Macroeconomics

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Macroeconomics The global economyAce
Institute of ManagementChapter 6 Unemployment

• Instructor
• Sandeep Basnyat
• Sandeep_basnyat_at_yahoo.com
• 9841 892281

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Unemployment- Major Macroeconomic Issue

• Major concern for all government
• Develop policies to curb unemployment or increase
  employment rate.
• However

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U.S. Unemployment, 1958-2002
What determines the natural rate of unemployment?
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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.

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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
• L EU or E L U or U L - E

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Assumptions

• 1. L is exogenously fixed.
• 2. During any given month,
• s fraction of employed workers that become
  separated from their jobs,
• f fraction of unemployed workers that find
  jobs.

s rate of job separations f rate of job
finding (both exogenous)
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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
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The transitions between employment and
unemployment
Employed
Unemployed
s ?E
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Solving for the equilibrium U rate

• f ?U s ?E
• s ?(L U )
• s ?L s ?U
• f xU s?U s ?L
• or, (f s)?U s ?L
• so,

Or,
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Example

• Each month, 1 of employed workers lose their
  jobs (s 0.01)
• Each month, 19 of unemployed workers find jobs
  (f 0.19)
• Find the natural rate of unemployment

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Policy implication

• A policy that aims to reduce the natural rate of
  unemployment will succeed only if it lowers s or
  increases f.

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Why is there unemployment?

• There are two reasons
• 1. Job search
• 2. Wage rigidity

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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

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Sectoral shifts

• def changes in the composition of demand among
  industries or regions
• example Technological change increases demand
  for computer repair persons, decreases demand for
  typewriter repair persons
• example A new international trade agreement
  causes greater demand for workers in the export
  sectors and less demand for workers in
  import-competing sectors.
• It takes time for workers to change sectors, so
  sectoral shifts cause frictional unemployment.

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Industry shares in U.S. GDP, 1960
Source World Development Indicators, World Bank
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Industry shares in U.S. GDP, 1997
Even the tiny category of agriculture drops by
more than half from 4.2 to 1.7 of GDP.
Source World Development Indicators, World Bank
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Sectoral shifts abound

• more examples
• Late 1800s decline of agriculture, increase in
  manufacturing
• Late 1900s relative decline of manufacturing,
  increase in service sector
• 1970s energy crisis caused a shift in demand away
  from huge gas guzzlers toward smaller cars.
• Sectoral shifts occur frequently, contributing
  to frictional unemployment.

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For your information

• Assess the trend in sectoral shift in the
  industrial sectors in
• Nepal
• India
• China
• Japan
• South Korea
• Taiwan
• Malaysia, and
• Vietnam

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Public Policy and Job Search

• Govt programs affecting unemployment
• 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

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Unemployment insurance (UI)

• UI pays part of a workers former wages for a
  limited time after losing his/her job.
• UI increases search unemployment, because it
• reduces the opportunity cost of being unemployed
• reduces the urgency of finding work
• hence, reduces f
• Studies The longer a worker is eligible for UI,
  the longer the duration of the average spell of
  unemployment.

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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.

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Why is there unemployment?

• There are two reasons
• 1. job search
• 2. wage rigidity

DONE ?
Next ?
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Unemployment from real wage rigidity
If the real wage is stuck above the eqm level,
then there arent enough jobs to go around.
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Unemployment from real wage rigidity
If the real wage is stuck above the eqm level,
then there arent 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.
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Reasons for wage rigidity

• 1. Minimum wage laws
• 2. Labor unions
• 3. Efficiency wages (employers offer high wage as
  incentive for worker productivity and loyalty)

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The minimum wage US Case Study

• In Sept 1996, the minimum wage was raised from
  4.25 to 4.75. Heres what happened

Unemployment rates, before after Unemployment rates, before after Unemployment rates, before after
3rd Q 1996 1st Q 1997
Teenagers 16.6 17.0
Single mothers 8.5 9.1
All workers 5.3 5.3

• Other studies A 10 increase in the minimum
  wage increases teenage unemployment by 1-3.

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Labor unions

• Unions exercise monopoly power to secure higher
  wages for their members.
• When the union wage exceeds the eqm wage,
  unemployment results.
• Employed union workers are insiders whose
  interest is to keep wages high.
• Unemployed non-union workers are outsiders and
  would prefer wages to be lower (so that labor
  demand would be high enough for them to get
  jobs).

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Efficiency Wage Theory

• Theories in which high wages increase worker
  productivity
• attract higher quality job applicants
• increase worker effort and reduce shirking
• reduce turnover, which is costly
• improve health of workers (in developing
  countries)
• The increased productivity justifies the cost of
  paying above-equilibrium wages.
• The result unemployment

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Wage Inflation and Unemployment

• In 1958, economist A W Philips, through empirical
  study of Britains economy, concluded that there
  exists inverse relationship between wage
  Inflation and Unemployment
• It shows the trade-off between wage inflation and
  unemployment.
• Logic
• When Labour demand is high, most of the labour
  get employed and labour market is in shortage of
  labour or tight.
• Labour unions find opportunities to bargain with
  employers or they have high bargaining power for
  increasing wage rates faster.
• So, Lower the unemployment rate, higher the wage
  rate.

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Relationship Between Inflation and Unemployment

• Faster increase in wage rates will result in
  faster increase in disposable income of the
  labour causing higher increase in price level or
  inflation.
• Conclusion Higher the employment rate or Lower
  the Unemployment rate, higher the inflation rate.

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The Phillips Curve

• The Phillips curve shows the relationship between
  the inflation rate and the unemployment rate.

• This macroeconomic relationship has been widely
  studied.
• It shows that there is a trade-off between
  inflation and unemployment. To lower the
  inflation rate, we must accept a higher
  unemployment rate.

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Unemployment and Growth

• In 1960s, Arthur Okun, through empirical study,
  concluded that there exists inverse relationship
  between unemployment and economic growth
• He concluded that one percent decrease in
  unemployment will increase the output by 2.5
  percent in the short run.
• This law is known as Okuns Law
• This relation can be used to deduce inflationary
  pressure curve, which along with Phillips curve
  gives the short run rate of inflation and
  unemployment

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Criticism of Phillip Curve-Non Trade off

• Milton Friedman
• Downward sloping curve is a short run and in the
  long run Phillips curve become vertical line
• In the long run, Phillips curve shifts constantly
  due to improvement in economic situations (such
  as labour market reform, labours wanting
  stability, increased competition in labour market
  etc. )
• Regardless of the rate of inflation, there is
  only one rate of unemployment in the long run,
  that is natural rate NAIRU (Non Accelerating
  Rate of Unemployment).

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Criticism of Phillip Curve-Non Trade off
Inflation Rate
B
C
A
New SR Phillips Curve
Initial SR Phillips Curve
Unemployment Rate
For further info Macroeconomic Analysis, Edward
Shapiro Macroeconomics, Theory and Policy, D.N.
Dwivedi
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• Thank You