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In this chapter, you will learn…
7 …about the natural rate of unemployment:
Unemployment and the Labor what it means
Market what causes it
understanding its behavior in the real world
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Natural rate of unemployment A first model of the natural rate
Notation:
Natural rate of unemployment:
The average rate of unemployment around which L = # of workers in labor force
the economy fluctuates.
E = # of employed workers
In a recession, the actual unemployment rate rises
above the natural rate. U = # of unemployed
In a boom, the actual unemployment rate falls below U/L = unemployment rate
the natural rate.
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The transitions between
Assumptions: employment and unemployment
1. L is exogenously fixed. s E
2. During any given month,
s = fraction of employed workers
that become separated from their jobs
Employed Unemployed
s is called the rate of job separations
f = fraction of unemployed workers
that find jobs
f is called the rate of job finding
s and f are exogenous f U
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The steady state condition Example:
Definition: the labor market is in Each month,
steady state, or long-run equilibrium, 1% of employed workers lose their jobs
if the unemployment rate is constant. (s = 0.01)
The steady-state condition is: 19% of unemployed workers find jobs
(f = 0.19)
s E = f U
Find the natural rate of unemployment:
# of employed
people who # of unemployed
lose or leave people who find
their jobs jobs
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Policy implication Why is there unemployment?
A policy will reduce the natural rate of If job finding were instantaneous (f = 1),
unemployment only if it lowers s or increases f. then all spells of unemployment would be brief,
and the natural rate would be near zero.
There are two reasons why f < 1:
1. job search
2. wage rigidity
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Job search & frictional unemployment Sectoral shifts
frictional unemployment: caused by the time def: Changes in the composition of demand
it takes workers to search for a job among industries or regions.
occurs even when wages are flexible and there example: Technological change
are enough jobs to go around more jobs repairing computers,
occurs because fewer jobs repairing typewriters
workers have different abilities, preferences example: A new international trade agreement
jobs have different skill requirements labor demand increases in export sectors,
geographic mobility of workers not instantaneous decreases in import-competing sectors
flow of information about vacancies and job Result: frictional unemployment
candidates is imperfect
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Public policy and job search Unemployment insurance (UI)
UI pays part of a worker’s former wages for a
Govt programs affecting unemployment
limited time after losing his/her job.
Govt employment agencies:
disseminate info about job openings to better
UI increases search unemployment,
because it reduces
match workers & jobs.
Public job training programs: the opportunity cost of being unemployed
help workers displaced from declining industries the urgency of finding work
get skills needed for jobs in growing industries. f
Studies: The longer a worker is eligible for UI,
the longer the duration of the average spell of
unemployment.
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Benefits of UI Why is there unemployment?
By allowing workers more time to search, The natural rate of unemployment:
UI may lead to better matches between
jobs and workers,
Two reasons why f < 1:
which would lead to greater productivity and
higher incomes. DONE 1. job search
Next 2. wage rigidity
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Unemployment from real wage Unemployment from real wage
rigidity rigidity
Real Supply
If real wage is wage The failure of wages to adjust to a level at which
stuck above Unemployment labor supply equals labor demand.
its eq’m level,
then there Rigid
aren’t enough real
jobs to go wage
around.
Demand
Labor
Amount of
Amount of labor
labor hired
willing to work
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Unemployment from real wage
Reasons for wage rigidity
rigidity
If real wage is 1. Minimum wage laws
stuck above Then, firms must ration the
its eq’m level,
scarce jobs among workers. 2. Labor unions
then there
aren’t enough
jobs to go 3. Efficiency wages
around. Structural unemployment:
The unemployment resulting
from real wage rigidity and
job rationing.
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1. The minimum wage 2. Labor unions
The min. wage may exceed the eq’m wage Unions exercise monopoly power to secure higher
of unskilled workers, especially teenagers. wages for their members.
Studies: a 10% increase in min. wage When the union wage exceeds the eq’m wage,
reduces teen employment by 1-3% unemployment results.
But, the min. wage cannot explain the Insiders: Employed union workers whose interest
majority of the natural rate of unemployment, is to keep wages high.
as most workers’ wages are well above Outsiders: Unemployed non-union workers who
the min. wage. prefer eq’m wages, so there would be enough jobs
for them.
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Union membership and wage ratios by industry, 2005
# employed U % of wage 3. Efficiency wage theory
industry
(1000s) total ratio
Private sector (total) 105,508 8.5% 122.3 Theories in which higher wages increase worker
Government (total) 20,381 40.5 121.7
productivity by:
Construction 8,053 13.8 156.9 attracting higher quality job applicants
Mining 600 9.5 113.7 increasing worker effort, reducing “shirking”
Manufacturing 15,518 13.7 107.8 reducing turnover, which is costly to firms
Retail trade 14,973 5.8 114.0 improving health of workers
Transportation 4,379 24.4 129.2 (in developing countries)
Finance, insurance 6,304 2.1 90.7
Firms willingly pay above-equilibrium wages to
Professional services 10,951 3.1 90.6
raise productivity.
Education 3,312 15.4 112.7
Health care 14,045 8 115.1 Result: structural unemployment.
wage ratio = 100(union wage)/(nonunion wage) slide 22 CHAPTER 6 Unemployment slide 23
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The duration of U.S. unemployment,
Question for discussion: average over 1/1990-5/2006
amount of time
• Use the material we’ve just covered to # of unemployed these workers spent
# of weeks persons unemployed
come up with a policy or policies
unemployed as % of total as % of total time all
to try to reduce the natural rate of # of unemployed workers spent
unemployment. unemployed
• Note whether your policy targets frictional 1-4 38% 7.2%
or structural unemployment.
5-14 31% 22.3%
15 or more 31% 70.5%
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The duration of unemployment Chapter Summary
The data: 1. The natural rate of unemployment
More spells of unemployment are short-term the long-run average or “steady state” rate of
than medium-term or long-term. unemployment
Yet, most of the total time spent unemployed depends on the rates of job separation and job
is attributable to the long-term unemployed. finding
This long-term unemployment is probably 2. Frictional unemployment
structural and/or due to sectoral shifts among due to the time it takes to match workers with jobs
vastly different industries.
may be increased by unemployment insurance
Knowing this is important because it can help
us craft policies that are more likely to work.
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Chapter Summary
3. Structural unemployment
results from wage rigidity: the real wage remains
above the equilibrium level
caused by: minimum wage, unions, efficiency
wages
4. Duration of unemployment
most spells are short term
but most weeks of unemployment are attributable
to a small number of long-term unemployed
persons
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