macro session 8

7/27/2019 Macro Session 8

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Macroeconomics & The globaleconomy

Ace Institute of Management

Session 8: Unemployment

InstructorRijan Dhakal

[email protected]

9851069004
mailto:[email protected]:[email protected]


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Unemployment- Major

Macroeconomic Issue

Major concern for all government

Develop policies to curb unemployment

or increase employment rate.

However


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U.S. Unemployment, 1958-2002

2

3

4

5

6

7

8

9

10

11

1955 1960 1965 1970 1975 1980 1985 1990 1995 2000

Percentoflaborforce

Unemployment rate Natural rate of unemployment

What determines the natural rate of unemployment?


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Natural Rate of Unemployment

Natural rate of unemployment:the average rate of unemployment around which

the economy fluctuates.

In a recession, the actual unemployment rate rises

above the natural rate.

In a boom, the actual unemployment rate falls

below the natural rate.


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A first model of the natural rate

Notation:

L = # of workers in labor force

E= # of employed workers

U= # of unemployed

U/L = unemployment rate

L = E+U orE = L U orU = L - E


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Assumptions:

1. L is exogenously fixed.2. During any given month,

s = fraction of employed workers

that become separated from their jobs,

f= fraction of unemployed workers

that find jobs.

s= rate of job separations

f = rate of job finding

(both exogenous)


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The steady state condition

Definition: the labor market is insteady state, or long-run equilibrium,

if the unemployment rate is constant.

The steady-state condition is:

sE = fU

# of employedpeople who lose orleave their jobs

# of unemployedpeople who find jobs


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Solving for the equilibrium U rate

f

U = s

E

=s(LU)

=sL sU

f xU+ sU = sL

or, (f + s)U = sL

so,

U s

L s f

Or,


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Example:

Each month, 1% of employed workerslose their jobs (s = 0.01)

Each month, 19% of unemployed workersfind jobs (f= 0.19)

Find the natural rate of unemployment:

0.010.05, or 5%

0.01 0.19

U s

L s f


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Policy implication

A policy that aims to reduce the naturalrate of unemployment will succeed only if

it lowers s or increasesf.


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Why is there unemployment?

There are two reasons:

1. Job search

2. Wage rigidity


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Job Search & Frictional Unemployment

frictional unemployment: caused by the time ittakes workers to search for a job

occurs even when wages are flexible and there areenough jobs to go around

occurs because workers have different abilities, preferences

jobs have different skill requirements

geographic mobility of workers not

instantaneous

flow of information about vacancies and jobcandidates is imperfect


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Sectoral shifts def: changes in the composition of demand among

industries or regions

example: Technological change

increases demand for computer repair persons,

decreases demand for typewriter repair persons

example: A new international trade agreement

causes greater demand for workers in the export

sectors and less demand for workers in import-

competing sectors.

It takes time for workers to change sectors,

so sectoral shifts cause frictional unemployment.


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Public Policy and Job Search

Govt programs affecting unemployment

Govt employment agencies:

disseminate info about job openings to better match

workers & jobs

Public job training programs:

help workers displaced from declining industries get

skills needed for jobs in growing industries


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Unemployment insurance (UI)

UI pays part of a workers former wages for a limitedtime after losing his/her job.

UI increases search unemployment, because it:

reduces the opportunity cost of being

unemployed

reduces the urgency of finding work

hence, reducesf

Studies: The longer a worker is eligible for UI,

the longer the duration of the average spell of

unemployment.


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Why is there unemployment?

There are two reasons:1. job search

2. wage rigidity

The natural rate of unemployment:U s

L s f

DONE Next


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Unemployment from real wage rigidity

Labor

Realwage

Supply

Demand

Unemployment

Rigidrealwage

Amount of laborwilling to work

Amount oflabor hired

If the realwage is stuckabove the eqmlevel, thenthere arentenough jobs togo around.

Structural

unemployment:

the unemployment

resulting from real

wage rigidity


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Reasons for wage rigidity

1. Minimum wage laws

2. Labor unions

3. Efficiency wages (employers offer high wage asincentive for worker productivity and loyalty)


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The minimum wage : US Case Study

In Sept 1996, the minimum wage was raised

from $4.25 to $4.75. Heres what happened:

Unemployment rates, before & after

3

rd

Q 1996 1

st

Q 1997Teenagers 16.6% 17.0%

Singlemothers

8.5% 9.1%

All workers 5.3% 5.3%

Other studies: A 10% increase in the minimum

wage increases teenage unemployment by 1-3%.


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Wage Inflation and Unemployment

In 1958, economist A W Philips, through empirical study of

Britains economy, concluded that there exists inverserelationship between wage Inflation and Unemployment

It shows the trade-off between wage inflation andunemployment.

Logic:

1. When Labour demand is high, most of the labour get

employed and labour market is in shortage of labour.

2. Labour unions find opportunities to bargain with

employers or they have high bargaining power for

increasing wage rates faster.

3. So, Lower the unemployment rate, higher the wage rate.


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Relationship Between Inflation and

Unemployment

1. Faster increase in wage rates will result in

faster increase in disposable income of the

labour causing higher increase in price level

or inflation.

2. Conclusion: Higher the employment rate or

Lower the Unemployment rate, higher the

inflation rate.


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The Phillips Curve

The Phillips curve shows the relationship between the

inflation rate and the unemployment rate.

This macroeconomic

relationship has been

widely studied.

It shows that there is a

trade-off between inflation

and unemployment. To

lower the inflation rate, we

must accept a higher

unemployment rate.


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Unemployment and Growth

In 1960s, Arthur Okun, through empirical study,concluded that there exists inverse relationshipbetween unemployment and economic growth

He concluded that one percent decrease in

unemployment will increase the output by 2.5percent in the short run.

This law is known as Okuns Law

This relation can be used to deduce inflationarypressure curve, which along with Phillips curvegives the short run rate of inflation andunemployment


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Criticism of Phillip Curve-Non Trade off

Milton Friedman:

Downward sloping Phillips curve is found inthe short run and in the long run Phillipscurve becomes vertical line

In the long run, Phillips curve shifts constantly dueto improvement in economic situations (such aslabour market reform, labour wanting stability,increased competition in labour market etc. )

Regardless of the rate of inflation, there is onlyone rate of unemployment in the long run, that isnatural rate


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Criticism of Phillip Curve-Non Trade off

A

B C

Inflation Rate

Unemployment RateInitial SR Phillips Curve

New SR Phillips Curve

For further info: Macroeconomic Analysis, Edward Shapiro

Macroeconomics, Theory and Policy, D.N. Dwivedi


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Thank You

macro session 8

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