Unemployment

1
Lecture10

• Unemployment

2
1. Unemployment

• The concept of unemployment is somewhat ambiguous
  since in theory virtually anyone would be willing
  to be employed in return for a generous enough
  compensation package.
• ?Economists define unemployment in terms of an
  individuals willingness to be employed at some
  prevailing market wage.
• u(unemployment rate)U/L
• Government statistic U (temporary layoff waiting
  to be recalled , actively search for work in the
  previous week or month )

3

• Note Limitations of unemployment rate data
• ?For a number of reasons, they do not necessarily
  provide an accurate reflection of the economic
  hardship that members of a group are suffering.

4

• Individuals who are not actively searching for
  work, including those who search unsuccessfully
  and then gave up, are not counted among the
  unemployed. e.g., discouraged worker.
• Unemployment statistics tell us nothing about the
  earnings levels of those who are employed.
• A substantial fraction of the unemployed come
  from families in which other earners are present
  and the unemployed are often not the primary
  source of their family support.
• Unemployed receive some income support such as
  government unemployment compensation.
• Unemployment rate data tell us little about the
  fraction of the population that is employed.

5
2. Types of Unemployment and Their Causes
(1)Frictional Unemployment
D0 Labor Demand S0 Labor Supply (W0, E0)
Equilibrium Wage and Employment
Level
W
S0
Even in a market-equilibrium or full-employment
situation there will still be some frictional
unemployment, because some people will be
between jobs.
W0
D0
Employment
E0
Frictional unemployment arises because labor
markets are inherently dynamic, because
information flows are imperfect, and because it
takes time for unemployed workers and employers
with job vacancies to find each other.
6
(2) Structural Unemployment
Structural unemployment arises when changes in
the pattern of labor demand cause a mismatch
between the skills demanded and supplied in a
given area or cause an imbalance between the
supplies and demands for workers across areas.
W
W
S0B
S0A
W1B
W0A
W0B
D0A
D0B
D1A
D1B
E0B
E1B
Employment
E1A
E0A
Employment
?Unemployment of E0A E1A workers would be
created in the short run.
7

• If wages were completely flexible and if costs of
  occupational or geographic mobility were low,
  market adjustments would quickly eliminate this
  type of unemployment.
• Note It has been argued that structural
  unemployment may also arise if some employers are
  paying above market-clearing (or efficiency)
  wages to reduce employee turnover and/or shirking
  and to increase productivity.

8
(3) Demand-Deficient Unemployment
Demand-deficient unemployment occurs when a
decline in aggregate demand in the output market
causes the aggregate demand for labor to decline
in the face of downward inflexibility in real
wages.
If real wages are inflexible downward, E fall to
E1, and E0 E1 workers will become
unemployed. ?Flows into unemployment increase
while flows into employed decline.
W
S0
One appropriate government response to
demand-deficient unemployment is to pursue
macroeconomic policies to increase aggregate
demand these policies include increasing the
level of government spending, reducing taxes, and
increasing the rate of growth of the money supply.
W0
W2
D0
D1
E
E0
E2
E1
9

• Why employers respond to a cyclical decline in
  demand by temporarily laying off some of their
  work force rather than reducing real wages.
• Rigid money wage employers are not free to
  unilaterally cut money wages because of the
  presence of unions.
• The asymmetry of the information between
  employers and employees makes layoffs the
  preferred policy.
• In the presence of investments in firm-specific
  human capital, layoffs affect only the
  least-experienced workers, the workers in whom
  the firm has invested the smallest amount of
  resources.
• ?The firm will find choosing the layoff
  strategy a more profitable
• alternative.
• A system of layoffs in which the newest employees
  are laid off first provides an implicit contract
  (a guarantee or form of insurance to experienced
  workers) that they will be immune to all but the
  severest declines in demand.
• ?They will be willing to pay for the
  stability by accepting lower
• wages.

10

• (4) Seasonal Unemployment
• Seasonal unemployment is similar to
  demand-deficient unemployment in that it is
  induced by fluctuations in the demand for labor.
  However, the fluctuations can be regularly
  anticipated and follow a systematic pattern over
  the course of a year.
• e.g., Agricultural employee
• To attract workers to such seasonal
  industries, firm will have to pay workers higher
  wages to compensate them for being periodically
  unemployed.
• ?The existence of compensating wage
  differentials makes it difficult to evaluate
  whether this type of unemployment is voluntary or
  involuntary in nature.

11
3. Job Search

• Many theories claim to explain the existence and
  persistence of unemployment in competitive
  markets. Any given worker can choose from among
  many different job offers. Because it takes time
  to learn about the opportunities provided by
  different employers, search activities prolong
  the duration of the unemployment spell. The
  worker, however, is willing to endure a longer
  unemployment spell because it might lead to a
  higher-paying job. In fact, search unemployment
  is a human capital investment in information.

12
(1) The Wage Offer Distribution

• To simplify the analysis, we assume that search
  activities are conducted only by unemployed
  workers. The wage offer distribution gives the
  frequency distribution describing the various
  offers available to a particular unemployed
  worker in the labor market.
• The unemployed worker knows the shape of the wage
  offer distribution. Search activities, however,
  are costly. Each time the worker applies for a
  new job, he incurs transportation and other types
  of search costs. Moreover, he is also forgoing
  earnings He could have been working at a
  lower-paying job. The workers economic
  trade-offs are clear The longer he searches, the
  more likely he will get a high wage offer the
  longer he searches, however, the more it costs to
  find that job.

13
(2) The Asking Wage

• The asking wage is the threshold wage that
  determines if the unemployed worker accepts or
  rejects incoming job offers. There is a clear
  link between a workers asking wage and the
  length of the unemployment spell the worker will
  experience. Workers who have low asking wages
  will find acceptable jobs very quickly and the
  unemployment spell will be short. Workers with
  high asking wages will take a long time to find
  an acceptable job and the unemployment spell will
  be very long.

14
The marginal revenue curve gives the gain from
an additional search. It is downward sloping
because the better the offer at hand, the less
there is to gain from an additional search. The
marginal cost curve gives the cost of an
additional search. It is upward sloping because
the better the job offer at hand, the greater the
opportunity cost of an additional search. The
asking wage equates the marginal revenue and the
marginal cost of search.
Dollars
MC
MR
0
10
20
25
5
Wage Offer at Hand
The Determination of the Asking Wage
15
(3) Determinants of the Asking Wage

• The workers asking wage will respond to changes
  in the benefits and costs of search activities.
  Workers with high discount rates are
  present-oriented, and hence perceive the future
  benefits from search to be low.
• A major component of search costs is the
  opportunity cost resulting from rejecting a job
  offer and continuing the search. The unemployment
  insurance (UI) system, compensates workers who
  are unemployed and who are actively engaging in
  search activities. Unemployment insurance
  benefits, therefore, reduce the marginal cost of
  search.

16
4. Inflation and Unemployment

• Note Because our focus is on the labor market,
  we shall emphasize the price of labor-the wage
  rate-when discussing the issue of inflation.
• The Inflation/Unemployment Trade-Off
• The negative relationship between
  unemployment and wage inflation was dubbed the
  Phillips curve.

Rate of Wage Inflation
During the 1970s the relationship appears to have
broken down. ?An interpretation is that while a
trade-off between the rates of inflation and
unemployment exists at a point in time, the
position of the trade-off curve is determined by
a number of other factors that can change over
time.
Unemployment
17
Rate of Wage Inflation ( )
Early 1980s
1970s
1960s
Progressively higher rates of wage inflation have
become associated with any given level of
unemployment.
W2
W1
W0
Unemployment Rate (U)
U0
It is also possible that the Phillips curve has
become much flatter over recent years, so that
the decrease in wage inflation accompanying a 1
point increase in the unemployment rate is now
smaller than it once was.
18
(2) The Basic Model of the Inflation/Unemployment
Trade-Off
Wage
It is reasonable to assume that the speed at
which The wage rate changes is related to the
extend to which the labor market is in
disequilibrium, as measured by the excess demand
for labor.
Supply
W2
W1
W0
W3
W4
Demand
E
i.e., the percentage rate of change of wage (
) is proportional to the excess demand for labor
(X)
19
Excess Demand for Labor (X)
W
WaX
Relationship Between the Excess Demand for Labor
and the Unemployment Rate
X1
W1
X
U
X1
U1
U
Excess Supply Xlt0
Excess Demand Xgt0
Because the excess demand for labor is usually
not observable, it is necessary to replace it
with an observable variable, such as the
unemployment rate.
U is the unemployment rate that exists when the
excess demand for labor is zero. i.e., natural or
full-employment rate of unemployment.
20
W
Trade-off Between Wage Inflation and the
Unemployment Rate
W1
U
U1
U