Chapter 11
Unemployment and Labor
Force Participation
This outline is based on Cowen and Tabarrok (2011)
111 Defining Unemployment
The US Census Bureau conducts a monthly survey of approxi-
mately 60000 households to assess the state of the labor market
Current Population Survey
Unemployment is calculated as a percentage of the labor
force To be in the labor force you either have to be working
or actively looking for a job Children most students retirees
1
prisoners and others that are confined to medical or mental
institutions are not in the labor force
Here are some important definitions
Unemployed to be counted as unemployed a person must not
have a job but be actively looking for one
Employed To be employed you have to either
1 have a job outside of the home
2 have a job inside the home and be paid for doing it
Labor Force consists of people 16 years of age and older who
are either employed (working) or unemployed (not working
but looking)
Unemployed + Employed = Labor Force
We usually exclude people who are institutionalized (eg
penal and mental facilities homes for the aged) and the
Civilian Labor Force excludes active duty military person-
nel
Discouraged Worker A worker who wants to work but has
quit looking for a job
Marginally Attached Worker Persons not in the labor force
who want and are available for work and who have looked
2
for a job sometime in the prior 12 months (or since the
end of their last job if they held one within the past 12
months) but were not counted as unemployed because they
had not searched for work in the 4 weeks preceding the
survey Discouraged workers are a subset of the marginally
attached httpwwwblsgovblsglossaryhtmM
Underemployment These workers have part-time jobs but
would prefer full-time work It also includes discouraged
workers The government series is U-6 Total unemployed
plus all marginally attached workers plus total employed
part time for economic reasons (U6RATE) U-6 peaked at
171 in April 2010 It has fallen to 137 (August 2013)
Historically this is still quite high (average is 106 since
1994)
Unemployment Rate The unemployment rate represents the
number of unemployed as a percentage of the labor force
Labor force data are restricted to people 16 years of age
and older who currently reside in 1 of the 50 states or the
District of Columbia who do not reside in institutions and
who are not on active duty in the Armed Forces U-3
Unemployment Rate =Unemployed
Unemployed + Employedtimes 100
=Unemployed
Labor Forcetimes 100
3
Figure 111 Employment to Population
Part-Time in the US part-time is working between 1 and 34
hours per week
Employment-Population Ratio this is another measure of
the condition of the labor force
Employment-Population Ratio =Employed
Working Age Population
4
Links to Updated FRED Graphs
Unemployment U-3 httpresearchstlouisfedorg
fred2graphg=sX2
Employment-to-Population httpresearchstlouisfed
orgfred2graphg=sX4
LFP httpresearchstlouisfedorgfred2graphg=
sX6
Unemployment U-6 httpresearchstlouisfedorg
fred2graphg=sWJ
Hours Worked httpresearchstlouisfedorgfred2
graphg=sX8
Hours Worked Usually during recessions hours worked de-
cline Such was the case after the financial crisis of 2007
See Figure 112
How can the unemployment rate fall when em-
ployment goes down
Recently wersquove seen reductions in the unemployment rate (nor-
mally a good thing) that were viewed as a bad sign for the labor
market This happens if those looking but unable to find a job
drop out of the labor force Here is a simple example
5
Figure 112 Hours Worked ndash 2006 to present
6
Figure 113 Civilian Unemployment Rate
7
Figure 114 Population Labor Force Employment and Unemployed since
1947 Notice that after the financial crisis (2007-2008) that the growth rates
of the labor force and the population begin to diverge Employment dipped
and more Americans are being lsquosupportedrsquo by fewer workers Also notice how
the number of unemployed (right-hand scale) is fairly variable rising sharply
at the beginning of recessions and falling rather slowly once they end The
rate of decline appears to be fairly constant after each recession
8
Suppose we have 6 people employed and 4 others unemployed
The unemployment rate is
4
6 + 4times 100 = 40
Now suppose one of the 4 unemployed drops out of the labor
force3
6 + 3times 100 = 33
Magically the unemployment rate drops to 33 even though
the number of people actually employed has stayed the same
If the economy canrsquot generate enough jobs then eventually
the labor force will shrink and the unemployment rate along
with it This is one reason why we look at other indicators of
the state of the labor market to guage its health
Why are people Unemployed
1 Lose your job
2 Quit your job
3 New entrant into the labor force
4 Re-enter the labor force after being out of it for a while
9
112 Frictional Unemployment
Frictional unemployment is short-term unemployment caused by
the ordinary difficulties of matching employee to employer
bull This type of unemployment is usually short in duration
bull Innovation and competition drive progress Progress cre-
ates new jobs and destroys old jobs Good restaurants dis-
place bad ones
bull This type of unemployment is due to things like changing
jobs turnover new entrants into the labor force and so on
bull A certain amount of this kind of unemployment is a good
thing For the overall health of the economy it is impor-
tant that people are constantly being matched with things
for which they are better suited and its helpful for employ-
ers to be able to replace workers with ones that fit better
Freedom of choice on supply and demand sides of the labor
market create frictional unemployment
113 Structural Unemployment
Structural unemployment persistent long-term unemployment
caused by long-lasting shocks or permanent features of an econ-
10
omy that make it more difficult for some workers to find jobs
Shocks (unexpected economic events) could be technological
due to conflict weather or other natural disasters
1 One cause is large economy-wide shocks that occur rela-
tively quickly Adjusting to these shocks can create long-
lasting unemployment as the economy takes time to restruc-
ture
2 Labor regulations can lead to structural unemployment
(a) Unemployment Benefits ndash the higher the benefit the
more it pays to stay unemployed
(b) Minimum Wages ndash this limits new low skilled entrants
into the labor force
(c) Unions ndash insiders vs outsiders Insiders already work
for a firm and have some influence over the wage rate
They act to prevent lower wages which reduces a firms
willingness to hire and train new workers
(d) Employment-at-will This doctrine allows people to be
hired and fired at any time for any reason It con-
tributes to lower levels of structural unemployment
Countries with more rigid labor markets tend to have
much higher unemployment rates
11
Figure 115 Hiring and Firing The more costly it is to do the more unem-
ployment a country experiences
12
With this kind of unemployment the number of job openings
may be equal to the number of job applicants But the available
applicants are not qualified for the available jobs
114 Cyclical Unemployment
This is unemployment due to fluctuations of GDP around its
potential When we are in a recession GDP is below potential
and people who would like to work cannot find jobs
The normal level of unemployment (structural + frictional)
is consistent with an economy that creates new jobs and destroys
old ones due mainly to progress This is called the natural rate
of unemployment
Fluctuations of the actual unemployment rate around this
natural rate is blamed on cyclical factors (business cycle) which
at least in recession represents are real opportunity cost to the
economy as a whole
Estimates of the Natural Rate and its variation
The Congressional Budget Office estimates it to be 55 Economists
from the San Francisco Fed estimated it to be 67 in early 2011
13
(Weidner and Williams 2011)
The natural rate of unemployment depends on things like
institutions (unionization unemployment benefits labor market
regulations retraining opportunities etc) and things that affect
friction like labor mobility information exchanges work ethic
and so on
The natural rate rose in the 1960s and 70s as there was a
large influx of new entrants into the labor force (first time job
seekers and women enter the LF in large numbers) It takes new
entrants longer to match up with available jobs
In the most recent recession relaxing eligibility for SNAP
extension of unemployment benefits and other programs have
increased incentives to wait for better opportunitiesndashthus in-
creasing the level of structural unemployment in the US
115 Labor Force Participation
There are numerous things that affect a countryrsquos LFP Essen-
tially itrsquos a matter of demographics and incentives See Figure
116
1 Life-Cycle effects (changing demographics) more teenagers
14
are avoiding the LF Retirement ages and preferences also
have a big impact
2 Retirement benefits ndash how these are structured and who
qualifies has a big effect on when a person decides to retire
3 Cultural changes ndash feminism divorce rates widely available
inexpensive birth control etc
4 The degree of mismatch between job seekers and employers
has widened According to Weidner and Williams (2011)
ldquo[t]he construction finance and real estate sectors have
shrunk after the bursting of the housing bubble and the sub-
sequent financial crisis The skills of workers who used to be
employed in those sectors may not be easily transferable to
growing sectors such as education and health care (see Riss-
man 2009 and Barnichon et al 2010 httpwwwfrbsf
orgpublicationseconomicspapers2010wp10-32bk
pdf) Similarly the housing bust has left millions of home-
owners underwater on their mortgages which locks them
in to their homes and may make it more difficult for them
to move to higher growth areas These sectoral and geo-
graphic mismatches between workers and job openings may
be making it harder for employers to fill vacanciesrdquo
5 Tax rates ndash high marginal tax rates discourage work item
Weidner and Williams (2011) claim that another explana-
tion for the current increase ldquoinvolves the sizable increase
15
Figure 116 Labor Force Participation Rates Seasonally Adjusted The rate
of 633 in early 2013 is the lowest since October 1978 LFPR peaked at
673 in the spring of 2000
in long-term unemployment over the past few years Work-
ers out of jobs for extended periods may experience higher
rates of unemployment owing to deterioration of skills and
weakening labor market attachmentrdquo
16
116 Model of the Labor Market
This market coordinates the supply of and demand for labor
Demand for labor comes from firms who hire labor to produce
products As the price of labor falls firms will increase employ-
ment Supply comes from households who generally increase
their willingness to seek employment as wage rates rise (as wage
offers surpass reservation wages people are drawn into the labor
force)
The price in this market is the real wage rate It is the wage
offered divided by the overall price level This is shown in Figure
117
Real Wage =Nominal Wage
Price Level
1161 Two Ways to account for unemployment
Figure 118 shows how wages above equilibrium can lead to un-
employment
Job Rationing For some reason the actual real wage is stuck
above the equilibrium wage This creates unemployment
At wH the number of people wanting to work exceeds the
17
Figure 117 Labor Market w is the equilibrium real wage rate and Em-
ployment the level of employment During a boom demand increases and
real wage rates and employment rise During recession demand falls and
real wage rates and employment fall
18
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
prisoners and others that are confined to medical or mental
institutions are not in the labor force
Here are some important definitions
Unemployed to be counted as unemployed a person must not
have a job but be actively looking for one
Employed To be employed you have to either
1 have a job outside of the home
2 have a job inside the home and be paid for doing it
Labor Force consists of people 16 years of age and older who
are either employed (working) or unemployed (not working
but looking)
Unemployed + Employed = Labor Force
We usually exclude people who are institutionalized (eg
penal and mental facilities homes for the aged) and the
Civilian Labor Force excludes active duty military person-
nel
Discouraged Worker A worker who wants to work but has
quit looking for a job
Marginally Attached Worker Persons not in the labor force
who want and are available for work and who have looked
2
for a job sometime in the prior 12 months (or since the
end of their last job if they held one within the past 12
months) but were not counted as unemployed because they
had not searched for work in the 4 weeks preceding the
survey Discouraged workers are a subset of the marginally
attached httpwwwblsgovblsglossaryhtmM
Underemployment These workers have part-time jobs but
would prefer full-time work It also includes discouraged
workers The government series is U-6 Total unemployed
plus all marginally attached workers plus total employed
part time for economic reasons (U6RATE) U-6 peaked at
171 in April 2010 It has fallen to 137 (August 2013)
Historically this is still quite high (average is 106 since
1994)
Unemployment Rate The unemployment rate represents the
number of unemployed as a percentage of the labor force
Labor force data are restricted to people 16 years of age
and older who currently reside in 1 of the 50 states or the
District of Columbia who do not reside in institutions and
who are not on active duty in the Armed Forces U-3
Unemployment Rate =Unemployed
Unemployed + Employedtimes 100
=Unemployed
Labor Forcetimes 100
3
Figure 111 Employment to Population
Part-Time in the US part-time is working between 1 and 34
hours per week
Employment-Population Ratio this is another measure of
the condition of the labor force
Employment-Population Ratio =Employed
Working Age Population
4
Links to Updated FRED Graphs
Unemployment U-3 httpresearchstlouisfedorg
fred2graphg=sX2
Employment-to-Population httpresearchstlouisfed
orgfred2graphg=sX4
LFP httpresearchstlouisfedorgfred2graphg=
sX6
Unemployment U-6 httpresearchstlouisfedorg
fred2graphg=sWJ
Hours Worked httpresearchstlouisfedorgfred2
graphg=sX8
Hours Worked Usually during recessions hours worked de-
cline Such was the case after the financial crisis of 2007
See Figure 112
How can the unemployment rate fall when em-
ployment goes down
Recently wersquove seen reductions in the unemployment rate (nor-
mally a good thing) that were viewed as a bad sign for the labor
market This happens if those looking but unable to find a job
drop out of the labor force Here is a simple example
5
Figure 112 Hours Worked ndash 2006 to present
6
Figure 113 Civilian Unemployment Rate
7
Figure 114 Population Labor Force Employment and Unemployed since
1947 Notice that after the financial crisis (2007-2008) that the growth rates
of the labor force and the population begin to diverge Employment dipped
and more Americans are being lsquosupportedrsquo by fewer workers Also notice how
the number of unemployed (right-hand scale) is fairly variable rising sharply
at the beginning of recessions and falling rather slowly once they end The
rate of decline appears to be fairly constant after each recession
8
Suppose we have 6 people employed and 4 others unemployed
The unemployment rate is
4
6 + 4times 100 = 40
Now suppose one of the 4 unemployed drops out of the labor
force3
6 + 3times 100 = 33
Magically the unemployment rate drops to 33 even though
the number of people actually employed has stayed the same
If the economy canrsquot generate enough jobs then eventually
the labor force will shrink and the unemployment rate along
with it This is one reason why we look at other indicators of
the state of the labor market to guage its health
Why are people Unemployed
1 Lose your job
2 Quit your job
3 New entrant into the labor force
4 Re-enter the labor force after being out of it for a while
9
112 Frictional Unemployment
Frictional unemployment is short-term unemployment caused by
the ordinary difficulties of matching employee to employer
bull This type of unemployment is usually short in duration
bull Innovation and competition drive progress Progress cre-
ates new jobs and destroys old jobs Good restaurants dis-
place bad ones
bull This type of unemployment is due to things like changing
jobs turnover new entrants into the labor force and so on
bull A certain amount of this kind of unemployment is a good
thing For the overall health of the economy it is impor-
tant that people are constantly being matched with things
for which they are better suited and its helpful for employ-
ers to be able to replace workers with ones that fit better
Freedom of choice on supply and demand sides of the labor
market create frictional unemployment
113 Structural Unemployment
Structural unemployment persistent long-term unemployment
caused by long-lasting shocks or permanent features of an econ-
10
omy that make it more difficult for some workers to find jobs
Shocks (unexpected economic events) could be technological
due to conflict weather or other natural disasters
1 One cause is large economy-wide shocks that occur rela-
tively quickly Adjusting to these shocks can create long-
lasting unemployment as the economy takes time to restruc-
ture
2 Labor regulations can lead to structural unemployment
(a) Unemployment Benefits ndash the higher the benefit the
more it pays to stay unemployed
(b) Minimum Wages ndash this limits new low skilled entrants
into the labor force
(c) Unions ndash insiders vs outsiders Insiders already work
for a firm and have some influence over the wage rate
They act to prevent lower wages which reduces a firms
willingness to hire and train new workers
(d) Employment-at-will This doctrine allows people to be
hired and fired at any time for any reason It con-
tributes to lower levels of structural unemployment
Countries with more rigid labor markets tend to have
much higher unemployment rates
11
Figure 115 Hiring and Firing The more costly it is to do the more unem-
ployment a country experiences
12
With this kind of unemployment the number of job openings
may be equal to the number of job applicants But the available
applicants are not qualified for the available jobs
114 Cyclical Unemployment
This is unemployment due to fluctuations of GDP around its
potential When we are in a recession GDP is below potential
and people who would like to work cannot find jobs
The normal level of unemployment (structural + frictional)
is consistent with an economy that creates new jobs and destroys
old ones due mainly to progress This is called the natural rate
of unemployment
Fluctuations of the actual unemployment rate around this
natural rate is blamed on cyclical factors (business cycle) which
at least in recession represents are real opportunity cost to the
economy as a whole
Estimates of the Natural Rate and its variation
The Congressional Budget Office estimates it to be 55 Economists
from the San Francisco Fed estimated it to be 67 in early 2011
13
(Weidner and Williams 2011)
The natural rate of unemployment depends on things like
institutions (unionization unemployment benefits labor market
regulations retraining opportunities etc) and things that affect
friction like labor mobility information exchanges work ethic
and so on
The natural rate rose in the 1960s and 70s as there was a
large influx of new entrants into the labor force (first time job
seekers and women enter the LF in large numbers) It takes new
entrants longer to match up with available jobs
In the most recent recession relaxing eligibility for SNAP
extension of unemployment benefits and other programs have
increased incentives to wait for better opportunitiesndashthus in-
creasing the level of structural unemployment in the US
115 Labor Force Participation
There are numerous things that affect a countryrsquos LFP Essen-
tially itrsquos a matter of demographics and incentives See Figure
116
1 Life-Cycle effects (changing demographics) more teenagers
14
are avoiding the LF Retirement ages and preferences also
have a big impact
2 Retirement benefits ndash how these are structured and who
qualifies has a big effect on when a person decides to retire
3 Cultural changes ndash feminism divorce rates widely available
inexpensive birth control etc
4 The degree of mismatch between job seekers and employers
has widened According to Weidner and Williams (2011)
ldquo[t]he construction finance and real estate sectors have
shrunk after the bursting of the housing bubble and the sub-
sequent financial crisis The skills of workers who used to be
employed in those sectors may not be easily transferable to
growing sectors such as education and health care (see Riss-
man 2009 and Barnichon et al 2010 httpwwwfrbsf
orgpublicationseconomicspapers2010wp10-32bk
pdf) Similarly the housing bust has left millions of home-
owners underwater on their mortgages which locks them
in to their homes and may make it more difficult for them
to move to higher growth areas These sectoral and geo-
graphic mismatches between workers and job openings may
be making it harder for employers to fill vacanciesrdquo
5 Tax rates ndash high marginal tax rates discourage work item
Weidner and Williams (2011) claim that another explana-
tion for the current increase ldquoinvolves the sizable increase
15
Figure 116 Labor Force Participation Rates Seasonally Adjusted The rate
of 633 in early 2013 is the lowest since October 1978 LFPR peaked at
673 in the spring of 2000
in long-term unemployment over the past few years Work-
ers out of jobs for extended periods may experience higher
rates of unemployment owing to deterioration of skills and
weakening labor market attachmentrdquo
16
116 Model of the Labor Market
This market coordinates the supply of and demand for labor
Demand for labor comes from firms who hire labor to produce
products As the price of labor falls firms will increase employ-
ment Supply comes from households who generally increase
their willingness to seek employment as wage rates rise (as wage
offers surpass reservation wages people are drawn into the labor
force)
The price in this market is the real wage rate It is the wage
offered divided by the overall price level This is shown in Figure
117
Real Wage =Nominal Wage
Price Level
1161 Two Ways to account for unemployment
Figure 118 shows how wages above equilibrium can lead to un-
employment
Job Rationing For some reason the actual real wage is stuck
above the equilibrium wage This creates unemployment
At wH the number of people wanting to work exceeds the
17
Figure 117 Labor Market w is the equilibrium real wage rate and Em-
ployment the level of employment During a boom demand increases and
real wage rates and employment rise During recession demand falls and
real wage rates and employment fall
18
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
for a job sometime in the prior 12 months (or since the
end of their last job if they held one within the past 12
months) but were not counted as unemployed because they
had not searched for work in the 4 weeks preceding the
survey Discouraged workers are a subset of the marginally
attached httpwwwblsgovblsglossaryhtmM
Underemployment These workers have part-time jobs but
would prefer full-time work It also includes discouraged
workers The government series is U-6 Total unemployed
plus all marginally attached workers plus total employed
part time for economic reasons (U6RATE) U-6 peaked at
171 in April 2010 It has fallen to 137 (August 2013)
Historically this is still quite high (average is 106 since
1994)
Unemployment Rate The unemployment rate represents the
number of unemployed as a percentage of the labor force
Labor force data are restricted to people 16 years of age
and older who currently reside in 1 of the 50 states or the
District of Columbia who do not reside in institutions and
who are not on active duty in the Armed Forces U-3
Unemployment Rate =Unemployed
Unemployed + Employedtimes 100
=Unemployed
Labor Forcetimes 100
3
Figure 111 Employment to Population
Part-Time in the US part-time is working between 1 and 34
hours per week
Employment-Population Ratio this is another measure of
the condition of the labor force
Employment-Population Ratio =Employed
Working Age Population
4
Links to Updated FRED Graphs
Unemployment U-3 httpresearchstlouisfedorg
fred2graphg=sX2
Employment-to-Population httpresearchstlouisfed
orgfred2graphg=sX4
LFP httpresearchstlouisfedorgfred2graphg=
sX6
Unemployment U-6 httpresearchstlouisfedorg
fred2graphg=sWJ
Hours Worked httpresearchstlouisfedorgfred2
graphg=sX8
Hours Worked Usually during recessions hours worked de-
cline Such was the case after the financial crisis of 2007
See Figure 112
How can the unemployment rate fall when em-
ployment goes down
Recently wersquove seen reductions in the unemployment rate (nor-
mally a good thing) that were viewed as a bad sign for the labor
market This happens if those looking but unable to find a job
drop out of the labor force Here is a simple example
5
Figure 112 Hours Worked ndash 2006 to present
6
Figure 113 Civilian Unemployment Rate
7
Figure 114 Population Labor Force Employment and Unemployed since
1947 Notice that after the financial crisis (2007-2008) that the growth rates
of the labor force and the population begin to diverge Employment dipped
and more Americans are being lsquosupportedrsquo by fewer workers Also notice how
the number of unemployed (right-hand scale) is fairly variable rising sharply
at the beginning of recessions and falling rather slowly once they end The
rate of decline appears to be fairly constant after each recession
8
Suppose we have 6 people employed and 4 others unemployed
The unemployment rate is
4
6 + 4times 100 = 40
Now suppose one of the 4 unemployed drops out of the labor
force3
6 + 3times 100 = 33
Magically the unemployment rate drops to 33 even though
the number of people actually employed has stayed the same
If the economy canrsquot generate enough jobs then eventually
the labor force will shrink and the unemployment rate along
with it This is one reason why we look at other indicators of
the state of the labor market to guage its health
Why are people Unemployed
1 Lose your job
2 Quit your job
3 New entrant into the labor force
4 Re-enter the labor force after being out of it for a while
9
112 Frictional Unemployment
Frictional unemployment is short-term unemployment caused by
the ordinary difficulties of matching employee to employer
bull This type of unemployment is usually short in duration
bull Innovation and competition drive progress Progress cre-
ates new jobs and destroys old jobs Good restaurants dis-
place bad ones
bull This type of unemployment is due to things like changing
jobs turnover new entrants into the labor force and so on
bull A certain amount of this kind of unemployment is a good
thing For the overall health of the economy it is impor-
tant that people are constantly being matched with things
for which they are better suited and its helpful for employ-
ers to be able to replace workers with ones that fit better
Freedom of choice on supply and demand sides of the labor
market create frictional unemployment
113 Structural Unemployment
Structural unemployment persistent long-term unemployment
caused by long-lasting shocks or permanent features of an econ-
10
omy that make it more difficult for some workers to find jobs
Shocks (unexpected economic events) could be technological
due to conflict weather or other natural disasters
1 One cause is large economy-wide shocks that occur rela-
tively quickly Adjusting to these shocks can create long-
lasting unemployment as the economy takes time to restruc-
ture
2 Labor regulations can lead to structural unemployment
(a) Unemployment Benefits ndash the higher the benefit the
more it pays to stay unemployed
(b) Minimum Wages ndash this limits new low skilled entrants
into the labor force
(c) Unions ndash insiders vs outsiders Insiders already work
for a firm and have some influence over the wage rate
They act to prevent lower wages which reduces a firms
willingness to hire and train new workers
(d) Employment-at-will This doctrine allows people to be
hired and fired at any time for any reason It con-
tributes to lower levels of structural unemployment
Countries with more rigid labor markets tend to have
much higher unemployment rates
11
Figure 115 Hiring and Firing The more costly it is to do the more unem-
ployment a country experiences
12
With this kind of unemployment the number of job openings
may be equal to the number of job applicants But the available
applicants are not qualified for the available jobs
114 Cyclical Unemployment
This is unemployment due to fluctuations of GDP around its
potential When we are in a recession GDP is below potential
and people who would like to work cannot find jobs
The normal level of unemployment (structural + frictional)
is consistent with an economy that creates new jobs and destroys
old ones due mainly to progress This is called the natural rate
of unemployment
Fluctuations of the actual unemployment rate around this
natural rate is blamed on cyclical factors (business cycle) which
at least in recession represents are real opportunity cost to the
economy as a whole
Estimates of the Natural Rate and its variation
The Congressional Budget Office estimates it to be 55 Economists
from the San Francisco Fed estimated it to be 67 in early 2011
13
(Weidner and Williams 2011)
The natural rate of unemployment depends on things like
institutions (unionization unemployment benefits labor market
regulations retraining opportunities etc) and things that affect
friction like labor mobility information exchanges work ethic
and so on
The natural rate rose in the 1960s and 70s as there was a
large influx of new entrants into the labor force (first time job
seekers and women enter the LF in large numbers) It takes new
entrants longer to match up with available jobs
In the most recent recession relaxing eligibility for SNAP
extension of unemployment benefits and other programs have
increased incentives to wait for better opportunitiesndashthus in-
creasing the level of structural unemployment in the US
115 Labor Force Participation
There are numerous things that affect a countryrsquos LFP Essen-
tially itrsquos a matter of demographics and incentives See Figure
116
1 Life-Cycle effects (changing demographics) more teenagers
14
are avoiding the LF Retirement ages and preferences also
have a big impact
2 Retirement benefits ndash how these are structured and who
qualifies has a big effect on when a person decides to retire
3 Cultural changes ndash feminism divorce rates widely available
inexpensive birth control etc
4 The degree of mismatch between job seekers and employers
has widened According to Weidner and Williams (2011)
ldquo[t]he construction finance and real estate sectors have
shrunk after the bursting of the housing bubble and the sub-
sequent financial crisis The skills of workers who used to be
employed in those sectors may not be easily transferable to
growing sectors such as education and health care (see Riss-
man 2009 and Barnichon et al 2010 httpwwwfrbsf
orgpublicationseconomicspapers2010wp10-32bk
pdf) Similarly the housing bust has left millions of home-
owners underwater on their mortgages which locks them
in to their homes and may make it more difficult for them
to move to higher growth areas These sectoral and geo-
graphic mismatches between workers and job openings may
be making it harder for employers to fill vacanciesrdquo
5 Tax rates ndash high marginal tax rates discourage work item
Weidner and Williams (2011) claim that another explana-
tion for the current increase ldquoinvolves the sizable increase
15
Figure 116 Labor Force Participation Rates Seasonally Adjusted The rate
of 633 in early 2013 is the lowest since October 1978 LFPR peaked at
673 in the spring of 2000
in long-term unemployment over the past few years Work-
ers out of jobs for extended periods may experience higher
rates of unemployment owing to deterioration of skills and
weakening labor market attachmentrdquo
16
116 Model of the Labor Market
This market coordinates the supply of and demand for labor
Demand for labor comes from firms who hire labor to produce
products As the price of labor falls firms will increase employ-
ment Supply comes from households who generally increase
their willingness to seek employment as wage rates rise (as wage
offers surpass reservation wages people are drawn into the labor
force)
The price in this market is the real wage rate It is the wage
offered divided by the overall price level This is shown in Figure
117
Real Wage =Nominal Wage
Price Level
1161 Two Ways to account for unemployment
Figure 118 shows how wages above equilibrium can lead to un-
employment
Job Rationing For some reason the actual real wage is stuck
above the equilibrium wage This creates unemployment
At wH the number of people wanting to work exceeds the
17
Figure 117 Labor Market w is the equilibrium real wage rate and Em-
ployment the level of employment During a boom demand increases and
real wage rates and employment rise During recession demand falls and
real wage rates and employment fall
18
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
Figure 111 Employment to Population
Part-Time in the US part-time is working between 1 and 34
hours per week
Employment-Population Ratio this is another measure of
the condition of the labor force
Employment-Population Ratio =Employed
Working Age Population
4
Links to Updated FRED Graphs
Unemployment U-3 httpresearchstlouisfedorg
fred2graphg=sX2
Employment-to-Population httpresearchstlouisfed
orgfred2graphg=sX4
LFP httpresearchstlouisfedorgfred2graphg=
sX6
Unemployment U-6 httpresearchstlouisfedorg
fred2graphg=sWJ
Hours Worked httpresearchstlouisfedorgfred2
graphg=sX8
Hours Worked Usually during recessions hours worked de-
cline Such was the case after the financial crisis of 2007
See Figure 112
How can the unemployment rate fall when em-
ployment goes down
Recently wersquove seen reductions in the unemployment rate (nor-
mally a good thing) that were viewed as a bad sign for the labor
market This happens if those looking but unable to find a job
drop out of the labor force Here is a simple example
5
Figure 112 Hours Worked ndash 2006 to present
6
Figure 113 Civilian Unemployment Rate
7
Figure 114 Population Labor Force Employment and Unemployed since
1947 Notice that after the financial crisis (2007-2008) that the growth rates
of the labor force and the population begin to diverge Employment dipped
and more Americans are being lsquosupportedrsquo by fewer workers Also notice how
the number of unemployed (right-hand scale) is fairly variable rising sharply
at the beginning of recessions and falling rather slowly once they end The
rate of decline appears to be fairly constant after each recession
8
Suppose we have 6 people employed and 4 others unemployed
The unemployment rate is
4
6 + 4times 100 = 40
Now suppose one of the 4 unemployed drops out of the labor
force3
6 + 3times 100 = 33
Magically the unemployment rate drops to 33 even though
the number of people actually employed has stayed the same
If the economy canrsquot generate enough jobs then eventually
the labor force will shrink and the unemployment rate along
with it This is one reason why we look at other indicators of
the state of the labor market to guage its health
Why are people Unemployed
1 Lose your job
2 Quit your job
3 New entrant into the labor force
4 Re-enter the labor force after being out of it for a while
9
112 Frictional Unemployment
Frictional unemployment is short-term unemployment caused by
the ordinary difficulties of matching employee to employer
bull This type of unemployment is usually short in duration
bull Innovation and competition drive progress Progress cre-
ates new jobs and destroys old jobs Good restaurants dis-
place bad ones
bull This type of unemployment is due to things like changing
jobs turnover new entrants into the labor force and so on
bull A certain amount of this kind of unemployment is a good
thing For the overall health of the economy it is impor-
tant that people are constantly being matched with things
for which they are better suited and its helpful for employ-
ers to be able to replace workers with ones that fit better
Freedom of choice on supply and demand sides of the labor
market create frictional unemployment
113 Structural Unemployment
Structural unemployment persistent long-term unemployment
caused by long-lasting shocks or permanent features of an econ-
10
omy that make it more difficult for some workers to find jobs
Shocks (unexpected economic events) could be technological
due to conflict weather or other natural disasters
1 One cause is large economy-wide shocks that occur rela-
tively quickly Adjusting to these shocks can create long-
lasting unemployment as the economy takes time to restruc-
ture
2 Labor regulations can lead to structural unemployment
(a) Unemployment Benefits ndash the higher the benefit the
more it pays to stay unemployed
(b) Minimum Wages ndash this limits new low skilled entrants
into the labor force
(c) Unions ndash insiders vs outsiders Insiders already work
for a firm and have some influence over the wage rate
They act to prevent lower wages which reduces a firms
willingness to hire and train new workers
(d) Employment-at-will This doctrine allows people to be
hired and fired at any time for any reason It con-
tributes to lower levels of structural unemployment
Countries with more rigid labor markets tend to have
much higher unemployment rates
11
Figure 115 Hiring and Firing The more costly it is to do the more unem-
ployment a country experiences
12
With this kind of unemployment the number of job openings
may be equal to the number of job applicants But the available
applicants are not qualified for the available jobs
114 Cyclical Unemployment
This is unemployment due to fluctuations of GDP around its
potential When we are in a recession GDP is below potential
and people who would like to work cannot find jobs
The normal level of unemployment (structural + frictional)
is consistent with an economy that creates new jobs and destroys
old ones due mainly to progress This is called the natural rate
of unemployment
Fluctuations of the actual unemployment rate around this
natural rate is blamed on cyclical factors (business cycle) which
at least in recession represents are real opportunity cost to the
economy as a whole
Estimates of the Natural Rate and its variation
The Congressional Budget Office estimates it to be 55 Economists
from the San Francisco Fed estimated it to be 67 in early 2011
13
(Weidner and Williams 2011)
The natural rate of unemployment depends on things like
institutions (unionization unemployment benefits labor market
regulations retraining opportunities etc) and things that affect
friction like labor mobility information exchanges work ethic
and so on
The natural rate rose in the 1960s and 70s as there was a
large influx of new entrants into the labor force (first time job
seekers and women enter the LF in large numbers) It takes new
entrants longer to match up with available jobs
In the most recent recession relaxing eligibility for SNAP
extension of unemployment benefits and other programs have
increased incentives to wait for better opportunitiesndashthus in-
creasing the level of structural unemployment in the US
115 Labor Force Participation
There are numerous things that affect a countryrsquos LFP Essen-
tially itrsquos a matter of demographics and incentives See Figure
116
1 Life-Cycle effects (changing demographics) more teenagers
14
are avoiding the LF Retirement ages and preferences also
have a big impact
2 Retirement benefits ndash how these are structured and who
qualifies has a big effect on when a person decides to retire
3 Cultural changes ndash feminism divorce rates widely available
inexpensive birth control etc
4 The degree of mismatch between job seekers and employers
has widened According to Weidner and Williams (2011)
ldquo[t]he construction finance and real estate sectors have
shrunk after the bursting of the housing bubble and the sub-
sequent financial crisis The skills of workers who used to be
employed in those sectors may not be easily transferable to
growing sectors such as education and health care (see Riss-
man 2009 and Barnichon et al 2010 httpwwwfrbsf
orgpublicationseconomicspapers2010wp10-32bk
pdf) Similarly the housing bust has left millions of home-
owners underwater on their mortgages which locks them
in to their homes and may make it more difficult for them
to move to higher growth areas These sectoral and geo-
graphic mismatches between workers and job openings may
be making it harder for employers to fill vacanciesrdquo
5 Tax rates ndash high marginal tax rates discourage work item
Weidner and Williams (2011) claim that another explana-
tion for the current increase ldquoinvolves the sizable increase
15
Figure 116 Labor Force Participation Rates Seasonally Adjusted The rate
of 633 in early 2013 is the lowest since October 1978 LFPR peaked at
673 in the spring of 2000
in long-term unemployment over the past few years Work-
ers out of jobs for extended periods may experience higher
rates of unemployment owing to deterioration of skills and
weakening labor market attachmentrdquo
16
116 Model of the Labor Market
This market coordinates the supply of and demand for labor
Demand for labor comes from firms who hire labor to produce
products As the price of labor falls firms will increase employ-
ment Supply comes from households who generally increase
their willingness to seek employment as wage rates rise (as wage
offers surpass reservation wages people are drawn into the labor
force)
The price in this market is the real wage rate It is the wage
offered divided by the overall price level This is shown in Figure
117
Real Wage =Nominal Wage
Price Level
1161 Two Ways to account for unemployment
Figure 118 shows how wages above equilibrium can lead to un-
employment
Job Rationing For some reason the actual real wage is stuck
above the equilibrium wage This creates unemployment
At wH the number of people wanting to work exceeds the
17
Figure 117 Labor Market w is the equilibrium real wage rate and Em-
ployment the level of employment During a boom demand increases and
real wage rates and employment rise During recession demand falls and
real wage rates and employment fall
18
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
Links to Updated FRED Graphs
Unemployment U-3 httpresearchstlouisfedorg
fred2graphg=sX2
Employment-to-Population httpresearchstlouisfed
orgfred2graphg=sX4
LFP httpresearchstlouisfedorgfred2graphg=
sX6
Unemployment U-6 httpresearchstlouisfedorg
fred2graphg=sWJ
Hours Worked httpresearchstlouisfedorgfred2
graphg=sX8
Hours Worked Usually during recessions hours worked de-
cline Such was the case after the financial crisis of 2007
See Figure 112
How can the unemployment rate fall when em-
ployment goes down
Recently wersquove seen reductions in the unemployment rate (nor-
mally a good thing) that were viewed as a bad sign for the labor
market This happens if those looking but unable to find a job
drop out of the labor force Here is a simple example
5
Figure 112 Hours Worked ndash 2006 to present
6
Figure 113 Civilian Unemployment Rate
7
Figure 114 Population Labor Force Employment and Unemployed since
1947 Notice that after the financial crisis (2007-2008) that the growth rates
of the labor force and the population begin to diverge Employment dipped
and more Americans are being lsquosupportedrsquo by fewer workers Also notice how
the number of unemployed (right-hand scale) is fairly variable rising sharply
at the beginning of recessions and falling rather slowly once they end The
rate of decline appears to be fairly constant after each recession
8
Suppose we have 6 people employed and 4 others unemployed
The unemployment rate is
4
6 + 4times 100 = 40
Now suppose one of the 4 unemployed drops out of the labor
force3
6 + 3times 100 = 33
Magically the unemployment rate drops to 33 even though
the number of people actually employed has stayed the same
If the economy canrsquot generate enough jobs then eventually
the labor force will shrink and the unemployment rate along
with it This is one reason why we look at other indicators of
the state of the labor market to guage its health
Why are people Unemployed
1 Lose your job
2 Quit your job
3 New entrant into the labor force
4 Re-enter the labor force after being out of it for a while
9
112 Frictional Unemployment
Frictional unemployment is short-term unemployment caused by
the ordinary difficulties of matching employee to employer
bull This type of unemployment is usually short in duration
bull Innovation and competition drive progress Progress cre-
ates new jobs and destroys old jobs Good restaurants dis-
place bad ones
bull This type of unemployment is due to things like changing
jobs turnover new entrants into the labor force and so on
bull A certain amount of this kind of unemployment is a good
thing For the overall health of the economy it is impor-
tant that people are constantly being matched with things
for which they are better suited and its helpful for employ-
ers to be able to replace workers with ones that fit better
Freedom of choice on supply and demand sides of the labor
market create frictional unemployment
113 Structural Unemployment
Structural unemployment persistent long-term unemployment
caused by long-lasting shocks or permanent features of an econ-
10
omy that make it more difficult for some workers to find jobs
Shocks (unexpected economic events) could be technological
due to conflict weather or other natural disasters
1 One cause is large economy-wide shocks that occur rela-
tively quickly Adjusting to these shocks can create long-
lasting unemployment as the economy takes time to restruc-
ture
2 Labor regulations can lead to structural unemployment
(a) Unemployment Benefits ndash the higher the benefit the
more it pays to stay unemployed
(b) Minimum Wages ndash this limits new low skilled entrants
into the labor force
(c) Unions ndash insiders vs outsiders Insiders already work
for a firm and have some influence over the wage rate
They act to prevent lower wages which reduces a firms
willingness to hire and train new workers
(d) Employment-at-will This doctrine allows people to be
hired and fired at any time for any reason It con-
tributes to lower levels of structural unemployment
Countries with more rigid labor markets tend to have
much higher unemployment rates
11
Figure 115 Hiring and Firing The more costly it is to do the more unem-
ployment a country experiences
12
With this kind of unemployment the number of job openings
may be equal to the number of job applicants But the available
applicants are not qualified for the available jobs
114 Cyclical Unemployment
This is unemployment due to fluctuations of GDP around its
potential When we are in a recession GDP is below potential
and people who would like to work cannot find jobs
The normal level of unemployment (structural + frictional)
is consistent with an economy that creates new jobs and destroys
old ones due mainly to progress This is called the natural rate
of unemployment
Fluctuations of the actual unemployment rate around this
natural rate is blamed on cyclical factors (business cycle) which
at least in recession represents are real opportunity cost to the
economy as a whole
Estimates of the Natural Rate and its variation
The Congressional Budget Office estimates it to be 55 Economists
from the San Francisco Fed estimated it to be 67 in early 2011
13
(Weidner and Williams 2011)
The natural rate of unemployment depends on things like
institutions (unionization unemployment benefits labor market
regulations retraining opportunities etc) and things that affect
friction like labor mobility information exchanges work ethic
and so on
The natural rate rose in the 1960s and 70s as there was a
large influx of new entrants into the labor force (first time job
seekers and women enter the LF in large numbers) It takes new
entrants longer to match up with available jobs
In the most recent recession relaxing eligibility for SNAP
extension of unemployment benefits and other programs have
increased incentives to wait for better opportunitiesndashthus in-
creasing the level of structural unemployment in the US
115 Labor Force Participation
There are numerous things that affect a countryrsquos LFP Essen-
tially itrsquos a matter of demographics and incentives See Figure
116
1 Life-Cycle effects (changing demographics) more teenagers
14
are avoiding the LF Retirement ages and preferences also
have a big impact
2 Retirement benefits ndash how these are structured and who
qualifies has a big effect on when a person decides to retire
3 Cultural changes ndash feminism divorce rates widely available
inexpensive birth control etc
4 The degree of mismatch between job seekers and employers
has widened According to Weidner and Williams (2011)
ldquo[t]he construction finance and real estate sectors have
shrunk after the bursting of the housing bubble and the sub-
sequent financial crisis The skills of workers who used to be
employed in those sectors may not be easily transferable to
growing sectors such as education and health care (see Riss-
man 2009 and Barnichon et al 2010 httpwwwfrbsf
orgpublicationseconomicspapers2010wp10-32bk
pdf) Similarly the housing bust has left millions of home-
owners underwater on their mortgages which locks them
in to their homes and may make it more difficult for them
to move to higher growth areas These sectoral and geo-
graphic mismatches between workers and job openings may
be making it harder for employers to fill vacanciesrdquo
5 Tax rates ndash high marginal tax rates discourage work item
Weidner and Williams (2011) claim that another explana-
tion for the current increase ldquoinvolves the sizable increase
15
Figure 116 Labor Force Participation Rates Seasonally Adjusted The rate
of 633 in early 2013 is the lowest since October 1978 LFPR peaked at
673 in the spring of 2000
in long-term unemployment over the past few years Work-
ers out of jobs for extended periods may experience higher
rates of unemployment owing to deterioration of skills and
weakening labor market attachmentrdquo
16
116 Model of the Labor Market
This market coordinates the supply of and demand for labor
Demand for labor comes from firms who hire labor to produce
products As the price of labor falls firms will increase employ-
ment Supply comes from households who generally increase
their willingness to seek employment as wage rates rise (as wage
offers surpass reservation wages people are drawn into the labor
force)
The price in this market is the real wage rate It is the wage
offered divided by the overall price level This is shown in Figure
117
Real Wage =Nominal Wage
Price Level
1161 Two Ways to account for unemployment
Figure 118 shows how wages above equilibrium can lead to un-
employment
Job Rationing For some reason the actual real wage is stuck
above the equilibrium wage This creates unemployment
At wH the number of people wanting to work exceeds the
17
Figure 117 Labor Market w is the equilibrium real wage rate and Em-
ployment the level of employment During a boom demand increases and
real wage rates and employment rise During recession demand falls and
real wage rates and employment fall
18
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
Figure 112 Hours Worked ndash 2006 to present
6
Figure 113 Civilian Unemployment Rate
7
Figure 114 Population Labor Force Employment and Unemployed since
1947 Notice that after the financial crisis (2007-2008) that the growth rates
of the labor force and the population begin to diverge Employment dipped
and more Americans are being lsquosupportedrsquo by fewer workers Also notice how
the number of unemployed (right-hand scale) is fairly variable rising sharply
at the beginning of recessions and falling rather slowly once they end The
rate of decline appears to be fairly constant after each recession
8
Suppose we have 6 people employed and 4 others unemployed
The unemployment rate is
4
6 + 4times 100 = 40
Now suppose one of the 4 unemployed drops out of the labor
force3
6 + 3times 100 = 33
Magically the unemployment rate drops to 33 even though
the number of people actually employed has stayed the same
If the economy canrsquot generate enough jobs then eventually
the labor force will shrink and the unemployment rate along
with it This is one reason why we look at other indicators of
the state of the labor market to guage its health
Why are people Unemployed
1 Lose your job
2 Quit your job
3 New entrant into the labor force
4 Re-enter the labor force after being out of it for a while
9
112 Frictional Unemployment
Frictional unemployment is short-term unemployment caused by
the ordinary difficulties of matching employee to employer
bull This type of unemployment is usually short in duration
bull Innovation and competition drive progress Progress cre-
ates new jobs and destroys old jobs Good restaurants dis-
place bad ones
bull This type of unemployment is due to things like changing
jobs turnover new entrants into the labor force and so on
bull A certain amount of this kind of unemployment is a good
thing For the overall health of the economy it is impor-
tant that people are constantly being matched with things
for which they are better suited and its helpful for employ-
ers to be able to replace workers with ones that fit better
Freedom of choice on supply and demand sides of the labor
market create frictional unemployment
113 Structural Unemployment
Structural unemployment persistent long-term unemployment
caused by long-lasting shocks or permanent features of an econ-
10
omy that make it more difficult for some workers to find jobs
Shocks (unexpected economic events) could be technological
due to conflict weather or other natural disasters
1 One cause is large economy-wide shocks that occur rela-
tively quickly Adjusting to these shocks can create long-
lasting unemployment as the economy takes time to restruc-
ture
2 Labor regulations can lead to structural unemployment
(a) Unemployment Benefits ndash the higher the benefit the
more it pays to stay unemployed
(b) Minimum Wages ndash this limits new low skilled entrants
into the labor force
(c) Unions ndash insiders vs outsiders Insiders already work
for a firm and have some influence over the wage rate
They act to prevent lower wages which reduces a firms
willingness to hire and train new workers
(d) Employment-at-will This doctrine allows people to be
hired and fired at any time for any reason It con-
tributes to lower levels of structural unemployment
Countries with more rigid labor markets tend to have
much higher unemployment rates
11
Figure 115 Hiring and Firing The more costly it is to do the more unem-
ployment a country experiences
12
With this kind of unemployment the number of job openings
may be equal to the number of job applicants But the available
applicants are not qualified for the available jobs
114 Cyclical Unemployment
This is unemployment due to fluctuations of GDP around its
potential When we are in a recession GDP is below potential
and people who would like to work cannot find jobs
The normal level of unemployment (structural + frictional)
is consistent with an economy that creates new jobs and destroys
old ones due mainly to progress This is called the natural rate
of unemployment
Fluctuations of the actual unemployment rate around this
natural rate is blamed on cyclical factors (business cycle) which
at least in recession represents are real opportunity cost to the
economy as a whole
Estimates of the Natural Rate and its variation
The Congressional Budget Office estimates it to be 55 Economists
from the San Francisco Fed estimated it to be 67 in early 2011
13
(Weidner and Williams 2011)
The natural rate of unemployment depends on things like
institutions (unionization unemployment benefits labor market
regulations retraining opportunities etc) and things that affect
friction like labor mobility information exchanges work ethic
and so on
The natural rate rose in the 1960s and 70s as there was a
large influx of new entrants into the labor force (first time job
seekers and women enter the LF in large numbers) It takes new
entrants longer to match up with available jobs
In the most recent recession relaxing eligibility for SNAP
extension of unemployment benefits and other programs have
increased incentives to wait for better opportunitiesndashthus in-
creasing the level of structural unemployment in the US
115 Labor Force Participation
There are numerous things that affect a countryrsquos LFP Essen-
tially itrsquos a matter of demographics and incentives See Figure
116
1 Life-Cycle effects (changing demographics) more teenagers
14
are avoiding the LF Retirement ages and preferences also
have a big impact
2 Retirement benefits ndash how these are structured and who
qualifies has a big effect on when a person decides to retire
3 Cultural changes ndash feminism divorce rates widely available
inexpensive birth control etc
4 The degree of mismatch between job seekers and employers
has widened According to Weidner and Williams (2011)
ldquo[t]he construction finance and real estate sectors have
shrunk after the bursting of the housing bubble and the sub-
sequent financial crisis The skills of workers who used to be
employed in those sectors may not be easily transferable to
growing sectors such as education and health care (see Riss-
man 2009 and Barnichon et al 2010 httpwwwfrbsf
orgpublicationseconomicspapers2010wp10-32bk
pdf) Similarly the housing bust has left millions of home-
owners underwater on their mortgages which locks them
in to their homes and may make it more difficult for them
to move to higher growth areas These sectoral and geo-
graphic mismatches between workers and job openings may
be making it harder for employers to fill vacanciesrdquo
5 Tax rates ndash high marginal tax rates discourage work item
Weidner and Williams (2011) claim that another explana-
tion for the current increase ldquoinvolves the sizable increase
15
Figure 116 Labor Force Participation Rates Seasonally Adjusted The rate
of 633 in early 2013 is the lowest since October 1978 LFPR peaked at
673 in the spring of 2000
in long-term unemployment over the past few years Work-
ers out of jobs for extended periods may experience higher
rates of unemployment owing to deterioration of skills and
weakening labor market attachmentrdquo
16
116 Model of the Labor Market
This market coordinates the supply of and demand for labor
Demand for labor comes from firms who hire labor to produce
products As the price of labor falls firms will increase employ-
ment Supply comes from households who generally increase
their willingness to seek employment as wage rates rise (as wage
offers surpass reservation wages people are drawn into the labor
force)
The price in this market is the real wage rate It is the wage
offered divided by the overall price level This is shown in Figure
117
Real Wage =Nominal Wage
Price Level
1161 Two Ways to account for unemployment
Figure 118 shows how wages above equilibrium can lead to un-
employment
Job Rationing For some reason the actual real wage is stuck
above the equilibrium wage This creates unemployment
At wH the number of people wanting to work exceeds the
17
Figure 117 Labor Market w is the equilibrium real wage rate and Em-
ployment the level of employment During a boom demand increases and
real wage rates and employment rise During recession demand falls and
real wage rates and employment fall
18
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
Figure 113 Civilian Unemployment Rate
7
Figure 114 Population Labor Force Employment and Unemployed since
1947 Notice that after the financial crisis (2007-2008) that the growth rates
of the labor force and the population begin to diverge Employment dipped
and more Americans are being lsquosupportedrsquo by fewer workers Also notice how
the number of unemployed (right-hand scale) is fairly variable rising sharply
at the beginning of recessions and falling rather slowly once they end The
rate of decline appears to be fairly constant after each recession
8
Suppose we have 6 people employed and 4 others unemployed
The unemployment rate is
4
6 + 4times 100 = 40
Now suppose one of the 4 unemployed drops out of the labor
force3
6 + 3times 100 = 33
Magically the unemployment rate drops to 33 even though
the number of people actually employed has stayed the same
If the economy canrsquot generate enough jobs then eventually
the labor force will shrink and the unemployment rate along
with it This is one reason why we look at other indicators of
the state of the labor market to guage its health
Why are people Unemployed
1 Lose your job
2 Quit your job
3 New entrant into the labor force
4 Re-enter the labor force after being out of it for a while
9
112 Frictional Unemployment
Frictional unemployment is short-term unemployment caused by
the ordinary difficulties of matching employee to employer
bull This type of unemployment is usually short in duration
bull Innovation and competition drive progress Progress cre-
ates new jobs and destroys old jobs Good restaurants dis-
place bad ones
bull This type of unemployment is due to things like changing
jobs turnover new entrants into the labor force and so on
bull A certain amount of this kind of unemployment is a good
thing For the overall health of the economy it is impor-
tant that people are constantly being matched with things
for which they are better suited and its helpful for employ-
ers to be able to replace workers with ones that fit better
Freedom of choice on supply and demand sides of the labor
market create frictional unemployment
113 Structural Unemployment
Structural unemployment persistent long-term unemployment
caused by long-lasting shocks or permanent features of an econ-
10
omy that make it more difficult for some workers to find jobs
Shocks (unexpected economic events) could be technological
due to conflict weather or other natural disasters
1 One cause is large economy-wide shocks that occur rela-
tively quickly Adjusting to these shocks can create long-
lasting unemployment as the economy takes time to restruc-
ture
2 Labor regulations can lead to structural unemployment
(a) Unemployment Benefits ndash the higher the benefit the
more it pays to stay unemployed
(b) Minimum Wages ndash this limits new low skilled entrants
into the labor force
(c) Unions ndash insiders vs outsiders Insiders already work
for a firm and have some influence over the wage rate
They act to prevent lower wages which reduces a firms
willingness to hire and train new workers
(d) Employment-at-will This doctrine allows people to be
hired and fired at any time for any reason It con-
tributes to lower levels of structural unemployment
Countries with more rigid labor markets tend to have
much higher unemployment rates
11
Figure 115 Hiring and Firing The more costly it is to do the more unem-
ployment a country experiences
12
With this kind of unemployment the number of job openings
may be equal to the number of job applicants But the available
applicants are not qualified for the available jobs
114 Cyclical Unemployment
This is unemployment due to fluctuations of GDP around its
potential When we are in a recession GDP is below potential
and people who would like to work cannot find jobs
The normal level of unemployment (structural + frictional)
is consistent with an economy that creates new jobs and destroys
old ones due mainly to progress This is called the natural rate
of unemployment
Fluctuations of the actual unemployment rate around this
natural rate is blamed on cyclical factors (business cycle) which
at least in recession represents are real opportunity cost to the
economy as a whole
Estimates of the Natural Rate and its variation
The Congressional Budget Office estimates it to be 55 Economists
from the San Francisco Fed estimated it to be 67 in early 2011
13
(Weidner and Williams 2011)
The natural rate of unemployment depends on things like
institutions (unionization unemployment benefits labor market
regulations retraining opportunities etc) and things that affect
friction like labor mobility information exchanges work ethic
and so on
The natural rate rose in the 1960s and 70s as there was a
large influx of new entrants into the labor force (first time job
seekers and women enter the LF in large numbers) It takes new
entrants longer to match up with available jobs
In the most recent recession relaxing eligibility for SNAP
extension of unemployment benefits and other programs have
increased incentives to wait for better opportunitiesndashthus in-
creasing the level of structural unemployment in the US
115 Labor Force Participation
There are numerous things that affect a countryrsquos LFP Essen-
tially itrsquos a matter of demographics and incentives See Figure
116
1 Life-Cycle effects (changing demographics) more teenagers
14
are avoiding the LF Retirement ages and preferences also
have a big impact
2 Retirement benefits ndash how these are structured and who
qualifies has a big effect on when a person decides to retire
3 Cultural changes ndash feminism divorce rates widely available
inexpensive birth control etc
4 The degree of mismatch between job seekers and employers
has widened According to Weidner and Williams (2011)
ldquo[t]he construction finance and real estate sectors have
shrunk after the bursting of the housing bubble and the sub-
sequent financial crisis The skills of workers who used to be
employed in those sectors may not be easily transferable to
growing sectors such as education and health care (see Riss-
man 2009 and Barnichon et al 2010 httpwwwfrbsf
orgpublicationseconomicspapers2010wp10-32bk
pdf) Similarly the housing bust has left millions of home-
owners underwater on their mortgages which locks them
in to their homes and may make it more difficult for them
to move to higher growth areas These sectoral and geo-
graphic mismatches between workers and job openings may
be making it harder for employers to fill vacanciesrdquo
5 Tax rates ndash high marginal tax rates discourage work item
Weidner and Williams (2011) claim that another explana-
tion for the current increase ldquoinvolves the sizable increase
15
Figure 116 Labor Force Participation Rates Seasonally Adjusted The rate
of 633 in early 2013 is the lowest since October 1978 LFPR peaked at
673 in the spring of 2000
in long-term unemployment over the past few years Work-
ers out of jobs for extended periods may experience higher
rates of unemployment owing to deterioration of skills and
weakening labor market attachmentrdquo
16
116 Model of the Labor Market
This market coordinates the supply of and demand for labor
Demand for labor comes from firms who hire labor to produce
products As the price of labor falls firms will increase employ-
ment Supply comes from households who generally increase
their willingness to seek employment as wage rates rise (as wage
offers surpass reservation wages people are drawn into the labor
force)
The price in this market is the real wage rate It is the wage
offered divided by the overall price level This is shown in Figure
117
Real Wage =Nominal Wage
Price Level
1161 Two Ways to account for unemployment
Figure 118 shows how wages above equilibrium can lead to un-
employment
Job Rationing For some reason the actual real wage is stuck
above the equilibrium wage This creates unemployment
At wH the number of people wanting to work exceeds the
17
Figure 117 Labor Market w is the equilibrium real wage rate and Em-
ployment the level of employment During a boom demand increases and
real wage rates and employment rise During recession demand falls and
real wage rates and employment fall
18
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
Figure 114 Population Labor Force Employment and Unemployed since
1947 Notice that after the financial crisis (2007-2008) that the growth rates
of the labor force and the population begin to diverge Employment dipped
and more Americans are being lsquosupportedrsquo by fewer workers Also notice how
the number of unemployed (right-hand scale) is fairly variable rising sharply
at the beginning of recessions and falling rather slowly once they end The
rate of decline appears to be fairly constant after each recession
8
Suppose we have 6 people employed and 4 others unemployed
The unemployment rate is
4
6 + 4times 100 = 40
Now suppose one of the 4 unemployed drops out of the labor
force3
6 + 3times 100 = 33
Magically the unemployment rate drops to 33 even though
the number of people actually employed has stayed the same
If the economy canrsquot generate enough jobs then eventually
the labor force will shrink and the unemployment rate along
with it This is one reason why we look at other indicators of
the state of the labor market to guage its health
Why are people Unemployed
1 Lose your job
2 Quit your job
3 New entrant into the labor force
4 Re-enter the labor force after being out of it for a while
9
112 Frictional Unemployment
Frictional unemployment is short-term unemployment caused by
the ordinary difficulties of matching employee to employer
bull This type of unemployment is usually short in duration
bull Innovation and competition drive progress Progress cre-
ates new jobs and destroys old jobs Good restaurants dis-
place bad ones
bull This type of unemployment is due to things like changing
jobs turnover new entrants into the labor force and so on
bull A certain amount of this kind of unemployment is a good
thing For the overall health of the economy it is impor-
tant that people are constantly being matched with things
for which they are better suited and its helpful for employ-
ers to be able to replace workers with ones that fit better
Freedom of choice on supply and demand sides of the labor
market create frictional unemployment
113 Structural Unemployment
Structural unemployment persistent long-term unemployment
caused by long-lasting shocks or permanent features of an econ-
10
omy that make it more difficult for some workers to find jobs
Shocks (unexpected economic events) could be technological
due to conflict weather or other natural disasters
1 One cause is large economy-wide shocks that occur rela-
tively quickly Adjusting to these shocks can create long-
lasting unemployment as the economy takes time to restruc-
ture
2 Labor regulations can lead to structural unemployment
(a) Unemployment Benefits ndash the higher the benefit the
more it pays to stay unemployed
(b) Minimum Wages ndash this limits new low skilled entrants
into the labor force
(c) Unions ndash insiders vs outsiders Insiders already work
for a firm and have some influence over the wage rate
They act to prevent lower wages which reduces a firms
willingness to hire and train new workers
(d) Employment-at-will This doctrine allows people to be
hired and fired at any time for any reason It con-
tributes to lower levels of structural unemployment
Countries with more rigid labor markets tend to have
much higher unemployment rates
11
Figure 115 Hiring and Firing The more costly it is to do the more unem-
ployment a country experiences
12
With this kind of unemployment the number of job openings
may be equal to the number of job applicants But the available
applicants are not qualified for the available jobs
114 Cyclical Unemployment
This is unemployment due to fluctuations of GDP around its
potential When we are in a recession GDP is below potential
and people who would like to work cannot find jobs
The normal level of unemployment (structural + frictional)
is consistent with an economy that creates new jobs and destroys
old ones due mainly to progress This is called the natural rate
of unemployment
Fluctuations of the actual unemployment rate around this
natural rate is blamed on cyclical factors (business cycle) which
at least in recession represents are real opportunity cost to the
economy as a whole
Estimates of the Natural Rate and its variation
The Congressional Budget Office estimates it to be 55 Economists
from the San Francisco Fed estimated it to be 67 in early 2011
13
(Weidner and Williams 2011)
The natural rate of unemployment depends on things like
institutions (unionization unemployment benefits labor market
regulations retraining opportunities etc) and things that affect
friction like labor mobility information exchanges work ethic
and so on
The natural rate rose in the 1960s and 70s as there was a
large influx of new entrants into the labor force (first time job
seekers and women enter the LF in large numbers) It takes new
entrants longer to match up with available jobs
In the most recent recession relaxing eligibility for SNAP
extension of unemployment benefits and other programs have
increased incentives to wait for better opportunitiesndashthus in-
creasing the level of structural unemployment in the US
115 Labor Force Participation
There are numerous things that affect a countryrsquos LFP Essen-
tially itrsquos a matter of demographics and incentives See Figure
116
1 Life-Cycle effects (changing demographics) more teenagers
14
are avoiding the LF Retirement ages and preferences also
have a big impact
2 Retirement benefits ndash how these are structured and who
qualifies has a big effect on when a person decides to retire
3 Cultural changes ndash feminism divorce rates widely available
inexpensive birth control etc
4 The degree of mismatch between job seekers and employers
has widened According to Weidner and Williams (2011)
ldquo[t]he construction finance and real estate sectors have
shrunk after the bursting of the housing bubble and the sub-
sequent financial crisis The skills of workers who used to be
employed in those sectors may not be easily transferable to
growing sectors such as education and health care (see Riss-
man 2009 and Barnichon et al 2010 httpwwwfrbsf
orgpublicationseconomicspapers2010wp10-32bk
pdf) Similarly the housing bust has left millions of home-
owners underwater on their mortgages which locks them
in to their homes and may make it more difficult for them
to move to higher growth areas These sectoral and geo-
graphic mismatches between workers and job openings may
be making it harder for employers to fill vacanciesrdquo
5 Tax rates ndash high marginal tax rates discourage work item
Weidner and Williams (2011) claim that another explana-
tion for the current increase ldquoinvolves the sizable increase
15
Figure 116 Labor Force Participation Rates Seasonally Adjusted The rate
of 633 in early 2013 is the lowest since October 1978 LFPR peaked at
673 in the spring of 2000
in long-term unemployment over the past few years Work-
ers out of jobs for extended periods may experience higher
rates of unemployment owing to deterioration of skills and
weakening labor market attachmentrdquo
16
116 Model of the Labor Market
This market coordinates the supply of and demand for labor
Demand for labor comes from firms who hire labor to produce
products As the price of labor falls firms will increase employ-
ment Supply comes from households who generally increase
their willingness to seek employment as wage rates rise (as wage
offers surpass reservation wages people are drawn into the labor
force)
The price in this market is the real wage rate It is the wage
offered divided by the overall price level This is shown in Figure
117
Real Wage =Nominal Wage
Price Level
1161 Two Ways to account for unemployment
Figure 118 shows how wages above equilibrium can lead to un-
employment
Job Rationing For some reason the actual real wage is stuck
above the equilibrium wage This creates unemployment
At wH the number of people wanting to work exceeds the
17
Figure 117 Labor Market w is the equilibrium real wage rate and Em-
ployment the level of employment During a boom demand increases and
real wage rates and employment rise During recession demand falls and
real wage rates and employment fall
18
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
Suppose we have 6 people employed and 4 others unemployed
The unemployment rate is
4
6 + 4times 100 = 40
Now suppose one of the 4 unemployed drops out of the labor
force3
6 + 3times 100 = 33
Magically the unemployment rate drops to 33 even though
the number of people actually employed has stayed the same
If the economy canrsquot generate enough jobs then eventually
the labor force will shrink and the unemployment rate along
with it This is one reason why we look at other indicators of
the state of the labor market to guage its health
Why are people Unemployed
1 Lose your job
2 Quit your job
3 New entrant into the labor force
4 Re-enter the labor force after being out of it for a while
9
112 Frictional Unemployment
Frictional unemployment is short-term unemployment caused by
the ordinary difficulties of matching employee to employer
bull This type of unemployment is usually short in duration
bull Innovation and competition drive progress Progress cre-
ates new jobs and destroys old jobs Good restaurants dis-
place bad ones
bull This type of unemployment is due to things like changing
jobs turnover new entrants into the labor force and so on
bull A certain amount of this kind of unemployment is a good
thing For the overall health of the economy it is impor-
tant that people are constantly being matched with things
for which they are better suited and its helpful for employ-
ers to be able to replace workers with ones that fit better
Freedom of choice on supply and demand sides of the labor
market create frictional unemployment
113 Structural Unemployment
Structural unemployment persistent long-term unemployment
caused by long-lasting shocks or permanent features of an econ-
10
omy that make it more difficult for some workers to find jobs
Shocks (unexpected economic events) could be technological
due to conflict weather or other natural disasters
1 One cause is large economy-wide shocks that occur rela-
tively quickly Adjusting to these shocks can create long-
lasting unemployment as the economy takes time to restruc-
ture
2 Labor regulations can lead to structural unemployment
(a) Unemployment Benefits ndash the higher the benefit the
more it pays to stay unemployed
(b) Minimum Wages ndash this limits new low skilled entrants
into the labor force
(c) Unions ndash insiders vs outsiders Insiders already work
for a firm and have some influence over the wage rate
They act to prevent lower wages which reduces a firms
willingness to hire and train new workers
(d) Employment-at-will This doctrine allows people to be
hired and fired at any time for any reason It con-
tributes to lower levels of structural unemployment
Countries with more rigid labor markets tend to have
much higher unemployment rates
11
Figure 115 Hiring and Firing The more costly it is to do the more unem-
ployment a country experiences
12
With this kind of unemployment the number of job openings
may be equal to the number of job applicants But the available
applicants are not qualified for the available jobs
114 Cyclical Unemployment
This is unemployment due to fluctuations of GDP around its
potential When we are in a recession GDP is below potential
and people who would like to work cannot find jobs
The normal level of unemployment (structural + frictional)
is consistent with an economy that creates new jobs and destroys
old ones due mainly to progress This is called the natural rate
of unemployment
Fluctuations of the actual unemployment rate around this
natural rate is blamed on cyclical factors (business cycle) which
at least in recession represents are real opportunity cost to the
economy as a whole
Estimates of the Natural Rate and its variation
The Congressional Budget Office estimates it to be 55 Economists
from the San Francisco Fed estimated it to be 67 in early 2011
13
(Weidner and Williams 2011)
The natural rate of unemployment depends on things like
institutions (unionization unemployment benefits labor market
regulations retraining opportunities etc) and things that affect
friction like labor mobility information exchanges work ethic
and so on
The natural rate rose in the 1960s and 70s as there was a
large influx of new entrants into the labor force (first time job
seekers and women enter the LF in large numbers) It takes new
entrants longer to match up with available jobs
In the most recent recession relaxing eligibility for SNAP
extension of unemployment benefits and other programs have
increased incentives to wait for better opportunitiesndashthus in-
creasing the level of structural unemployment in the US
115 Labor Force Participation
There are numerous things that affect a countryrsquos LFP Essen-
tially itrsquos a matter of demographics and incentives See Figure
116
1 Life-Cycle effects (changing demographics) more teenagers
14
are avoiding the LF Retirement ages and preferences also
have a big impact
2 Retirement benefits ndash how these are structured and who
qualifies has a big effect on when a person decides to retire
3 Cultural changes ndash feminism divorce rates widely available
inexpensive birth control etc
4 The degree of mismatch between job seekers and employers
has widened According to Weidner and Williams (2011)
ldquo[t]he construction finance and real estate sectors have
shrunk after the bursting of the housing bubble and the sub-
sequent financial crisis The skills of workers who used to be
employed in those sectors may not be easily transferable to
growing sectors such as education and health care (see Riss-
man 2009 and Barnichon et al 2010 httpwwwfrbsf
orgpublicationseconomicspapers2010wp10-32bk
pdf) Similarly the housing bust has left millions of home-
owners underwater on their mortgages which locks them
in to their homes and may make it more difficult for them
to move to higher growth areas These sectoral and geo-
graphic mismatches between workers and job openings may
be making it harder for employers to fill vacanciesrdquo
5 Tax rates ndash high marginal tax rates discourage work item
Weidner and Williams (2011) claim that another explana-
tion for the current increase ldquoinvolves the sizable increase
15
Figure 116 Labor Force Participation Rates Seasonally Adjusted The rate
of 633 in early 2013 is the lowest since October 1978 LFPR peaked at
673 in the spring of 2000
in long-term unemployment over the past few years Work-
ers out of jobs for extended periods may experience higher
rates of unemployment owing to deterioration of skills and
weakening labor market attachmentrdquo
16
116 Model of the Labor Market
This market coordinates the supply of and demand for labor
Demand for labor comes from firms who hire labor to produce
products As the price of labor falls firms will increase employ-
ment Supply comes from households who generally increase
their willingness to seek employment as wage rates rise (as wage
offers surpass reservation wages people are drawn into the labor
force)
The price in this market is the real wage rate It is the wage
offered divided by the overall price level This is shown in Figure
117
Real Wage =Nominal Wage
Price Level
1161 Two Ways to account for unemployment
Figure 118 shows how wages above equilibrium can lead to un-
employment
Job Rationing For some reason the actual real wage is stuck
above the equilibrium wage This creates unemployment
At wH the number of people wanting to work exceeds the
17
Figure 117 Labor Market w is the equilibrium real wage rate and Em-
ployment the level of employment During a boom demand increases and
real wage rates and employment rise During recession demand falls and
real wage rates and employment fall
18
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
112 Frictional Unemployment
Frictional unemployment is short-term unemployment caused by
the ordinary difficulties of matching employee to employer
bull This type of unemployment is usually short in duration
bull Innovation and competition drive progress Progress cre-
ates new jobs and destroys old jobs Good restaurants dis-
place bad ones
bull This type of unemployment is due to things like changing
jobs turnover new entrants into the labor force and so on
bull A certain amount of this kind of unemployment is a good
thing For the overall health of the economy it is impor-
tant that people are constantly being matched with things
for which they are better suited and its helpful for employ-
ers to be able to replace workers with ones that fit better
Freedom of choice on supply and demand sides of the labor
market create frictional unemployment
113 Structural Unemployment
Structural unemployment persistent long-term unemployment
caused by long-lasting shocks or permanent features of an econ-
10
omy that make it more difficult for some workers to find jobs
Shocks (unexpected economic events) could be technological
due to conflict weather or other natural disasters
1 One cause is large economy-wide shocks that occur rela-
tively quickly Adjusting to these shocks can create long-
lasting unemployment as the economy takes time to restruc-
ture
2 Labor regulations can lead to structural unemployment
(a) Unemployment Benefits ndash the higher the benefit the
more it pays to stay unemployed
(b) Minimum Wages ndash this limits new low skilled entrants
into the labor force
(c) Unions ndash insiders vs outsiders Insiders already work
for a firm and have some influence over the wage rate
They act to prevent lower wages which reduces a firms
willingness to hire and train new workers
(d) Employment-at-will This doctrine allows people to be
hired and fired at any time for any reason It con-
tributes to lower levels of structural unemployment
Countries with more rigid labor markets tend to have
much higher unemployment rates
11
Figure 115 Hiring and Firing The more costly it is to do the more unem-
ployment a country experiences
12
With this kind of unemployment the number of job openings
may be equal to the number of job applicants But the available
applicants are not qualified for the available jobs
114 Cyclical Unemployment
This is unemployment due to fluctuations of GDP around its
potential When we are in a recession GDP is below potential
and people who would like to work cannot find jobs
The normal level of unemployment (structural + frictional)
is consistent with an economy that creates new jobs and destroys
old ones due mainly to progress This is called the natural rate
of unemployment
Fluctuations of the actual unemployment rate around this
natural rate is blamed on cyclical factors (business cycle) which
at least in recession represents are real opportunity cost to the
economy as a whole
Estimates of the Natural Rate and its variation
The Congressional Budget Office estimates it to be 55 Economists
from the San Francisco Fed estimated it to be 67 in early 2011
13
(Weidner and Williams 2011)
The natural rate of unemployment depends on things like
institutions (unionization unemployment benefits labor market
regulations retraining opportunities etc) and things that affect
friction like labor mobility information exchanges work ethic
and so on
The natural rate rose in the 1960s and 70s as there was a
large influx of new entrants into the labor force (first time job
seekers and women enter the LF in large numbers) It takes new
entrants longer to match up with available jobs
In the most recent recession relaxing eligibility for SNAP
extension of unemployment benefits and other programs have
increased incentives to wait for better opportunitiesndashthus in-
creasing the level of structural unemployment in the US
115 Labor Force Participation
There are numerous things that affect a countryrsquos LFP Essen-
tially itrsquos a matter of demographics and incentives See Figure
116
1 Life-Cycle effects (changing demographics) more teenagers
14
are avoiding the LF Retirement ages and preferences also
have a big impact
2 Retirement benefits ndash how these are structured and who
qualifies has a big effect on when a person decides to retire
3 Cultural changes ndash feminism divorce rates widely available
inexpensive birth control etc
4 The degree of mismatch between job seekers and employers
has widened According to Weidner and Williams (2011)
ldquo[t]he construction finance and real estate sectors have
shrunk after the bursting of the housing bubble and the sub-
sequent financial crisis The skills of workers who used to be
employed in those sectors may not be easily transferable to
growing sectors such as education and health care (see Riss-
man 2009 and Barnichon et al 2010 httpwwwfrbsf
orgpublicationseconomicspapers2010wp10-32bk
pdf) Similarly the housing bust has left millions of home-
owners underwater on their mortgages which locks them
in to their homes and may make it more difficult for them
to move to higher growth areas These sectoral and geo-
graphic mismatches between workers and job openings may
be making it harder for employers to fill vacanciesrdquo
5 Tax rates ndash high marginal tax rates discourage work item
Weidner and Williams (2011) claim that another explana-
tion for the current increase ldquoinvolves the sizable increase
15
Figure 116 Labor Force Participation Rates Seasonally Adjusted The rate
of 633 in early 2013 is the lowest since October 1978 LFPR peaked at
673 in the spring of 2000
in long-term unemployment over the past few years Work-
ers out of jobs for extended periods may experience higher
rates of unemployment owing to deterioration of skills and
weakening labor market attachmentrdquo
16
116 Model of the Labor Market
This market coordinates the supply of and demand for labor
Demand for labor comes from firms who hire labor to produce
products As the price of labor falls firms will increase employ-
ment Supply comes from households who generally increase
their willingness to seek employment as wage rates rise (as wage
offers surpass reservation wages people are drawn into the labor
force)
The price in this market is the real wage rate It is the wage
offered divided by the overall price level This is shown in Figure
117
Real Wage =Nominal Wage
Price Level
1161 Two Ways to account for unemployment
Figure 118 shows how wages above equilibrium can lead to un-
employment
Job Rationing For some reason the actual real wage is stuck
above the equilibrium wage This creates unemployment
At wH the number of people wanting to work exceeds the
17
Figure 117 Labor Market w is the equilibrium real wage rate and Em-
ployment the level of employment During a boom demand increases and
real wage rates and employment rise During recession demand falls and
real wage rates and employment fall
18
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
omy that make it more difficult for some workers to find jobs
Shocks (unexpected economic events) could be technological
due to conflict weather or other natural disasters
1 One cause is large economy-wide shocks that occur rela-
tively quickly Adjusting to these shocks can create long-
lasting unemployment as the economy takes time to restruc-
ture
2 Labor regulations can lead to structural unemployment
(a) Unemployment Benefits ndash the higher the benefit the
more it pays to stay unemployed
(b) Minimum Wages ndash this limits new low skilled entrants
into the labor force
(c) Unions ndash insiders vs outsiders Insiders already work
for a firm and have some influence over the wage rate
They act to prevent lower wages which reduces a firms
willingness to hire and train new workers
(d) Employment-at-will This doctrine allows people to be
hired and fired at any time for any reason It con-
tributes to lower levels of structural unemployment
Countries with more rigid labor markets tend to have
much higher unemployment rates
11
Figure 115 Hiring and Firing The more costly it is to do the more unem-
ployment a country experiences
12
With this kind of unemployment the number of job openings
may be equal to the number of job applicants But the available
applicants are not qualified for the available jobs
114 Cyclical Unemployment
This is unemployment due to fluctuations of GDP around its
potential When we are in a recession GDP is below potential
and people who would like to work cannot find jobs
The normal level of unemployment (structural + frictional)
is consistent with an economy that creates new jobs and destroys
old ones due mainly to progress This is called the natural rate
of unemployment
Fluctuations of the actual unemployment rate around this
natural rate is blamed on cyclical factors (business cycle) which
at least in recession represents are real opportunity cost to the
economy as a whole
Estimates of the Natural Rate and its variation
The Congressional Budget Office estimates it to be 55 Economists
from the San Francisco Fed estimated it to be 67 in early 2011
13
(Weidner and Williams 2011)
The natural rate of unemployment depends on things like
institutions (unionization unemployment benefits labor market
regulations retraining opportunities etc) and things that affect
friction like labor mobility information exchanges work ethic
and so on
The natural rate rose in the 1960s and 70s as there was a
large influx of new entrants into the labor force (first time job
seekers and women enter the LF in large numbers) It takes new
entrants longer to match up with available jobs
In the most recent recession relaxing eligibility for SNAP
extension of unemployment benefits and other programs have
increased incentives to wait for better opportunitiesndashthus in-
creasing the level of structural unemployment in the US
115 Labor Force Participation
There are numerous things that affect a countryrsquos LFP Essen-
tially itrsquos a matter of demographics and incentives See Figure
116
1 Life-Cycle effects (changing demographics) more teenagers
14
are avoiding the LF Retirement ages and preferences also
have a big impact
2 Retirement benefits ndash how these are structured and who
qualifies has a big effect on when a person decides to retire
3 Cultural changes ndash feminism divorce rates widely available
inexpensive birth control etc
4 The degree of mismatch between job seekers and employers
has widened According to Weidner and Williams (2011)
ldquo[t]he construction finance and real estate sectors have
shrunk after the bursting of the housing bubble and the sub-
sequent financial crisis The skills of workers who used to be
employed in those sectors may not be easily transferable to
growing sectors such as education and health care (see Riss-
man 2009 and Barnichon et al 2010 httpwwwfrbsf
orgpublicationseconomicspapers2010wp10-32bk
pdf) Similarly the housing bust has left millions of home-
owners underwater on their mortgages which locks them
in to their homes and may make it more difficult for them
to move to higher growth areas These sectoral and geo-
graphic mismatches between workers and job openings may
be making it harder for employers to fill vacanciesrdquo
5 Tax rates ndash high marginal tax rates discourage work item
Weidner and Williams (2011) claim that another explana-
tion for the current increase ldquoinvolves the sizable increase
15
Figure 116 Labor Force Participation Rates Seasonally Adjusted The rate
of 633 in early 2013 is the lowest since October 1978 LFPR peaked at
673 in the spring of 2000
in long-term unemployment over the past few years Work-
ers out of jobs for extended periods may experience higher
rates of unemployment owing to deterioration of skills and
weakening labor market attachmentrdquo
16
116 Model of the Labor Market
This market coordinates the supply of and demand for labor
Demand for labor comes from firms who hire labor to produce
products As the price of labor falls firms will increase employ-
ment Supply comes from households who generally increase
their willingness to seek employment as wage rates rise (as wage
offers surpass reservation wages people are drawn into the labor
force)
The price in this market is the real wage rate It is the wage
offered divided by the overall price level This is shown in Figure
117
Real Wage =Nominal Wage
Price Level
1161 Two Ways to account for unemployment
Figure 118 shows how wages above equilibrium can lead to un-
employment
Job Rationing For some reason the actual real wage is stuck
above the equilibrium wage This creates unemployment
At wH the number of people wanting to work exceeds the
17
Figure 117 Labor Market w is the equilibrium real wage rate and Em-
ployment the level of employment During a boom demand increases and
real wage rates and employment rise During recession demand falls and
real wage rates and employment fall
18
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
Figure 115 Hiring and Firing The more costly it is to do the more unem-
ployment a country experiences
12
With this kind of unemployment the number of job openings
may be equal to the number of job applicants But the available
applicants are not qualified for the available jobs
114 Cyclical Unemployment
This is unemployment due to fluctuations of GDP around its
potential When we are in a recession GDP is below potential
and people who would like to work cannot find jobs
The normal level of unemployment (structural + frictional)
is consistent with an economy that creates new jobs and destroys
old ones due mainly to progress This is called the natural rate
of unemployment
Fluctuations of the actual unemployment rate around this
natural rate is blamed on cyclical factors (business cycle) which
at least in recession represents are real opportunity cost to the
economy as a whole
Estimates of the Natural Rate and its variation
The Congressional Budget Office estimates it to be 55 Economists
from the San Francisco Fed estimated it to be 67 in early 2011
13
(Weidner and Williams 2011)
The natural rate of unemployment depends on things like
institutions (unionization unemployment benefits labor market
regulations retraining opportunities etc) and things that affect
friction like labor mobility information exchanges work ethic
and so on
The natural rate rose in the 1960s and 70s as there was a
large influx of new entrants into the labor force (first time job
seekers and women enter the LF in large numbers) It takes new
entrants longer to match up with available jobs
In the most recent recession relaxing eligibility for SNAP
extension of unemployment benefits and other programs have
increased incentives to wait for better opportunitiesndashthus in-
creasing the level of structural unemployment in the US
115 Labor Force Participation
There are numerous things that affect a countryrsquos LFP Essen-
tially itrsquos a matter of demographics and incentives See Figure
116
1 Life-Cycle effects (changing demographics) more teenagers
14
are avoiding the LF Retirement ages and preferences also
have a big impact
2 Retirement benefits ndash how these are structured and who
qualifies has a big effect on when a person decides to retire
3 Cultural changes ndash feminism divorce rates widely available
inexpensive birth control etc
4 The degree of mismatch between job seekers and employers
has widened According to Weidner and Williams (2011)
ldquo[t]he construction finance and real estate sectors have
shrunk after the bursting of the housing bubble and the sub-
sequent financial crisis The skills of workers who used to be
employed in those sectors may not be easily transferable to
growing sectors such as education and health care (see Riss-
man 2009 and Barnichon et al 2010 httpwwwfrbsf
orgpublicationseconomicspapers2010wp10-32bk
pdf) Similarly the housing bust has left millions of home-
owners underwater on their mortgages which locks them
in to their homes and may make it more difficult for them
to move to higher growth areas These sectoral and geo-
graphic mismatches between workers and job openings may
be making it harder for employers to fill vacanciesrdquo
5 Tax rates ndash high marginal tax rates discourage work item
Weidner and Williams (2011) claim that another explana-
tion for the current increase ldquoinvolves the sizable increase
15
Figure 116 Labor Force Participation Rates Seasonally Adjusted The rate
of 633 in early 2013 is the lowest since October 1978 LFPR peaked at
673 in the spring of 2000
in long-term unemployment over the past few years Work-
ers out of jobs for extended periods may experience higher
rates of unemployment owing to deterioration of skills and
weakening labor market attachmentrdquo
16
116 Model of the Labor Market
This market coordinates the supply of and demand for labor
Demand for labor comes from firms who hire labor to produce
products As the price of labor falls firms will increase employ-
ment Supply comes from households who generally increase
their willingness to seek employment as wage rates rise (as wage
offers surpass reservation wages people are drawn into the labor
force)
The price in this market is the real wage rate It is the wage
offered divided by the overall price level This is shown in Figure
117
Real Wage =Nominal Wage
Price Level
1161 Two Ways to account for unemployment
Figure 118 shows how wages above equilibrium can lead to un-
employment
Job Rationing For some reason the actual real wage is stuck
above the equilibrium wage This creates unemployment
At wH the number of people wanting to work exceeds the
17
Figure 117 Labor Market w is the equilibrium real wage rate and Em-
ployment the level of employment During a boom demand increases and
real wage rates and employment rise During recession demand falls and
real wage rates and employment fall
18
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
With this kind of unemployment the number of job openings
may be equal to the number of job applicants But the available
applicants are not qualified for the available jobs
114 Cyclical Unemployment
This is unemployment due to fluctuations of GDP around its
potential When we are in a recession GDP is below potential
and people who would like to work cannot find jobs
The normal level of unemployment (structural + frictional)
is consistent with an economy that creates new jobs and destroys
old ones due mainly to progress This is called the natural rate
of unemployment
Fluctuations of the actual unemployment rate around this
natural rate is blamed on cyclical factors (business cycle) which
at least in recession represents are real opportunity cost to the
economy as a whole
Estimates of the Natural Rate and its variation
The Congressional Budget Office estimates it to be 55 Economists
from the San Francisco Fed estimated it to be 67 in early 2011
13
(Weidner and Williams 2011)
The natural rate of unemployment depends on things like
institutions (unionization unemployment benefits labor market
regulations retraining opportunities etc) and things that affect
friction like labor mobility information exchanges work ethic
and so on
The natural rate rose in the 1960s and 70s as there was a
large influx of new entrants into the labor force (first time job
seekers and women enter the LF in large numbers) It takes new
entrants longer to match up with available jobs
In the most recent recession relaxing eligibility for SNAP
extension of unemployment benefits and other programs have
increased incentives to wait for better opportunitiesndashthus in-
creasing the level of structural unemployment in the US
115 Labor Force Participation
There are numerous things that affect a countryrsquos LFP Essen-
tially itrsquos a matter of demographics and incentives See Figure
116
1 Life-Cycle effects (changing demographics) more teenagers
14
are avoiding the LF Retirement ages and preferences also
have a big impact
2 Retirement benefits ndash how these are structured and who
qualifies has a big effect on when a person decides to retire
3 Cultural changes ndash feminism divorce rates widely available
inexpensive birth control etc
4 The degree of mismatch between job seekers and employers
has widened According to Weidner and Williams (2011)
ldquo[t]he construction finance and real estate sectors have
shrunk after the bursting of the housing bubble and the sub-
sequent financial crisis The skills of workers who used to be
employed in those sectors may not be easily transferable to
growing sectors such as education and health care (see Riss-
man 2009 and Barnichon et al 2010 httpwwwfrbsf
orgpublicationseconomicspapers2010wp10-32bk
pdf) Similarly the housing bust has left millions of home-
owners underwater on their mortgages which locks them
in to their homes and may make it more difficult for them
to move to higher growth areas These sectoral and geo-
graphic mismatches between workers and job openings may
be making it harder for employers to fill vacanciesrdquo
5 Tax rates ndash high marginal tax rates discourage work item
Weidner and Williams (2011) claim that another explana-
tion for the current increase ldquoinvolves the sizable increase
15
Figure 116 Labor Force Participation Rates Seasonally Adjusted The rate
of 633 in early 2013 is the lowest since October 1978 LFPR peaked at
673 in the spring of 2000
in long-term unemployment over the past few years Work-
ers out of jobs for extended periods may experience higher
rates of unemployment owing to deterioration of skills and
weakening labor market attachmentrdquo
16
116 Model of the Labor Market
This market coordinates the supply of and demand for labor
Demand for labor comes from firms who hire labor to produce
products As the price of labor falls firms will increase employ-
ment Supply comes from households who generally increase
their willingness to seek employment as wage rates rise (as wage
offers surpass reservation wages people are drawn into the labor
force)
The price in this market is the real wage rate It is the wage
offered divided by the overall price level This is shown in Figure
117
Real Wage =Nominal Wage
Price Level
1161 Two Ways to account for unemployment
Figure 118 shows how wages above equilibrium can lead to un-
employment
Job Rationing For some reason the actual real wage is stuck
above the equilibrium wage This creates unemployment
At wH the number of people wanting to work exceeds the
17
Figure 117 Labor Market w is the equilibrium real wage rate and Em-
ployment the level of employment During a boom demand increases and
real wage rates and employment rise During recession demand falls and
real wage rates and employment fall
18
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
(Weidner and Williams 2011)
The natural rate of unemployment depends on things like
institutions (unionization unemployment benefits labor market
regulations retraining opportunities etc) and things that affect
friction like labor mobility information exchanges work ethic
and so on
The natural rate rose in the 1960s and 70s as there was a
large influx of new entrants into the labor force (first time job
seekers and women enter the LF in large numbers) It takes new
entrants longer to match up with available jobs
In the most recent recession relaxing eligibility for SNAP
extension of unemployment benefits and other programs have
increased incentives to wait for better opportunitiesndashthus in-
creasing the level of structural unemployment in the US
115 Labor Force Participation
There are numerous things that affect a countryrsquos LFP Essen-
tially itrsquos a matter of demographics and incentives See Figure
116
1 Life-Cycle effects (changing demographics) more teenagers
14
are avoiding the LF Retirement ages and preferences also
have a big impact
2 Retirement benefits ndash how these are structured and who
qualifies has a big effect on when a person decides to retire
3 Cultural changes ndash feminism divorce rates widely available
inexpensive birth control etc
4 The degree of mismatch between job seekers and employers
has widened According to Weidner and Williams (2011)
ldquo[t]he construction finance and real estate sectors have
shrunk after the bursting of the housing bubble and the sub-
sequent financial crisis The skills of workers who used to be
employed in those sectors may not be easily transferable to
growing sectors such as education and health care (see Riss-
man 2009 and Barnichon et al 2010 httpwwwfrbsf
orgpublicationseconomicspapers2010wp10-32bk
pdf) Similarly the housing bust has left millions of home-
owners underwater on their mortgages which locks them
in to their homes and may make it more difficult for them
to move to higher growth areas These sectoral and geo-
graphic mismatches between workers and job openings may
be making it harder for employers to fill vacanciesrdquo
5 Tax rates ndash high marginal tax rates discourage work item
Weidner and Williams (2011) claim that another explana-
tion for the current increase ldquoinvolves the sizable increase
15
Figure 116 Labor Force Participation Rates Seasonally Adjusted The rate
of 633 in early 2013 is the lowest since October 1978 LFPR peaked at
673 in the spring of 2000
in long-term unemployment over the past few years Work-
ers out of jobs for extended periods may experience higher
rates of unemployment owing to deterioration of skills and
weakening labor market attachmentrdquo
16
116 Model of the Labor Market
This market coordinates the supply of and demand for labor
Demand for labor comes from firms who hire labor to produce
products As the price of labor falls firms will increase employ-
ment Supply comes from households who generally increase
their willingness to seek employment as wage rates rise (as wage
offers surpass reservation wages people are drawn into the labor
force)
The price in this market is the real wage rate It is the wage
offered divided by the overall price level This is shown in Figure
117
Real Wage =Nominal Wage
Price Level
1161 Two Ways to account for unemployment
Figure 118 shows how wages above equilibrium can lead to un-
employment
Job Rationing For some reason the actual real wage is stuck
above the equilibrium wage This creates unemployment
At wH the number of people wanting to work exceeds the
17
Figure 117 Labor Market w is the equilibrium real wage rate and Em-
ployment the level of employment During a boom demand increases and
real wage rates and employment rise During recession demand falls and
real wage rates and employment fall
18
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
are avoiding the LF Retirement ages and preferences also
have a big impact
2 Retirement benefits ndash how these are structured and who
qualifies has a big effect on when a person decides to retire
3 Cultural changes ndash feminism divorce rates widely available
inexpensive birth control etc
4 The degree of mismatch between job seekers and employers
has widened According to Weidner and Williams (2011)
ldquo[t]he construction finance and real estate sectors have
shrunk after the bursting of the housing bubble and the sub-
sequent financial crisis The skills of workers who used to be
employed in those sectors may not be easily transferable to
growing sectors such as education and health care (see Riss-
man 2009 and Barnichon et al 2010 httpwwwfrbsf
orgpublicationseconomicspapers2010wp10-32bk
pdf) Similarly the housing bust has left millions of home-
owners underwater on their mortgages which locks them
in to their homes and may make it more difficult for them
to move to higher growth areas These sectoral and geo-
graphic mismatches between workers and job openings may
be making it harder for employers to fill vacanciesrdquo
5 Tax rates ndash high marginal tax rates discourage work item
Weidner and Williams (2011) claim that another explana-
tion for the current increase ldquoinvolves the sizable increase
15
Figure 116 Labor Force Participation Rates Seasonally Adjusted The rate
of 633 in early 2013 is the lowest since October 1978 LFPR peaked at
673 in the spring of 2000
in long-term unemployment over the past few years Work-
ers out of jobs for extended periods may experience higher
rates of unemployment owing to deterioration of skills and
weakening labor market attachmentrdquo
16
116 Model of the Labor Market
This market coordinates the supply of and demand for labor
Demand for labor comes from firms who hire labor to produce
products As the price of labor falls firms will increase employ-
ment Supply comes from households who generally increase
their willingness to seek employment as wage rates rise (as wage
offers surpass reservation wages people are drawn into the labor
force)
The price in this market is the real wage rate It is the wage
offered divided by the overall price level This is shown in Figure
117
Real Wage =Nominal Wage
Price Level
1161 Two Ways to account for unemployment
Figure 118 shows how wages above equilibrium can lead to un-
employment
Job Rationing For some reason the actual real wage is stuck
above the equilibrium wage This creates unemployment
At wH the number of people wanting to work exceeds the
17
Figure 117 Labor Market w is the equilibrium real wage rate and Em-
ployment the level of employment During a boom demand increases and
real wage rates and employment rise During recession demand falls and
real wage rates and employment fall
18
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
Figure 116 Labor Force Participation Rates Seasonally Adjusted The rate
of 633 in early 2013 is the lowest since October 1978 LFPR peaked at
673 in the spring of 2000
in long-term unemployment over the past few years Work-
ers out of jobs for extended periods may experience higher
rates of unemployment owing to deterioration of skills and
weakening labor market attachmentrdquo
16
116 Model of the Labor Market
This market coordinates the supply of and demand for labor
Demand for labor comes from firms who hire labor to produce
products As the price of labor falls firms will increase employ-
ment Supply comes from households who generally increase
their willingness to seek employment as wage rates rise (as wage
offers surpass reservation wages people are drawn into the labor
force)
The price in this market is the real wage rate It is the wage
offered divided by the overall price level This is shown in Figure
117
Real Wage =Nominal Wage
Price Level
1161 Two Ways to account for unemployment
Figure 118 shows how wages above equilibrium can lead to un-
employment
Job Rationing For some reason the actual real wage is stuck
above the equilibrium wage This creates unemployment
At wH the number of people wanting to work exceeds the
17
Figure 117 Labor Market w is the equilibrium real wage rate and Em-
ployment the level of employment During a boom demand increases and
real wage rates and employment rise During recession demand falls and
real wage rates and employment fall
18
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
116 Model of the Labor Market
This market coordinates the supply of and demand for labor
Demand for labor comes from firms who hire labor to produce
products As the price of labor falls firms will increase employ-
ment Supply comes from households who generally increase
their willingness to seek employment as wage rates rise (as wage
offers surpass reservation wages people are drawn into the labor
force)
The price in this market is the real wage rate It is the wage
offered divided by the overall price level This is shown in Figure
117
Real Wage =Nominal Wage
Price Level
1161 Two Ways to account for unemployment
Figure 118 shows how wages above equilibrium can lead to un-
employment
Job Rationing For some reason the actual real wage is stuck
above the equilibrium wage This creates unemployment
At wH the number of people wanting to work exceeds the
17
Figure 117 Labor Market w is the equilibrium real wage rate and Em-
ployment the level of employment During a boom demand increases and
real wage rates and employment rise During recession demand falls and
real wage rates and employment fall
18
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
Figure 117 Labor Market w is the equilibrium real wage rate and Em-
ployment the level of employment During a boom demand increases and
real wage rates and employment rise During recession demand falls and
real wage rates and employment fall
18
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
Figure 118 Labor Market wh is above the equilibrium real wage rate
creating unemployment There are 3 reasons why this might happen
available number of jobs Firms get to choose who to hire
hence they are rationing jobs
1 Minimum Wages ndash firms are leagally prohibited from
offering lower wages This tends to inhibit new entry
into the labor forcendashand why youths in certain areas
have very high unemployment rates
2 Insiders vs Outsiders ndash insiders already work for the
19
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
firm and have some influence over the wage rate They
act to prevent the wage from falling to its equilibrium
(labor unions for example) Outsiders would be willing
to fill these jobs if allowed for lower pay
3 Efficieny Wage ndash Firms pay above the equilibrium wage
as an incentive to reduce turnover (which can be expen-
sive especially if the workers need training) Henry
Ford offered his workers twice the going rate to work
the assembly line This discouraged turnover and en-
couraged more conscientious workers to come to work
every day
Job Search In this view the market is never quite in equi-
librium Constant changes in entry job availability and
creative destruction keep the market from achieving equi-
librium When this happens people will tend to hold out
for higher paying jobs rather than accept the first lower
paying job offer that comes along Hence w tends to get
stuck above the equilibrium wage
20
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-
Bibliography
Cowen Tyler and Alex Tabarrok (2011) Modern Principles of
Economics 2nd edn Worth New York
Weidner Justin and John C Williams (2011) lsquoWhat is the
new normal unemployment ratersquo FRBSF Economic Letter
2011-05
URL httpwwwfrbsforgeconomic-
researchpublicationseconomic-letter2012decembernew-
normal-unemployment-rateel2011-05pdf
21
- Unemployment and Labor Force Participation
-
- Defining Unemployment
- Frictional Unemployment
- Structural Unemployment
- Cyclical Unemployment
- Labor Force Participation
- Model of the Labor Market
-
- Two Ways to account for unemployment
-