Unemployment in the Labor Market

If the real wage is sticky, it may be higher than the equilibrium real wage, meaning that some workers who want to work are unable to find a job.  “Unemployment in the Labor Market” shows us what the labor market must look like for there to be unemployment, but it is hardly an explanation of unemployment. Economists typically expect markets to look like Figure 8.3 “Labor Market”, not Figure 8.4 “Unemployment in the Labor Market”. That is, they think that the price in a market—in this case, the real wage—adjusts quickly to ensure that supply equals demand. If we want to explain unemployment with a picture like Figure 8.4 “Unemployment in the Labor Market”, we also need some story of why real wages might be sticky, so they remain above the equilibrium wage. Inflexible Real Wages Over the years, economists have offered several stories about why wages might be inflexible.  One story is that the wage is not allowed to decrease by law. Many economies have

minimum wage laws on their books. This could explain some unemployment. A difficulty with this explanation is that the minimum wage affects only low-income workers. Most workers in the economy actually earn a wage above the legal minimum and are unaffected by minimum-wage legislation.

 Another possibility is that firms find it difficult to adjust wages downward. The market for people’s time is not like the market for bread. Pay cuts are very visible to workers and are likely to meet a great deal of resistance. If a firm tries to cut wages, it is likely to find that its workers become demotivated and that its best workers start looking for jobs at other firms. Both of these stories are really explanations of why nominal wages may be unable to adjust. Figure 8.4 “Unemployment in the Labor Market” has the real wage on the axis. Remember that the real wage is calculated as follows: real wage = nominal wage price level .