Unemployment, job creation and job destruction

Chapter 3

Chapter topics

• Measuring unemployment

• Labor market dynamics

• The natural rate of unemployment

• US and European experience

• Unemployment over the business cycle

• Applying supply and demand to the labor market

Measuring unemployment• Labor force is the number of people aged

16 and over who are either working or unemployed

• Unemployed: those looking for employment during the week but who did not work

• Labor force participation rate: ratio of labor force to population

• Natural rate of unemployment is the rate of unemployment when the economy is in equilibrium

Unemployment in the Long Run

• 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.

Unemployment in the U.S.

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1955 1960 1965 1970 1975 1980 1985 1990 1995 2000

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Unemployment rate Natural rate of unemployment

Dynamics of the labor market

• Economy is characterized by large flows in and out of employment. Flows are about equal at three million or about 3% every month.

• Population over 16:– In the labor force, employed or unemployed– Out of the labor force

The natural rate

• L = labor force• U = unemployed• l = job losing rate = losses/L• f =job-finding rate = finds/U• u =unemployment rate = U/L• In equilibrium, losses=finds or l=uf• That is u=l/f, the unemployment rate is the

ratio of the loss rate to the find rate.

Flows into unemployment

• Job destruction

• Job loss without distraction

• Personal transitions

Flows out of unemployment

• Two thirds success in finding a job

• One third leave the labor force

• Finding rate is a crucial factor and is affected by– Efficiency wages– Union wage premiums – Minimum wages– Unemployment insurance

Minimum Wage

• The minimum wage is well below the eq’m wage for most workers, so it cannot explain the majority of natural rate unemployment.

• However, the minimum wage may exceed the eq’m wage of unskilled workers, especially teenagers.

• If so, then we would expect that increases in the minimum wage would increase unemployment among these groups.

Labor Unions

• Unions exercise monopoly power to secure higher wages for their members.

• When the union wage exceeds the eq’m wage, unemployment results.

• Employed union workers are insiders whose interest is to keep wages high.

• Unemployed non-union workers are outsiders and would prefer wages to be lower (so that labor demand would be high enough for them to get jobs).

Efficiency Wages

• Theories in which high wages increase worker productivity: – attract higher quality job applicants

– increase worker effort and reduce “shirking”

– reduce turnover, which is costly

• The increased productivity justifies the cost of paying above-equilibrium wages.

• The result: unemployment

Example

• One percent of the employed lose jobs every month while 20% of the unemployed find jobs.

• Then, the unemployment rate is– U/L = .01/(.01+.2) = .0476. – Or about 5%

• Why is the equilibrium unemployment rate positive? Why is f not equal to 1?

Frictional Unemployment

• Workers are not interchangeable parts. Skills and preferences vary as do job requirements. Takes time to match the individual and the job.

• Changes in the composition of demand (sectoral shift), firm failure, poor job performance, desire for career change all contribute to frictional unemployment.

Policy Issues

• Reduce duration of job search through – provision of information to workers and firms– job training programs

• Unemployment insurance helps improve the working of the labor market by facilitating better job search but it does increase the duration of job.

Structural Unemployment

• Structural unemployment results from wage rigidity and job rationing.

• Sources of wage rigidity:– Minimum wage laws– Unions and collective bargaining– Efficiency wages

• Market does not clear because wage is above the equilibrium level

Okun’s Law

• An empirical relationship between departures of GDP from its potential and the unemployment from its natural rate.

S-D and Unemployment

Fig. 3.4

Fig. 3.5