unemployment chapter 7. 2 introduction keynes first challenged the orthodox view that the economic...
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Unemployment
Chapter 7
2
Introduction
• Keynes first challenged the orthodox view that the economic system tends to return quickly to full-employment equilibrium during the Great Depression.
• We will study a model that incorporates elements from modern unemployment theories into a framework similar to that of the classical theory.
3
Explaining Unemployment
• Two dimensions:
1. Why there is any unemployment at all?
2. Why does unemployment move in a systematic way with other business cycle variables?
4
Frictional Unemployment
• The classical economists recognized that equality of demand and supply in the labor market does not imply the absence of unemployment.
• Labor turnover Frictional unemployment
5Figure 7.1
Flows Through the Labor Market
6
Cyclical Unemployment
• The increased unemployment that occurs during a recession is called cyclical unemployment.
• Keynesian : The economy does not respond to shocks as efficiently as it should. ( Nominal Rigidity)
• We will amend the classical model by allowing firms to choose the wage to describe unemployment as an equilibrium phenomenon.
7
Efficiency Wage Theory
• Firms choose to pay higher wage than the classical equilibrium wage to minimize the turnover costs.
• Three strands:1. High wage may ensure the productivity of its
workers.2. Higher wages will attract high-quality
applicants.3. Firms use the wage as a device to minimize
turnover costs.
8
The New-Keynesian Theory
• The firm explicitly recognizes its pool of workers as a stock and any given stock of workers can be associated with fast or slow labor turnover.
• The firm minimizes the costs of maintaining a stock of employed workers by adjusting the real wage.
9
The New-Keynesian Theory
• The stock of workers sent to the labor market by households is called the labor force.
- Increasing function to the real wage.
• The stock of workers employed by the firm is called employment.
- Decreasing function of real wage.
10Figure 7.2
The New-Keynesian Model of the Labor Market
11
Turnover Cost and Efficiency Wage
• In the new-Keynesian model, the firm must devote resources to the search process.
• The firm chooses its wage to minimize its wage bill:
- The wage paid to each worker.
- The cost of recruiting new workers, C(w/P, L).
12
Turnover Cost and Efficiency Wage
• We study a special case of a turnover cost function:
• In this case, turnover costs are proportional to the number of workers and the firm’s problem can be broken into two part:
1. Choose the efficiency wage to minimize cost per-worker.
2. Given the efficiency wage, choose L to maximize profit.
( / , ) ( / )C w P L c w P L
13
Firm’s Problem
( )
w wY L c L
P P
w wF L L c L
P P
1. 0
2. 0
ww PP
LL
14
Choosing the Efficiency Wage
• Marginal cost (1) = Marginal benefit (c’(w/P) )
1 ' 0.
1 ' .
wc
w PP
w wc
P P
15
The New-Keynesian Model of the FirmPanel A
16
Choosing a Stock of Workers
• Marginal Product = Marginal Cost
'( ) 0.
'( )
w wF L c
L P P
w wF L c L
P P
17
The New-Keynesian Model of the FirmPanel B
18
©2002 South-Western College Publishing
Figure 7.4
Demand and Supply in the New-Keynesian Model of the Labor Market
19
A Mathematical Example
• Production Function:
• Per-worker turnover cost:
• Labor supply:
2( / ) 1 2( / ) ( / )c w p w P w P
2(1/ 2)D DY L L
/SL w P
/ 1/ 2, 1/ 4.w P U
20
Unemployment and Economic Policy
• Two approaches:
1. Policies designed to control the natural rate are called structural policy and unemployment that results from poorly designed labor-market institutions is called structural unemployment.
2. The second deals with the control of cyclical unemployment as it fluctuates over the business cycle. (Chapter 8)
21©2002 South-Western College Publishing
Table 7.1
22
Unemployment and Economic Policy
• Possible reason:
Low-skill labor and labor market rigidity.
• Some economists have advocated reforms to make labor markets more flexible.
23
Homework
Question 1, 8, 10, 11
END