Economics 314 Coursebook, 2008 Jeffrey Parker 14 MODELS OF UNEMPLOYMENT Chapter 14 Contents A. Topics and Tools .................................................................................2 B. Defining Unemployment .....................................................................4 The statistical definition ....................................................................................4 Problems with the statistical measures................................................................5 Natural and cyclical unemployment ...................................................................7 C. Introduction to Theories of Unemployment......................................8 D. Minimum Wages and Unemployment ..............................................11 A simple minimum-wage model ......................................................................11 Minimum-wage effects on skilled and unskilled labor .......................................12 E. Unemployment Insurance and the Length of Job Search ................15 A simple model of job search.............................................................................15 Unemployment benefits and search duration.....................................................16 Optimal search duration .................................................................................18 F. Unions and Unemployment...............................................................19 An economy-wide labor union..........................................................................20 A two-sector model of unions and unemployment ..............................................21 G. Sectoral Shifts and Unemployment...................................................22 H. Understanding Romer’s Chapter 9 ...................................................24 Efficiency-wage models....................................................................................25 The Shapiro-Stiglitz model.............................................................................28 Implicit-contract models ..................................................................................34 Insider-outsider models....................................................................................34 Search and matching models............................................................................35 I. Suggestions for Further Reading.......................................................36 On European unemployment...........................................................................36 Theoretical models...........................................................................................36 J. Works Cited in Text..........................................................................3614 — 2 A. Topics and Tools Unemployment is one of the most visible indicators of economic activity. The rate of unemployment typically rises considerably during recessions then falls as the economic recovers. People commonly view the typical unemployed worker as suffering long-lasting despair and destitution, so the media publicize high unemployment as a great social problem. We shall see that this view of the unemployed worker is not an accurate depiction of the vast majority of those out of work in the United States. In contrast, most of the unemployed find work relatively quickly. While their income loss is significant, it is not catastrophic for most workers who suffer an unemployment spell. Some degree of unemployment is socially and perhaps personally desirable. Much of unemployment in the United States consists of new entrants to the la-bor market seeking their first job, individuals who are voluntarily changing jobs or occupations, and people in jobs for which periodic or seasonal layoffs are nor-mal, expected, and compensated for by higher wages during periods of employ-ment. For these individuals, unemployment is not a problem at all. It is merely part of the natural functioning of a flexible and efficient labor market. Economists often view unemployment as one facet of an inevitable process of search in the labor market. Jobs and workers are heterogeneous along many di-mensions. Workers differ (among other ways) by intelligence, creativity, educa-tion, training, experience, physical size and strength, manual dexterity, ability to sustain repetitive tasks, and preferences about their work environment. Jobs vary in the abilities, education, and experience that are required to perform them, as well as in working conditions, location, opportunities for advancement, and many other characteristics. Since workers and jobs are so heterogeneous, the process of matching the characteristics of a particular unemployed worker with the most suitable vacant job often cannot be accomplished quickly. Instead un-employed workers and employers having vacant jobs engage in a two-sided search, seeking to achieve a good match as quickly as possible. The length of this search process for a typical unemployed worker is a major factor in determining the unemployment rate. One can imagine an economy in which this matching problem could be solved trivially. If all workers and jobs were identical, for example, there would be no gain to searching for a better match. Or if everyone had instantaneous and perfect information about the characteristics of all workers and jobs, searches14 — 3 could be accomplished in just a moment. However, in an economy in which the matching problem cannot be solved trivially it is generally desirable to have both a positive unemployment rate and a positive job vacancy rate. Successful match-ing requires a pool of searching workers on one side of the market and a pool of available jobs on the other. The socially optimal unemployment rate depends on the size of the pool that is required in order for optimal matching to occur.1 The optimal pool size, in turn, depends on the efficiency of the “matching technol-ogy” in the economy as well as on a variety of social and policy variables. If the costs and benefits of search are largely internal to the workers and firms doing the searching, we might expect that a competitive market economy would gravitate toward the socially optimal amount of search. However, the la-bor markets of modern economies contain many distortions that might cause the long-run equilibrium unemployment rate (the so-called natural rate of unem-ployment) to be higher or lower than the optimal rate. In particular, a