How does an increase in labor costs affect unemployment?

While this pattern is very consistent with the Stock and Watson results of a lower inflation trend after recessions, this pattern is not fully consistent with the more basic Phillips curve. The breakdown is in the period after the peak of unemployment. The theory states that, as the unemployment rate decreases, labor costs should increase. In our analysis, we found that labor costs remain moderate after the peak of unemployment.

With a higher minimum wage, health insurance may be less generous for all employees, even for the most qualified employees who are not directly affected by the minimum wage. We examine the most direct connections between high levels of unemployment and the rate of increase in wages and labor costs, more generally. The profit margin chosen by the company when setting its price to maximize its profits is determined by the amount of competition the company faces, so it is not affected by increased productivity. Unemployment increased because the demand for labor in mining and related service activities fell.

This suggests that increases in unemployment cause a single adjustment in wage growth, rather than that there is a close and continuous relationship between unemployment and wage growth during recessions and after recessions. Once again, conventional regression methods would indicate that the current decreases in compensation are much smaller than expected, given the increase in unemployment. At the same time, an increase in the minimum wage increases business costs and the amount of labor required decreases (companies hire fewer workers). At point A, the employer sets the wage that maximizes profits at the tangency point of the isocost line and the best response function.

If we look at the equilibrium in which the negotiated wage-setting curve intersects the pricing curve, wages are not affected, but the level of employment is lower. Remember chapter 7 that, since cost (C) has fallen, at every point on the benefit curve there is now a higher level of benefit than before the fall in wages. Other policies that affect labor supply include policies to improve employment opportunities for women, such as subsidized child care and reducing discrimination against disadvantaged minorities. To determine the price to be set, the company finds the profit margin on its cost of production that balances the gains of a higher price with the losses of lower sales, in order to maximize its profits.

Figure 9.15 A company increases production and employment after an increase in demand as a result of monetary or fiscal policy. However, since benefits represent about 30 percent of total compensation (based on the employer's costs of compensating employees in the Bureau of Labor Statistics), we included them in our analysis. In addition, evidence from recent economic cycles suggests that compensation growth has been and is likely to remain fairly moderate until the recovery progresses much further, which is helping to reduce cost pressures for both domestic producers of goods and services.