Considering the Aggregate Labour Market as a Clearing Market
Labour markets are the focal point in studying employment in the economic perspective, particularly, the supply and demand for labour. A perfect market is manifested when the supply for labour meets the demand. On the other hand, in a prefect market, an individual who is equipped to provide labour has no power to dictate wage rates. Similarly, a firm who demands for labour has no capacity to dictate wage rates. A perfect market dictates that economic agents have perfect information so that they become reasonable.
Important Concepts in the study of labour markets
The study of labour markets necessitates that some concepts should be defined. The term labour force refers to the total number of the capable workforce, both employed and unemployed labour units. Unemployment rate is defined as the number of unemployed versus the total of the labour force while employment rate is defined as the number of employed labour units versus the total of the labour force (Artis Nixon 2007 Blanchard 2005).
The classical and traditional theory
Classical and traditional economic theories are supported by the assumption that full employment exist in an economy and that markets have perfect competition. Both theories also assume that there exist a large number of buyers and sellers. In full employment theory, labour units will be employed if it accepts the prevailing market wage rate. Consequently, labour units that are not amenable to the prevailing market wage rate will be unemployed of their own accord. In such a setting, involuntary employment is non-existent since the labour market is able to take in all available labour units at the prevailing wage rates (Chrystal 1994 Dornbusch Fisher 1990)
The Keynesian Theory
Keynes was not open to the idea of full employment. Yet, he also resisted the idea that only voluntary employment will be prevalent in the labour market. His assertion point to a market equilibrium characterized by high unacceptable employment rates. To ensure that unemployment rates in the labour markets remain at acceptable levels, Keynes advocated for government interventions such as implementing monetary and fiscal policies that will help regulate the labour market. Projects that have the capacity to increase employment opportunities should be given special attention by the government by allocating extra budget. Providing subsidies that will help generate employment opportunities can also be adopted. Such monetary policies suggested by the Keynesian theory also include reduced interest rates to boost investments in the private sector which also has the capacity to contribute significantly to the labour market. The aggregate labour market created by such policies will introduce a clearing market so that the available labour units can fill the increase in demand which will also set definitive wage rates. The end result will be a perfect market wherein employment levels will reach acceptable levels and only voluntary unemployment will exist (Hillier 1991 Levacic Rebmann 1984).
New classical and New Keynesian theory
New classical economists follow the standards set by classical economists. Rational expectation concept is incorporated with the classical theory creating the modern classical theory. The new theory dictates that wages are adapting to economic changes and labour markets will adjust accordingly with changes in the levels of supply and demand. This implies that wage rate will change along with the different economic forces involved. This theory involves rational expectations wherein firms and people can make informed decisions regarding employment.
The labour market participants will gain information about the labour markets while employers will be knowledgeable of data concerning the demand and supply of labour from which both can make an informed decision. Households that provide labour will know of employment opportunities within their reach as well as prevailing wage rates. From there, they will be able to decide which jobs are appropriate for them based on their skills and their needs. The aggregate labour market will gather the informed rational suppliers of labour and employers. Employers will have access to the workers that they need and labour units will find jobs that are appropriate for them. Full employment can be achieved and only those labour units that refuse to take the prevailing market wage rates will remain without a job (Chrystal 1994).
On the other hand, the new Keynesian theory suggests that wages are fixed. Full employment cannot be realized by the simple interaction of supply and demand forces in the labour market. The theory states that economic agents make rational decisions and their expectations are dependent on whatever information they have. The theory also suggests that the relationship between supply and demand does not have great influence that it could possibly lead to full employment. While economic agents can make informed decisions from the knowledge that they gain, this also will not result in full employment. Instead, this will lead to unacceptable employment levels and involuntary unemployment. This effect can however be prevented by implementing effective fiscal and monetary policies which is aimed at creating employment opportunities to the unemployed workforce. The government spending will increase the income of employed household which will eventually increase the demand for goods and services. This increase in demand for goods and services will help keep the economy afloat as this will be a desirable location for investors. This means more production which translates to more demand in labour force. More jobs will be created and only voluntary unemployment will exist in the long run (Chrystal 1994 Leslie 1993).
The rule of rational expectation states that economic agents are rational beings such that it will constantly make rational decision based on self interest. Rational decisions are always regarded as the best of all choices available to the economic agent (Leslie 1993).
Employing this concept, it is to be expected that the supplier of labour, which is the household, will expect the best wage rates from whatever information they have gained about the labour market. Alternatively, employers will want to employ whoever fits the jobs best with consideration given to skills, experiences, other desirable traits and best wage rate. In an employers perspective, the best wage rate would refer to the lowest possible wage rate. The expectation an employer will also depend on the information obtained about the market and weighing effectively between good, skilled employees and good wage rates.
In a large labour market, such that of the United States, a large flow of workers is experienced (Blanchard 2005). This can better be explained like how an airport operates. Workers do their jobs as passenger ride on the planes. Some reasons will result in employees shifting some aspects of their job as weather, destination, or any other reason can affect what plane a passenger takes. Similarly, the airport clears the demand for transport of various customers. A labour market will function to bring demand and supply of labour as long as the willing supplier of labour will meet with the willing employer who requires labour. An active labour market is manifested by a flow of workers leaving and entering stages of employment. Workers are bound to leave their jobs if they find a better, more rewarding job. Some workers are laid off by an employer and will soon find themselves working for another employer. The labour markets will eventually deal with issues such as high unemployment, increase in layoffs, and decrease in labour supply.
With labour unions, collective bargaining agreements will play a significant role in determining appropriate wages for employees. However, the role of labour unions in liberal economies such as the U.S. is limited. Bargaining will play a major role in determining wages taking into consideration the quality of the specific labour unit involvedskills and experiences considered. Certain external factors can also affect the determination of wages. Technically, a lower unemployment rate translates to higher wages since the cost of replacing a worker is higher if there is greater demand than supply which ultimately affects bargaining power. Through the labour market, a firm may be able to lay off a worker who asks for a higher wage since he can be replaced by someone who is amenable to the current wage rate. Inversely, it would be difficult for a firm to lay off a worker especially someone holding a position if there is low unemployment since it would be difficult for the firm to find a replacement, In such a situation, employers will want to keep their workers satisfied with high wages so that they will not desert their jobs.
Supply and demand forces in the labour market which affects unemployment rates play a major role in the conclusion of collective and individual bargaining of labour units with employers. Blanchard (2005) utilizes the classical theory to explain the scenario. In the labour demand and labour supply market structure, less unemployment will shift the balance to the labour units and they are able to state their demands such as better wage rates. Blanchard indicates that market wages are dependent on factors like unemployment rate, expected price levels, employee benefits, bargaining power, etc. (p.24).
Parkin and Blade (2001) indicates that the expectations in prices of certain products in the market play a critical role in the function of the labour markets. Employers want to maximize their profits and since product prices is an important factor in determining profits, expectations of low prices will result in employers letting go of some employees or negotiate for lower wage rates. In such a case, the labour unit that does not agree with a lower wage rate will be laid off in place of a new labour unit taken from the aggregate who is amenable with the offered low wage rate.
Conclusion
The labour market is the core for employers, who provide the demand, the labour units who supply the labour. It is where households obtain jobs that they need to survive and where employees get the workforce that they require for their business to function. They complement each other since a balance must be maintained between the supply and the demand. In this aspect, the labour market acts as a clearing market.