Chapter 6 Classical Theory of UnemploymentNatural rate of unemploymentActual and natural rates of unemployment, U.S., 1960-2010A first model of the natural rateAssumptions:The transitions between employment and unemploymentThe steady state conditionWhy is there unemployment?Job search & frictional unemploymentSectoral shiftsCASE STUDY: Structural change over the long runMore examples of sectoral shiftsPublic policy and job searchWhy is there unemployment?Unemployment from real wage rigidityReasons for wage rigidity1. The minimum wage2. Labor unions3. Efficiency wage theoryThe duration of U.S. unemployment, average, 1960 – 2009The duration of unemploymentEXPLAINING THE TREND: DemographicsUnemployment in Europe, 1960-2009Percent of workers covered by collective bargaining, selected countriesChapter SummaryChapter SummaryChapter Summary0 CHAPTER 6 Unemployment Chapter 6 Classical Theory of Unemployment  A crucial assumption for the labor market equilibrium in the benchmark model (Chapter 3): Homogeneity of labor and jobs  Allowing for heterogeneity of labor and jobs leads to another type of labor market equilibrium: Inflow = Outflow1 CHAPTER 6 Unemployment Natural rate of unemployment  Natural rate of unemployment: The average rate of unemployment at which inflow is equal to outflow (a long-run concept).  In a boom, the actual unemployment rate falls below the natural rate.  In a recession, the actual unemployment rate rises above the natural rate.0246810121960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010Actual and natural rates of unemployment, U.S., 1960-2010 Percent of labor force Unemployment rate Natural rate of unemployment3 CHAPTER 6 Unemployment A first model of the natural rate Notation: L = # of workers in labor force E = # of employed workers U = # of unemployed U/L = unemployment rate4 CHAPTER 6 Unemployment Assumptions: 1. L is exogenously fixed. 2. During any given month, s = rate of job separations, the fraction of employed workers that become separated from their jobs f = rate of job finding, fraction of unemployed workers that find jobs s and f are exogenous5 CHAPTER 6 Unemployment The transitions between employment and unemployment Employed Unemployed s ×E f ×U6 CHAPTER 6 Unemployment The steady state condition  Definition: the labor market is in steady state, or long-run equilibrium, if the unemployment rate is constant.  The steady-state condition is: s ×E = f ×U # of employed people who lose or leave their jobs # of unemployed people who find jobs7 CHAPTER 6 Unemployment Why is there unemployment?  There is no unemployment if  Job separation is 0 (s = 0) OR  If job finding were instantaneous  There are two reasons for unemployment:  Frictional unemployment  Sectoral shift  Heterogeneity of workers and jobs  Structural unemployment  Minimum wage laws  Union premium  Efficiency Wage Theory8 CHAPTER 6 Unemployment Job search & frictional unemployment  frictional unemployment: caused by the time it takes workers to search for a job  occurs even when wages are flexible and there are enough jobs to go around  occurs because  workers have different abilities, preferences  jobs have different skill requirements  geographic mobility of workers not instantaneous  flow of information about vacancies and job candidates is imperfect9 CHAPTER 6 Unemployment Sectoral shifts  def: Changes in the composition of demand among industries or regions.  example: Technological change more jobs repairing computers, fewer jobs repairing typewriters  example: A new international trade agreement labor demand increases in export sectors, decreases in import-competing sectors  These scenarios result in frictional unemploymentCASE STUDY: Structural change over the long run 4.2%28.0%9.9%57.9%AgricultureManufacturingOther industryServices19601.1%13.9%8.5%76.5%200611 CHAPTER 6 Unemployment More examples of sectoral shifts  Industrial revolution (1800s): agriculture declines, manufacturing soars  Energy crisis (1970s): demand shifts from larger cars to smaller ones  Health care spending as % of GDP: 1960: 5.2% 2000: 13.8% 1980: 9.1% 2008: 16.2% In our dynamic economy, smaller sectoral shifts occur frequently, contributing to frictional unemployment.12 CHAPTER 6 Unemployment Public policy and job search Govt programs affecting unemployment include:  Govt employment agencies disseminate info about job openings to better match workers & jobs.  Public job training programs help workers displaced from declining industries get skills needed for jobs in growing industries.  Unemployment Insurance Program  Reducing the opportunity cost of being unemployed  Maybe better matches between jobs and workers.13 CHAPTER 6 Unemployment Why is there unemployment?  Two reasons for unemployment: 1. Friction unemployment 2. Structural unemployment : the unemployment resulting from real wage rigidity and job rationing UsL sf=+DONE  Next  The natural rate of unemployment:14 CHAPTER 6 Unemployment Unemployment from real wage rigidity Labor Real wage Supply Demand Unemployment Rigid real wage Amount of labor willing to work Amount of labor hired If real wage is stuck above its eq’m level, then there aren’t enough jobs to go around.15 CHAPTER 6 Unemployment Reasons for wage rigidity 1. Minimum wage laws 2. Monopoly power of labor unions 3. Efficiency wages16 CHAPTER 6 Unemployment 1. The minimum wage  The min. wage may exceed the eq’m wage of unskilled workers, especially teenagers.  Studies: a 10% increase in min. wage reduces teen unemployment by 1-3%  But, the min. wage cannot explain the majority of the natural rate of unemployment, as most workers’ wages are well above the min. wage.17 CHAPTER 6 Unemployment 2. Labor unions  Unions exercise monopoly power to secure higher wages for their members.  When the union wage exceeds the eq’m wage, unemployment results.  Insiders: Employed union workers whose interest is to keep wages high.  Outsiders: Unemployed non-union workers who prefer eq’m wages, so there would be enough jobs for them.18 CHAPTER 6 Unemployment 3. Efficiency wage theory  Theories in which higher wages increase worker productivity by:  attracting higher quality job applicants  increasing worker effort, reducing “shirking” 