Chapter 7IN THIS CHAPTER, YOU WILL LEARN:Natural rate of unemploymentActual and natural rates of unemployment, U.S., 1960–2012A first model of the natural rateAssumptions:The transitions between employment and unemploymentThe steady state conditionFinding the “equilibrium” U rateExample:Policy implicationWhy is there unemployment?Job search & frictional unemploymentSectoral shiftsCASE STUDY: Structural change over the long runMore examples of sectoral shiftsPublic policy and job searchUnemployment insurance (UI)Benefits of UIWhy is there unemployment?Unemployment from real wage rigidityUnemployment from real wage rigidityReasons for wage rigidity1. The minimum wage2. Labor unionsUnion membership and wage ratios by industry, 20113. Efficiency wagesThe Median Duration of UnemploymentSlide 29EXPLAINING THE TREND: The minimum wageEXPLAINING THE TREND: Union membershipEXPLAINING THE TREND: Sectoral shiftsEXPLAINING THE TREND: DemographicsUnemployment in Europe, 1960–2011Why unemployment rose in Europe but not the U.S.Slide 36CHAPTER SUMMARYCHAPTER SUMMARYCHAPTER SUMMARYCHAPTER SUMMARY1Chapter 7Unemployment2IN THIS CHAPTER, YOU WILL LEARN:…about the natural rate of unemployment:what it meanswhat causes itunderstanding its behavior in the real world23Natural 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.4024681012P e r c e n t o f la b o r f o r c eActual and natural rates of unemployment, U.S., 1960–2012Unemployment rateNatural rate of unemployment5A first model of the natural rateNotation:L = # of workers in labor forceE = # of employed workersU = # of unemployedU/L = unemployment rate6Assumptions:1. L is exogenously fixed. 2. During any given month, s = rate of job separations, fraction of employed workers that become separated from their jobsf = rate of job finding, fraction of unemployed workers that find jobss and f are exogenous7The transitions between employment and unemploymentEmployedUnemployeds Ef U8The 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 jobs9Finding 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 sL s f10Example: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:0 010 05, or 5%0 01 0 19U sL s f= = =+ +... .11Policy implicationA policy will reduce the natural rate of unemployment only if it lowers s or increases f.12Why 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 search2. wage rigidity13Job 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 imperfect14Sectoral 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 unemployment15CASE STUDY: Structural change over the long run16More 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: 13.81980: 9.1 2010: 17.9In our dynamic economy, smaller sectoral shifts occur frequently, contributing to frictional unemployment.In our dynamic economy, smaller sectoral shifts occur frequently, contributing to frictional unemployment.17Public policy and job searchGovt programs affecting unemployment include:Govt employment agenciesdisseminate info about job openings to better match workers & jobs. Public job training programshelp workers displaced from declining industries get skills needed for jobs in growing industries.18Unemployment 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.19Benefits 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.20Why is there unemployment?Two reasons why f < 1:1. job search2. wage rigidityDONE Next The natural rate of unemployment:U sL s f=+21Unemployment from real wage rigidityLaborReal wageSupplyDemandUnemploymentRigid real wageAmount of labor willing to workAmount of labor hiredIf real wage is stuck above its eq’m level, there aren’t enough jobs to go around.22Unemployment from real wage rigidityThen, firms must ration the scarce jobs among workers. Then, firms must ration the scarce jobs among workers. Structural unemployment: The unemployment resulting from real wage rigidity and job rationing.Structural unemployment: The unemployment resulting from real wage rigidity and job rationing.If real wage is stuck above its eq’m level, there aren’t enough jobs to go around.23Reasons for wage rigidity1. Minimum wage laws2. Labor unions3. Efficiency wages241. 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