firms are capable of paying their employees and as well reach their breaking even points where they make no losses or profits. At this point the MRPL- Marginal Revenue Product of Labour equals the MPL- Marginal Product labour multiplied with the prices of outputs of the firm. MRPL= change in firm’s output (which is a function of capital and labour) divided by change in labour. Note that capital is not taken to affect anything since it remains fixed. Therefore, MRPL falls as labour (L) increases. At any amount of real wages, firms recruit workers to such an extent that MRPL= Real wages (W). Economically speaking, the more the wages the lesser the recruitment of employees by employers. This brings about a curve of demand and labour that is downward sloping. (D) Based on the argument raised and utilising the classical theory’s assumptions, the clearing point of a labour market is gotten where D=S and the two curves meet at L*. The unemployment levels can be computed as L- L*. The prime assumption of the classical school is that in case of any unemployment, it is voluntary since all the unemployed people do not want to take up jobs at the existing wage rates in the market. The diagram below presents an illustration of the equilibrium of a labour market which is also the market clearing point. Figure 3; Market clearing point L*. Wages S W* D L* L D,S Apart from the classical school type of case, there are cases of sticky wages. Sticky wages are wages in a situation in which levels of prices have changed while nominal wages remain at an unchanged rate. This happens where the economy has some kind of rigidity caused by numerous reasons. These may include a situation where employees and the firms do not negotiate on wages as often. Due to this, wages offered do not account for the altered levels of prices. This is unlike the classical approach where each employee is assumed to have the ability to negotiate with the employer on the level of wages. Under classical theory, the market is bound to reach a clearing point freely, but in the second scenario of sticky wages hindrances come in like trade unions. Employees protected by trade unions are unlikely to accept a nominal wage reduction and are only willing to remain with a higher wage rate. Firms cannot also fire workers under this case anyhow so as to recruit those who are ready to take lower wages. Wages remain higher than market clearing wage levels in this case as shown in the diagram. Figure 4; wages in a unionised labour market Wages S W W* D X X* D,S The difference in X-X* reflects involuntary unemployment due to the rigidity in this labour market. The second case, together with other cases which argue against the classical theory are, thus, not likely to achieve an aggregate labour situation and also is the market clearing point. (ox.ac.uk, 2011) Therefore, while concluding it is important to note that aggregate demand shows a market clearing point position of a macroeconomic market. However, this argument may only stand in the classical school of thought where market hurdles or restrictions are not there. Also market equilibrium in a labour market is closely related to the market’s clearing point. This is in trying to find the best answer to the study question, “Is it appropriate to regard the aggregate labour market as a clearing market?” Reference list: Abbott, Lewis. (2010). Theories of the Labour Market and Employment: A Review. Industrial Systems Research. Edition 2, revised. p1. Black, John et al. (2009). A Dictionary Of Economics. Oxford University Press. Edition 3, illustrated. p282. Castles, Francis Geoffrey. (1998). Comparative public policy: patterns of post-war transformation. Edward Elgar Publishing. Edition illustrated, reprint. p198. econguru.com. (2008). Economic Definition of labor market. Defined. Retrieved 14 April 2011 http://glossary.econguru.com/economic-term/labor+market eurofound.europa.eu. (2011). Labour Market. Retrieved 14 April 2011 http://www.eurofound.europa.eu/areas/labourmarket/index.htm faculty.lebow.drexel.edu. (2011). Equilibrium in the Market for Labor. Retrieved 14 April 2011 http://faculty.lebow.drexel.edu/McCainR//top/prin/txt/factors/labor4.html McGinnity, Frances. (2004). Welfare for the unemployed in Britain and Germany: who benefits? Edward Elgar Publishing. Edition illustrated. pp14,15. O'Hara, Phillip Anthony. (2001). Encyclopedia of political economy, Volume 1. Routledge. Edition reprint. p511. ox.ac.uk. (2011). Introduction to Labour Market, Aggregate Supply and AD-AS Model. Retrieved 14 April 2011 http://docs.google.com/viewer?a=v&q=cache:jwojQhyq4PUJ:users.ox.ac.uk/~sedm1375/ Teaching/Macro/aggregatesupplystickywages.pdf+aggregate+in+the+labour+market&hl =en&gl=ke&pid=bl&srcid=ADGEESg9DXh0hbd_ZFSznuYa7bST1DzE1H4XKUuye3n 4ULCiptiVxnRbbdZtFhXuPRmlnHFIYQAtV6foAuU2627EIRdOIwUJupKtTV3sbpBK VVkvZ19RliFSrAy5eOLFlKFxTV1oNg0S&sig=AHIEtbR76mO3J2WMNFL20tJEzYM baGX46g Zanetti, Francesco. (2008). Labor Market Institutions And Aggregate Fluctuations In A Search And Marching Model. Retrieved 14 April 2011 http://www.bankofengland.co.uk/publications/workingpapers/wp333.pdf Read More