© The McGraw-Hill Companies, 2005 Chapter 27 Unemployment David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 8th Edition, McGraw-Hill, 2005 PowerPoint presentation by Alex Tackie and Damian Ward

© The McGraw-Hill Companies, 2005 Some key terms Unemployment rate: –the percentage of the labour force without a job but registered as being willing and available for work. Labour force –those people holding a job or registered as being willing and available for work. Participation rate –the percentage of the population of working age declaring themselves to be in the labour force.

© The McGraw-Hill Companies, 2005 Unemployment in the UK Source: Economic Trends Annual Supplement, Labour Market Trends

© The McGraw-Hill Companies, 2005 Unemployment in Turkey Source: TURKSTAT, SPO

© The McGraw-Hill Companies, 2005 Unemployment (%) in selected countries

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Labour market flows It is tempting to see the labour market in static terms WorkingUnemployed Non-participants but... LABOUR FORCE

© The McGraw-Hill Companies, 2005 Labour market flows LABOUR FORCE Working Unemployed Non-participants Taking a job Job-losers Lay-offs Quits New hires Recalls Discouraged workers Re-entrants New entrants Retiring Temporarily leaving

© The McGraw-Hill Companies, 2005 More on labour market flows The size of these flows is surprisingly high. In 1999 unemployment in the UK began at 1.29 million. During the year: –3.14 million became unemployed –but 3.3 million left the ranks of the unemployed.

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Types of unemployment Frictional –the irreducible minimum level of unemployment in a dynamic society people between jobs the ‘almost unemployable’ Structural –unemployment arising from a mismatch of skills and job opportunities when the pattern of demand and production changes it takes time for ex-coal miners to retrain as international bankers

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Types of unemployment (2) Demand-deficient unemployment –occurs when output is below full capacity –‘Keynesian’ unemployment occurs in the transitional period before wages and prices have fully adjusted Classical unemployment –created when the wage is deliberately maintained above the level at which labour supply and labour demand schedules intersect

© The McGraw-Hill Companies, 2005 Keynesian unemployment Number of workers Real wage LD LF AJ w* With sticky wages and prices in the short-run, the economy will move to equilibrium at A E F and there will be unemployment of AF. Of which EF will be voluntary and AE will be involuntary (ie Keynesian). Beginning at E, suppose labour demand falls to LD’. A LD’ w2w2 H If labour demand remains at LD’, the new equilibrium when wages and prices have fully adjusted will be at G. G

© The McGraw-Hill Companies, 2005 w2w2 Suppose that union power succeeds in maintaining a real wage of w 2. Classical unemployment Number of workers Real wage LD LF AJ w* N* N1N1 and AB is involuntary. A N2N2 Equilibrium is at A B of which BC is voluntary C and unemployment is AC, To the extent that this unemployment reflects a conscious decision by unions to restrict employment, it is voluntary unemployment.

© The McGraw-Hill Companies, 2005 A ‘modern’ view of unemployment A similar categorisation is retained, but an important distinction is to be noted between: Voluntary unemployment –when a worker chooses not to accept a job at the going wage rate. Involuntary unemployment –when a worker would be willing to accept a job at the going wage but cannot get an offer.

© The McGraw-Hill Companies, 2005 The natural rate of unemployment The natural rate of unemployment is the rate of unemployment when the labour market is in equilibrium. This is entirely voluntary. It includes: –frictional unemployment –structural unemployment

© The McGraw-Hill Companies, 2005 The natural rate of unemployment Number of workers Real wage LD LD: labour demand LF LF: size of labour force AJ AJ: the number of workers prepared to accept jobs AJ is to the left of LF because some members of the labour force are between jobs, others are waiting for better offers. w* N* N1N1 Equilibrium is at w*/ N*. The distance EF is the natural rate of unemployment. E F

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The natural rate of unemployment in the UK,

© The McGraw-Hill Companies, 2005 Supply-side economics entails the use of microeconomic incentives to alter –the level of full employment –the level of potential output –the natural rate of unemployment. In the long run the performance of the economy can only be changed by affecting the level of full employment and the corresponding level of potential output.

© The McGraw-Hill Companies, 2005 w3w3 w 1 > w 3 (the take-home net pay of workers). F Unemployment is now EF. Unemployment is BC C Tax cuts and unemployment Number of workers Real wage LD LF AJ w1w1 Firms pay a gross wage of w 1 N1N1 Equilibrium is at N 1 EF < BC i.e. unemployment is reduced. w2w2 N2N2 E Without tax, equilibrium is at E. AB is the amount of tax A B

© The McGraw-Hill Companies, 2005 Other supply-side policies Trade union reform –reducing the power of trade unions may limit distortions in the labour market Other labour supply policies –training and retraining measures –improving the efficiency of the labour market such measures may affect frictional and structural unemployment Investment –higher investment may increase the demand for labour may be achieved via tax incentives or low interest rates

© The McGraw-Hill Companies, 2005 Hysteresis The idea that a (short-run) fall in aggregate demand can lead to a persistence of unemployment even when the fall in aggregate demand has been reversed. This could help to explain high and persistent unemployment in Europe in the 1980s.

© The McGraw-Hill Companies, 2005 Hysteresis (continued) Four channels: –Insider-outsider distinction only those in work take part in wage bargaining & they protect their own positions –Discouraged workers people stop looking for jobs –Search and mismatch firms and workers get used to low search –capital stock low levels of investment in recession lead to permanently low capital stock levels

© The McGraw-Hill Companies, 2005 Summary Unemployment is a dynamic phenomenon. It impacts upon different groups differently. Modern view emphasises difference between voluntary and involuntary unemployment. Supply-side policies are a favoured way of dealing with the problem. Hysteresis may help to explain unemployment persistence.