Chapter 7 Unemployment 1 IN THIS CHAPTER YOU WILL LEARN about the natural rate of unemployment what it means what causes it understanding its behavior in the real world 2 Natural rate of unemployment Natural rate of unemployment The average rate of unemployment around which the economy fluctuates In a recession the actual unemployment rate rises above the natural rate In a boom the actual unemployment rate falls below the natural rate 3 P e rc e n t o f la b o r f o rc e Actual and natural rates of unemployment U S 1960 2012 Unemployment rate 12 10 8 6 4 Natural rate of unemployment 2 0 4 A first model of the natural rate Notation L of workers in labor force E of employed workers U of unemployed U L unemployment rate 5 Assumptions 1 L is exogenously fixed 2 During any given month s rate of job separations 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 exogenous 6 The transitions between employment and unemployment s E Employed Unemploye d f U 7 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 U of employed people who lose or leave their jobs f of unemployed people who find jobs 8 Finding the equilibrium U rate f U s E s L U s L s U Solve for U L f s U s L so U s L s f 9 Example Each month 1 of employed workers lose their jobs s 0 01 19 of unemployed workers find jobs f 0 19 Find the natural rate of unemployment U s 0 01 0 05 or 5 L s f 0 01 0 19 10 Policy implication A policy will reduce the natural rate of unemployment only if it lowers s or increases f 11 Why is there unemployment If job finding were instantaneous f 1 then all spells of unemployment would be brief and the natural rate would be near zero There are two reasons why f 1 1 job search 2 wage rigidity 12 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 imperfect 13 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 unemployment 14 CASE STUDY Structural change over the long run 15 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 1980 9 1 2000 13 8 2010 17 9 In our dynamic economy smaller sectoral shifts occur frequently contributing to frictional unemployment 16 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 17 Unemployment insurance UI UI pays part of a worker s former wages for a limited time after the worker loses his her job UI increases frictional unemployment because it reduces the opportunity cost of being unemployed the urgency of finding work f Studies The longer a worker is eligible for UI the longer the average spell of unemployment 18 Benefits of UI By allowing workers more time to search UI may lead to better matches between jobs and workers which would lead to greater productivity and higher incomes 19 Why is there unemployment The natural rate of unemployment U s L s f Two reasons why f 1 DONE 1 job search Next 2 wage rigidity 20 Unemployment from real wage rigidity If real wage is stuck above its eq m level there aren t enough jobs to go around Real wage Supply Unemployment Rigid real wage Demand Labor Amount of labor hired Amount of labor willing to work 21 Unemployment from real wage rigidity If real wage is stuck above its eq m level there aren t enough jobs to go around Then firms must ration the scarce jobs among workers Structural unemployment The unemployment resulting from real wage rigidity and job rationing 22 Reasons for wage rigidity 1 Minimum wage laws 2 Labor unions 3 Efficiency wages 23 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 employment 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 24 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 25 Union membership and wage ratios by industry industry Private sector total 2011 employed 1000s U of total wage ratio 104 737 6 9 122 6 20 450 37 0 121 1 6 244 14 0 151 7 780 7 2 96 4 Manufacturing 13 599 10 5 107 2 Retail trade 14 582 4 9 102 4 Transportation 4 355 20 4 123 5 Finance insurance 6 111 1 1 90 2 12 171 2 1 99 1 4 020 13 0 112 6 15 835 7 5 114 9 Government total Construction Mining Professional services Education Health care wage ratio 100 union wage nonunion wage 26 3 Efficiency wages Theories in which higher wages increase worker productivity by attracting higher quality job applicants increasing worker effort reducing shirking reducing turnover which is costly to firms improving health of workers in developing countries Firms willingly pay above equilibrium wages to raise productivity Result structural unemployment 27 0 1965 01 01 1966 07 01 1968 01 01 1969 07 01 1971 01 01 1972 07 01 1974 01 01 1975 07 01 1977 01 01 1978 07 01 1980 01 01 1981 07 01 1983 01 01 1984 07 01 1986 01 01 1987 07 01 1989 01 01 1990 07 01 1992 01 01 1993 07 01 1995 01 01 1996 07 01 1998 01 01 1999 07 01 2001 01 01 2002 07 01 2004 01 01 2005 07 01 2007 01 01 Weeks The Median Duration of Unemployment 25 20 The duration of unemployment typically rises in recessions but its