Market theory is expected to apply to factor markets in a similar way to its application to product markets. However, there is extensive evidence in the Mauritian economy to suggest that the operation of this theory in the labour market is ineffective.
In market theory, the price of labour should adjust to market conditions. However, even during a recession some wages can continue to rise and labour shortages remain, despite high levels of unemployment. Since the demand for labour is a derived demand this would appear to contradict market theory. Many economists blame inflexibility in the labour market for this apparent contradiction. The Organisation for Economic Co-operation and Development (OECD) has suggested that, whilst money wages may react strongly to price rises, there is little response in money wages to rising levels of unemployment. In addition, the introduction of a minimum wage in Mauritius did not lead to the rapid rise in unemployment anticipated by some people, but it may have distorted labour market efficiency.
During this recession, unemployment has risen less than anticipated due to improved labour market flexibility such as reduced working hours. The continued existence of a large pool of long-term unemployed workers, at the same time as shortages persist in some labour markets, indicates that progress has been limited. The longer individuals are out of the labour market the harder it becomes to find employment. It has been suggested that the mismatch between workers and jobs occurs because the labour force lacks mobility and because there may be a lack of incentive to enter or re-enter the labour market. The housing market is also a major impediment to labour mobility and contributes to the large variations in unemployment throughout Mauritius.
Required:
(i) Explain what is meant by the following:
a) Recession
b) inflexibility in the labour market
(ii) For what reasons might money wages react strongly to price rises, but weakly to rising unemployment?
(iii) Explain reasons, other than reduced working hours, why unemployment did not rise as much as anticipated during the recent recession.
(iv) Suggest reasons why those in long-term unemployment might find it hard to re- enter the labour market.
(v) Explain why the housing market is an impediment to labour mobility.
(vi) Explain the different types of Unemployment that normally occurs in an economy?