ECON CHAPTER 6- UNEMPLOYMENT 1 Textbook Notes

Unemployment
In reality, not everyone in the labor force has a job all the time: all free market economies experience some unemployment Rate of unemployment: The percentage of the labour force unemployed Natural Rate of Unemployment: The average rate of unemployment around which the economy fluctuates. The natural rate of unemployment is the rate toward which the economy gravitates in the long run, given all the labor-market imperfections that impede workers from instantly finding jobs. Another name for natural unemployment: Frictional or structural unemployment Unemployment rises when economy is in a recession. Short run variations in the unemployment rate is called cyclical unemployment

6.1 Job Loss, Job Finding and the Natural Rate of Unemployment
What determines the natural rate of unemployment? Let L denote Labor Force Let E be the number of employed workers Let U be the number of unemployed workers L= E+U (Labor force is the sum of the employed and unemployed workers) Unemployment Rate= U/L In this chapter, assume labor force is fixed The Transitions between Employment and Unemployment Let s denote the rate of job separation (the fraction of employed individuals who lose or leave their job each month) Let f denote the rate of job finding (the fraction of unemployed individuals who find a job each month) s and f together determine the rate of unemployment If the unemployment rate is neither rising nor falling (labor market is in steady state), then the number of people finding jobs must equal the number of people finding jobs. fU= Number of unemployed finding jobs sE= Number of employed losing jobs Therefore, the steady state condition: fU=sE

Using the steady state condition to find the Steady State Unemployment Rate: We know that, L= E+U Therefore, E= L-U (Number of unemployed equals the labor force minus the unemployed) 1. Thus, by substituting (L-U) for E in the steady state condition, we get:

ECON CHAPTER 6- UNEMPLOYMENT 2 Textbook Notes fU= s(L-U) 2. Divide both sides of this equation by L to obtain: F (U/L)= S[(L/L)-(U/L)] F (U/L)= S[1-(U/L)] 3. Solve for U/L: U/L= s/ (s+f) U/L= 1/ 1+(f/s) This equation shows the steady-state rate of unemployment U/L depends on rates of job separation s and job finding f Numerical Example: Suppose that 1 percent of the employed lose their jobs each month (s=0.01). This means that on average jobs last 100 months or about 8 years, Suppose further that 20% of the unemployed find a job each month (f=0.20, which means that unemployment lasts around 5 months on average. Find the steady rate of unemployment: U/L= s/ (s+f) U/L= 0.01/(0.01+0.20) U/L= 0.0476 Therefore, the rate of unemployment is about 5%.

Implications on Public Policy: Any policy aimed at lowering the natural rate of unemployment must either reduce the rate of job separation or increase the rate of job finding Similarly, any policy that affects the rate of job separations or job finding also changes the natural rate of unemployment.

6.2 Job Search and Frictional Unemployment

One reason it for unemployment is that it takes time to match workers and jobs

ECON CHAPTER 6- UNEMPLOYMENT 3 Textbook Notes Workers have different preferences and abilities and jobs have different attributes, geographic mobility of workers is not instantaneous and for all of these reasons searching for appropriate job takes time and effort and tends to reduce the rate of job finding f. The unemployment caused by the time it takes for a worker to find a job is called Frictional Unemployment Unemployment could happen if an increase in the price of oil cause the demand for labor in the oil producing province rises, but because expensive oil makes driving more expensive, it decreases the demand for labor in the auto-producing province. This is called a Sectoral Shift.

Public Policy and Frictional Unemployment Many public policies seek to decrease the natural rate of unemployment by reducing frictional unemployment Government agencies make it convenient for people to search for jobs that matches their criteria Publicly funded retraining programs allow workers to transition from declining to growing industries These programs are made to increase rate of job finding which consequently reduces the unemployment rate Some programs may increase frictional unemployment, such as Employment Insurance (EI) When they have pay coming in from EI, workers tend to stop looking for jobs which increases the unemployment rate by reducing the rate of job finding and raise the rate of job separation

6.3 Real Wage Rigidity and Structural Unemployment

The Second reason for unemployment is wage rigidity- the failure of wages to adjust to a level at which labor supply equals labor demand.

ECON CHAPTER 6- UNEMPLOYMENT 4 Textbook Notes The graph above shows how wage rigidity leads to unemployment When the real wage is above the level that equilibrates the supply and demand, the quantity of labor supplied exceeds the quantity demanded. Real Wage rigidity reduces the rate of job finding f and raises the level of unemployment The unemployment resulting from wage rigidity and job rationing is often called structural unemployment This basically means that, there is unemployment not because workers are looking for jobs that best suit their individual skills but rather there are not enough jobs available for the workers that want to work. At the going wage, the labor exceeds the demand which results in many workers waiting for jobs to open up. When real wage exceeds he equilibrium level and the supply of workers exceeds demand, firms should lower the wages they pay. Structural employment occurs when firms fail to reduce the wage despite an excess of supply of labor

Three Causes of Wage Rigidity 1) Minimum-Wage Laws The government causes Wage rigidity when it prevents wages from falling to equilibrium levels Minimum-Wage laws set a legal minimum on the wages that firms pay to their employees Sometimes, unskilled and inexperienced workers get paid minimum wage which might be higher than the equilibrium level wage for that particular work, which reduced the quantity of labor demanded by the firm Thus, a percent change in the minimum wage leads to some percent increase in the unemployment rate. Some argue that higher minimum wage leads to raising the income of the working poor while others argue that higher minimum wage is not the best way to help the working poor as it increases unemployment rate Many economists believe that tax credits are better way to increase the income of working poor. 2) Unions and Collective Bargaining The wages of unionized workers is not determined by the equilibrium of the supply and demand but rather by the bargaining between union leaders and firm managers. This often results in the reduction in the number of workers hired, a lower rate of job finding f and increase in structural unemployment Unions can also influence wages paid by firms whose employees are not unionized because of the threat of their employees possibly unionizing. Unions can cause problems between the insiders (employees employed by the firm) and the outsiders (the unemployed, looking to get hired)

ECON CHAPTER 6- UNEMPLOYMENT 5 Textbook Notes 3) Efficiency Wages Works under the theory that higher paid workers are more productive Firms who believe that paying a higher pay increases efficiency fail to reduce wages despite excess of labor supply Four possible Efficiency Wages Theory Higher Paid workers are healthier: Better nutrition means healthier workers and healthier workers means more productive workers. High wages reduce labor turnover: The more a firm pays to the worker, the more incentive the worker has to stay with the firm. By paying a higher wage, firms reduce the frequency at which its workers quit, which decreases the time and money spent on rehiring and training new employees. Average Quality of a firms work force depends on the wage it pays: If a firm reduces its wage, the higher knowledge employees may quit and take jobs elsewhere. High wage improves employee effort: By paying a higher pay, employees do not shirk and this consequently increases efficiency. The result of this higher than equilibrium wage is lower rate of job finding and greater structural unemployment.

ECON CHAPTER 6- UNEMPLOYMENT 6 Textbook Notes