11Employment & UnemploymentAgenda • Employment & Unemployment.¾ Definitions & Measurement.• Sources of Unemployment.• Okun’s Law.• The Costs and Benefits of Unemployment.2Employment• Definition: The number of people 16 years old and above who are working for pay.• Measurement: ¾ Payroll survey of 400,000 business firms.¾ Household survey of 60,000 households.3Payroll Employment50751001251501960 1965 1970 1975 1980 1985 1990 1995 2000 2005Millions4Unemployment• Definition: The number of people aged 16 years old and above who are not working BUTare willing and able to work AND are actively searching for a job, UN.• Measurement:¾ Household survey of 60,000 households.5Number of Unemployed People051015Q1-70 Q1-75 Q1-80 Q1-85 Q1-90 Q1-95 Q1-00 Q1-05Millions6Unemployment• Decomposition of the (Noninstitutional) AdultPopulation.¾ Total Population, POP.• Not in the Labor Force.• Civilian Labor Force, CLF.¾ Employed, N.¾ Unemployed, UN.27Composition of the PopulationEmployment Status of the PopulationJuly 2003Unemployed9.062 millionEmployed137.488 millionNot in Labor Force74.712 million Labor Force146.550 million8Unemployment• Key Ratio:¾ Unemployment rate: U = UN/CLF * 100.9Unemployment RateUnemployment Rate246810121960 1965 1970 1975 1980 1985 1990 1995 2000 2005Percent10Unemployment and Policy• In a dynamic economy, some U is inevitable but also beneficial.¾ Allows for labor resource re-allocation.• However, there are costs associated with U.¾ Lost income and output.¾ Inequitable distribution.• Therefore, what is the appropriate level of U?¾ How low is “low unemployment”?11Job Vacancies• Businesses always have job vacancies.¾ Workers leave and positions are open.¾ New positions are created.• Job vacancies are strongly procyclical.¾ The more job vacancies there are, the lower the duration of unemployment.• If job vacancies exist, why is there U?12Unemployment• Search costs: job search and labor search are both costly and time consuming.313Flows into Unemployment• Reasons for Unemployment:¾ Job destruction or loss.• Employer determined.¾ Job leavers.• Employee determined.¾ New Entrant/Re-entrants to the Labor Force.• Job seeker determined.14Sources of Unemployment• Types of Unemployment:¾ Frictional or Turnover Unemployment.¾ Structural or Mismatch Unemployment.¾ Insider-Outsider or Disequilibria Unemployment.¾ Cyclical Unemployment.15Sources of Unemployment• Types of Unemployment:¾ Frictional or Turnover Unemployment.• Results from the normal turnover in jobs and search by workers.¾ Job search and labor search are both costly and time consuming.¾ Sector shifts cause dislocations.• and public policy.¾ Policies that reduces frictional unemployment.¾ Policies that raises frictional unemployment.• Frictional unemployment is unavoidable.¾ Even in normal times. ¾ Even when wages are at their equilibrium level.16Sources of Unemployment• Types of Unemployment:¾ Structural or Mismatch Unemployment.• Mismatch of skills.¾ Lack of job training.¾ Inflexibility of relative wages.¾ Discrimination.• Mismatch of location.• and public policy.¾ Policies that reduces structural unemployment.17Sources of Unemployment• Types of Unemployment:¾ Insider-Outsider, or Disequilibria, Unemployment.• Occurs when W > We. ¾ Helps insiders (who have jobs).¾ Creates unemployment among outsiders (who do not have jobs).• Sources of increased wage pressure.¾ Labor unions.¾ Government.¾ Efficiency wages.• Reduces employee turnover.• Attracts larger pool of applicants.• Boosts employee morale.18Natural Rate of Unemployment• Definition: The level of unemployment that exists when the economy is at potential GDP.¾ Also called the Non-Accelerating Inflation Rate of Unemployment (NAIRU)419Natural Rate of Unemployment• Natural Rate of Unemployment =¾ frictional plus¾ structural plus¾ insider-outsider unemployment ¾ in “normal” times.20Natural Rate of UnemploymentUnemployment Rates 24681012Q1-60 Q1-65 Q1-70 Q1-75 Q1-80 Q1-85 Q1-90 Q1-95 Q1-00 Q1-05PercentActual Unemployment Rate Natural Unemployment Rate21Natural Rate of Unemployment• The Natural Rate will change with:¾ Demographic changes.• A changing proportion of inexperienced workers.¾ Changes in job search/labor search costs.• A change in unemployment benefits,• The rise of Internet job sites/spread of temporary job agencies.¾ Structural changes in the economy.• Large sector shifts,• A change in union strength,• A change in minimum wages,• A change in incarceration rates.22Sources of Unemployment• Types of Unemployment:¾ Cyclical Unemployment.• The level of unemployment that exits because GDP is not at its potential (natural) level.¾ The difference between actual and natural unemployment.¾ Can be either positive or negative.• and public policy¾ Effective macroeconomic policy is designed to minimize the fluctuations of output around potential.23Cyclical UnemploymentUnemployment Rates 24681012Q1-60 Q1-65 Q1-70 Q1-75 Q1-80 Q1-85 Q1 -90 Q1 -95 Q1-00 Q1-05PercentActual Unemployment Rate Natural Unemployment Rate24Cyclical Unemployment• Costs of Cyclical Unemployment:¾ Measured by the gap between actual output and potential output.• When Y < Yn.• The unemployment rate is closely related to deviations of real GDP from potential GDP.¾ Measured using Okun’s Rule of Thumb (or Law).525Okun’s Law• Okun’s Rule of Thumb (Law) :¾ The inverse relationship between the unemployment rate and output growth (relative to potential) or the output ratio.26Okun’s LawY-hatUUnŶ = 0U = Un – 0.5 * ŶU27Okun’s Law• Okun’s Rule of Thumb (Law):¾ Mathematically: U = Un – 0.5 * Ŷ¾ If Ŷ = 0, then U = Un28Okun’s Law• Okun’s Rule of Thumb (Law):¾ For each percentage point increase in the unemployment rate, there will be a 2 percentage point decreasein GDP growth (relative to potential).• U = Un – 0.5 * Ŷ• ∆U = – 0.5 * ∆Ŷ• 1% increase in U => $200 billion decrease in GDP per year.¾ $2,000 per household29Okun’s LawY-hatUX+1%X%Z-2% Z%UU = Un – 0.5 * Ŷ30Okun’s Law• Okun’s Rule of Thumb (Law):¾ The unemployment rate changes approximately 1/2 of the change in the output ratio, but in the opposite direction in a year.• For each percentage point U > Un, real GDP is 2% < potential GDP631Costs of Unemployment• Costs of Cyclical Unemployment:¾ Economic costs.•