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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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