Chapter 6:UnemploymentChapter 6:Unemployment

Historical Data (US)

Historical Data (EU)

Variations in Unemployment

Age White-M White-F Black-M Black-F

16-19

20+

14.3 12.8 36.5 28.7

3.6 3.7 8.5 8.8

Demographic Groups, 1997

Civilian Labor Force

Individuals between 16 and 64, who are employed for pay or unemployed

Individuals in prisons or mental hospitals, children, and retired are excluded

Unemployment

Members of the labor force who are:– 16 years of age or older– out of work– actively looking for work

Unemployment rate = No. of unemployed workers as a % of the labor force

Discouraged Workers

Members of the labor force who quit looking for jobs (e.g., the homeless)

Unemployment rate is underestimated by 2 to 3% because discouraged workers are excluded

Frictional UnemploymentFrictional UnemploymentFrictional UnemploymentFrictional Unemployment

Unemployment of individuals who are searching for jobs or waiting between jobs

Supply-side effect and transitional

Structural Unemployment

Unemployment due to fundamental economic changes that eliminate some jobs, while creating other jobs for which qualified workers may not be readily available

Normal due to technological advancement and changes in consumer preferences

Cyclical Unemployment

Unemployment caused by contraction in economic activities (i.e., recession)

Needs public policy to increase employment

Natural Rate of Unemployment

An average rate around which the actual unemployment rate fluctuates

The average of last and next 10 years unemployment rate

Future unemployment rate is set at 5.5%

Duration of Unemployment

Short-term if frictionalLong-term if structural or cyclical

Evidence from 1974 is mixed– 60% of the spells of unemployment ended within one

month– 69% of the weeks of unemployment occurred in

spells that lasted two or more months

Duration of Unemployment

If policy goal is to reduce the natural rate of unemployment, we need long-term investment in job creation (education, training, etc.)

If policy goal is to reduce the unemployment rate, we need short-term investment in job retention and information

Unemployment Rate

L = Labor ForceE = EmploymentU = unemploymentL = E + USo,E = L – U and U = L – EU/L = Unemployment Rate

Job Loss

s = the rate of job separation: the fraction of “employed” workers who lose jobs each month

sE = the number of “employed” workers who lose jobs each month

Job GainJob GainJob GainJob Gain

f = the rate of job finding: the fraction of “unemployed” workers who find jobs each month

fU = the number of “unemployed” workers who find jobs each month

Employment-Unemployment Transition The rates of job separation and job finding determine the rate of unemployment.

Employed Unemployed

Job Finding (f)

Job Separation (s)

Steady State Unemployment Rate

In a steady-state labor market: fU = sE

Write:fU = s(L – U)

fU = sL – sU

sU + fU = sL

(s + f)U = sLU/L = s / s+f

Example

s = 0.01: on average, jobs last 100 months

f = 0.20: on average, unemployment lasts 5 months

U/L = 0.01/0.21 = 4.8%

Policy ImplicationsPolicy Implications Policy ImplicationsPolicy Implications

Public policy to reduce the rate of job separation and/or increase the rate of job finding will lower the natural rate of unemployment

Public policy to lower the natural rate of unemployment must either reduce the rate of job separation or increase the rate of job finding

Policy and Frictional Unemployment

Job Fairs:

– provide information on job openings, which lowers f and increases U/L

Policy and Frictional Unemployment

Unemployment Benefits: U/L could increase

– Some unemployed workers may refuse job offers and wait for higher ones, lowering f

– Some employed workers may not care losing jobs since their incomes are partially compensated, increasing s

Wage Rigidity and Unemployment

Demand

A B

W1

W2

Real Wage

Labor

Unemployment

L1L2

Supply

Amount of labor willing to workAmount of labor hired

Wait Unemployment

Unions setting wages higher than the market wage

Some union members must remain unemployed

Unemployed union members must “wait” for job openings

Minimum Wage law

Workers are paid a wage rate above the market rate

– Help those who are employed

– Hurt those who are unemployed

Efficiency Wage

Firms pay wages above the market values to

– Maintain a stable labor force

– Attract qualified workers

– Improve productivity and profitability