Labor Demand, Labor Supply, and Employment Volatility

If labor demand and labor supply are both flat, small shifts in either schedule bring substantial shifts in employment. Flatness of demand and supply seems the most promising explanation of observed aggregate employment volatility. Empirical work on labor demand in US industries suggests flatness: When exogenous forces change the level of employment in an industry, the product wage in that industry changes relatively little. Other evidence corroborates this. For example, firms do not build inventories in anticipation of future higher levels of production; cost minimization would compel such production smoothing if the marginal product of labor was higher in slumps than in booms. Complementarities may be one of the reasons that labor demand is flat. With respect to labor supply, flatness occurs if the marginal value of alternative activities is not sensitive to the amount of time devoted to those activities. The paper focuses on reorganization as the primary alternative use of time. Empirical evidence on the relation between job matching and the volume of unemployment is consistent with the hypothesis of no decline in marginal effectiveness of job search as unemployment rises.