Chapter 6: Unemployment

Topical Outline and Key Points

1. Unemployment and the “misery index”

a. Is there a trade-off?

b. What is the natural rate of unemployment?

2. Job loss, Job finding, and the natural rate of unemployment.

L = E + U (L is labor force, E is employed, U is unemployed)

fU = sE (f is rate of job finding, s is rate of job separation)

U/L = s / (s + f ) (solve for natural rate of unemployment)

3. Policies must either reduce the separation rate or increase the finding rate to lower the natural rate of unemployment.

4. Job search and frictional unemployment

a. role of imperfect information

b. sectoral (industry and region) shifts

c. role of unemployment insurance

effect on separation rate and finding rate

“just in time” personnel management

proposals for reform (100 % experience rated)

case study 5-1: empirical evidence

5. Real-wage rigidity and wait unemployment (failure to “clear the labor market”

a. minimum wage laws

traditional view

revisionist view (depends on “unrealized” market power)

b. unions and collective bargaining

insiders versus outsiders (outsiders pay part of cost of high wages to insiders)

Canadian versus US experience

c. efficiency wages (high wages make workers more productive)

6. Patterns of Unemployment

a. duration (mostly short-term) Long-term due to wait unemployment

b. upward drift versus recent downward drift

composition of labor force

two income households

sectoral shifts due to oil

7. Transitions into and out of the labor force

a. LIFO effect

b. discouraged worker effect

c. Eurosclerosis (Welfare state)

d. Relative income (US) vs relative employment (Europe)

Key Points in Chapter 6:

1. When the real wage adjusts to equate labor supply and labor demand, we say that the market clears. When the market clears, everyone who wants to work (labor supply) has a job (labor demand) at the prevailing real wage, so we say that the economy has full employment of labor.

2. The unemployment rate is not zero even if the labor market is clearing. The natural rate of unemployment is the rate of unemployment that occurs when the labor market clears. One purpose of this chapter is to explain why the natural rate of unemployment is positive.

3. The natural rate of unemployment is given by s/(s + f), where s = rate of job separation and f = rate of job finding. Any policy aimed at reducing the natural rate of unemployment must either decrease s, increase f, or both. Existing public policy has ambiguous effects in this area.

a. Government employment placement agencies increase f

b. Unemployment insurance decreases f

c. Government job training programs try to decrease s by making workers more productive and helping workers develop good work habits.

4. The actual unemployment rate can exceed the natural rate of unemployment because of a real wage rate that is “sticky” above the market clearing real wage rate. Unemployment created is called wait unemployment. Causes of wage rigidity include:

a. Minimum wage laws

b. Unions and collective bargaining

c. Efficiency wages

5. The facts about unemployment

a. Most spells of unemployment are short, but most weeks of unemployment are experienced by those who are unemployed over the long-term.

b. Younger persons have higher unemployment rates than older persons, primarily because of higher separation rates. (Finding rates are similar.)

c. Non-white persons have higher unemployment rates than whites because of both higher separation rates and lower finding rates.

6. Although most of the analysis of this chapter assumes a constant labor force, in fact transitions into and out of the labor force are very important.

a. One-third of the unemployed have only recently entered the labor force (LIFO effect)

b. One-half of all spells of unemployment end in withdrawal from the labor force (discouraged worker effect.)

c. The presence of discouraged workers causes the unemployment rate to understate the actual labor market impact of the business cycle.