Lecture 28

In 1914, Ford started paying $5 per day to workers (against the prevailing $2 or $3 wage). According to Ford, this is in fact “the finest cost cutting move” he has ever made. The increase in wage increases the firm’s productivity. Absenteeism fell by 75% and shop floor costs fell as well.

• Cyclical unemployment - This refers to the year-to-year fluctuations around its natural rate, which is associated with the short-run ups and downs of economic activity.
• Disguised unemployment
• Structural unemployment
• Seasonal unemployment - people may be hired only in summers
• Frictional unemployment
• Hidden unemployment - people not registered in the official statistics, underemployed people, and skilled people in low-skilled jobs.

Some workers, known as discouraged workers claim to be unemployed but are not really trying to find a job.

A union is a worker association that bargains with workers over wages, benefits, and working conditions. The process by which unions and firms agree on the terms of employment is referred to as collective bargaining. If an agreement is not reached, a union can withdraw labour, resulting in a strike. Union workers usually earn about 10 to 20 percent more than similar workers who are not in unions. Unions just serve as an antidote against any market power that the firms that hire workers may possess.
When the wage increases due to union activity, there is a decrease in demand for labour. This causes a conflict between “insiders”, who are the union workers that gain from the increased wages, and the “outsiders”, who do not get the union jobs. Workers not in unions bear some of the cost as well. Even if the unions have this adverse effect of pushing wages above the equilibrium level and causing unemployment, the advantage is that firms have a happy and productive workforce.

The negative relationship between unemployment and GDP is called Okun’s law. It is defined as

\[\text{\% change in real GDP} = \text{Relation between real GDP and unemployment} - 2\times\text{change in unemployment rate}.\]

Okun obtained the above by running a linear regression on the data.

Some problems in GDP measurement are:

• Illegal activities
• Tax avoidance (4-5% of earning population paying tax)
• Hoarding assets - gold for example
  The above three are primarily in developing countries like India.
• Non-market transactions like a barter system in villages and payments to domestic servants. If a chef cooks food for his family, it is not counted, but it is if he cooks it for a customer at his restaurant. The value added to the raw ingredients is left out of the GDP.
• Negative externalities - for example, degrading the soil results in the growth of the fertilizer industry.
• It does not take depletion of natural resources into account.
• It does not talk about the distribution of income.
• It does not measure changes in happiness. For example, higher GDP does not mean better education, but it does mean that the government can afford better education.

Is GDP a good measure of economic welfare?

• Growth and development are different. For example, a large fraction of India’s GDP is in healthcare, but people’s health has not significantly improved.
• GDP does not talk about equal distribution of wealth.
• Even if the GDP of a nation increases, the median income can go down.