1. Chapter 6
Unemployment (continued)
CHAPTER 6 Unemployment

2. Summary Three types of unemployment Cyclical Frictional Structural
Due to business cycles
↑ during recessions, ↓ during expansions
Zero in the long run
Frictional
Due to job search
Exists in the short run and the long run
Structural
Due to wage rigidity
CHAPTER 6 Unemployment

3. Question for discussion:
Use the material we’ve just covered to come up with a policy or policies to try to reduce the natural rate of unemployment.
Note whether your policy targets frictional or structural unemployment.
It is useful to pause your lecture at this point and give students an opportunity to apply what you’ve covered so far to answer this policy question.
Possible answers:
Stop raising the (nominal) minimum wage, so that its real value will gradually erode to zero.
Regulate unions (just like other monopolies are regulated) to reduce unions’ impact on wages.
Reduce the generosity of unemployment insurance benefits.
Implement government employment agencies to increase the accessibility of information about job vacancies and available workers.
Increase public funding to help retrain workers displaced from jobs in declining industries.
Suggestions for conducting the discussion:
If you ask for responses immediately after posing the question, it is likely that a small number of students will volunteer to participate - the same students that always do, the ones that are the best prepared and/or the quickest thinkers.
To elicit participation from a larger number of students, I suggest the following:
Pair students up. Allow 10 minutes for the students, working in their pairs, to come up with answers to the question. During this time, circulate around the room and ask the pairs if you can be of assistance, either to help them get started or give feedback on what they’re coming up with. Then, reconvene the class and ask for volunteers.
Doing this increases the quantity and quality of participation: students who would not otherwise participate are more likely to do so because they have had time to formulate their answers and have had a chance to run their answers by a classmate. Additionally, even students who don’t participate will have at least had the opportunity to discuss the question with one other student.
CHAPTER 6 Unemployment

4. The duration of unemployment
How long does a person stay unemployed?
If the cause of unemployment is frictional it will likely be short-run.
If the cause of unemployment is structural it will likely be long-run.
CHAPTER 6 Unemployment

5. What does the data suggest?
It depends on how you look at the data.
If you look at the duration of unemployment, data suggests that the majority of unemployment is short term (i.e. less than a month)  frictional.
Alternatively, if what you care about is not the duration of unemployment by the total number of weeks that are spent as unemployed by the nation as a whole, this is more likely caused by structural unemployment.
CHAPTER 6 Unemployment

6. Example Suppose there are 10 unemployed. Total months unemployed
8 people find a job within a month: months
2 people find a job within 12 months: months
_________
32 months
Looking at the duration of unemployment: 80% people: short term
Weeks of unemployment: 24/32 = 75% months: long term
CHAPTER 6 Unemployment

7. The duration of unemployment
The data:
More spells of unemployment are short-term than medium-term or long-term.
Yet, most of the total time spent unemployed is attributable to the long-term unemployed.
This long-term unemployment is probably structural and/or due to sectoral shifts among vastly different industries.
Knowing this is important because it can help us craft policies that are more likely to work.
Regarding the point about structural unemployment and sectoral shifts:
Structural unemployment - workers are waiting for jobs to become available, but there just aren’t enough jobs to go around; hence, this can be long-term unemployment.
Sectoral shifts across vastly different industries, e.g. a shift in demand from textiles to software design; obviously, jobs in these industries require vastly different skill sets. Sectoral shifts can occur among similar industries (e.g., demand shifts from desktop to laptop computers), but this is less likely to produce long-term unemployment.
CHAPTER 6 Unemployment

8. If the goal is to decrease the percentage of people who are unemployed, focus on policies to reduce time spent on job search.
If the goal is to decrease the percentage of weeks that are spent unemployed, focus on policies to prevent wage rigidities or train workers for the new sectors.
CHAPTER 6 Unemployment

9. Trends in Unemployment
Natural rate of unemployment tends to fluctuate over time. What are the likely reasons?
Changes in wage rigidities
Demographics
Ceteris paribus, ↑in population  ↑unemployment
↑in young population  ↑unemployment
Sectoral shifts:
The greater the amount of sectoral reallocation, the greater the rate of job separation and frictional unemployment.
Rise of computer industry,
oil price volatility: shifts from more energy intensive to less energy sectors
Productivity
↑ productivity → ↑ MPL → ↑ W/P
CHAPTER 6 Unemployment

10. Productivity and Unemployment
Natural rate D
(W/P)1
(W/P)2 S
CHAPTER 6 Unemployment

11. Suppose that nominal wages only adjust slowly (workers are slow to catch the news about productivity)  D > S (green dotted region in the above graph)
Due to excess demand at (W/P)1, employers will try to get the existing frictionally unemployed labor force by providing more appealing offers Natural rate of unemployment decreases.
Note: In the LR it is possible for an economy to produce beyond long run potential (i.e. natural rate) by adjustments to frictional unemployment.
CHAPTER 6 Unemployment

12. EXPLAINING THE TREND: The minimum wage
The trend in the real minimum wage is similar to that of the natural rate of unemployment. 9 8 7 6
minimum wage in 2006 dollars 5
Dollars per hour 4 3
minimum wage in current dollars 2
The trend in the real minimum wage rises until the mid to late 1970s, then falls. This is fairly similar to the trend of the natural rate of unemployment.
The U.S. Department of Labor has lots of good information on the minimum wage, at: 1
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
CHAPTER 6 Unemployment

13. EXPLAINING THE TREND: Union membership
Union membership selected years
year
percent of labor force
1930
12%
1945
35%
1954
1970
27%
1983
20.1%
2005
12.5%
Since the early 1980s, the natural rate of unemploy-ment and union membership have both fallen.
But, from 1950s to about 1980, the natural rate rose while union membership fell.
source: AFL-CIO website
and, for the 2005 figure,
Also see
good set of links to info on labor unions
The BLS’ annual news release of info on union membership, earnings.
Earlier in the chapter, we saw cross-sectional data that showed a positive correlation between the union wage premium and union members’ share of the labor force across industries.
We would expect that, other things equal, changes over time in the aggregate share of unions in employment should be associated with similar changes in unions’ impact on average wages, and hence on the natural rate of unemployment.
In plain English, we would expect that the decline in the extent of unionization shown on this slide would correspond to a decline in the natural rate of unemployment. Unfortunately for the theory, this is only true for the time period beginning in the early 1980s, when the natural rate started coming down. From the 1950s through 1980, the natural rate rose, but union membership fell.
Does this mean the theory is not relevant? Not necessarily, as other things (other determinants of the natural rate) were not constant during this time period.
CHAPTER 6 Unemployment

14. EXPLAINING THE TREND: Sectoral shifts
From mid 1980s to early 2000s, oil prices less volatile, so fewer sectoral shifts.
Price per barrel of oil, in 2006 dollars
source: Dow Jones & Company
obtained from:
Earlier in the chapter, we learned that sectoral shifts are a source of job separations and lead to frictional unemployment. One would expect that a decrease in the frequency and magnitude of sectoral shifts would be associated with fewer job separations, less frictional unemployment, and a lower natural rate of unemployment.
Unfortunately, there is no single “index of sectoral shocks.” However, we know that large changes in oil prices are one source of sectoral shocks. A significant fall in the price of oil causes a decrease in demand for workers at oil fields in Oklahoma and Texas, and an increase in demand for workers at factories that produce SUVs. A significant increase in oil prices would do the opposite.
The graph shows data on the price of oil since 1970.
During , the real price of oil fluctuated between $18 and $98. Also during this time, the natural rate of unemployment was rising.
During , the real price of oil fluctuated between $20 and $40, except for a brief spike during the Gulf War. Also during this time, the natural rate of unemployment was falling.
The data are roughly consistent with the notion that sectoral shifts contribute to the natural rate.
Note the recent increase in oil prices: from about $22 to $70 during :1. This represents a sectoral shift and may contribute to an increase in the natural rate of unemployment. Or maybe not, as oil consumption per dollar of GDP is lower today than in the 1970s and 1980s.
CHAPTER 6 Unemployment

15. EXPLAINING THE TREND: Demographics
1970s: The Baby Boomers were young. Young workers change jobs more frequently (high value of s).
Late 1980s through today: Baby Boomers aged. Middle-aged workers change jobs less often (low s).
For details on this, plus one other explanation involving productivity, see pp
CHAPTER 6 Unemployment

16. Unemployment in Europe, 1960-2005
France 12 9
Percent of labor force 6
Italy
U.K. 3
Figure 6-4, p.177
Source: bls.gov, obtained from
Germany
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
slide 16

17. The rise in European unemployment
Shock Technological progress has shifted labor demand from unskilled to skilled workers in recent decades.
Effect in United States An increase in the “skill premium” – the wage gap between skilled and unskilled workers.
Effect in Europe Higher unemployment, due to generous govt benefits for unemployed workers and strong union presence.
CHAPTER 6 Unemployment

18. Percent of workers covered by collective bargaining
United States
18%
United Kingdom 47
Switzerland 53
Spain 68
Sweden 83
Germany 90
France 92
Austria 98
Table 6-1, p.169
Source: Same as text (OECD Economic Outlook 2004, as reported in NBER Macroeconomics Annual 2005.)
CHAPTER 6 Unemployment

19. End of chapter problem 5
Consider an economy with the following Cobb-Douglas production function: .
The economy has 1000 units of capital and 1000 units of labor.
Derive the equation describing labor demand in this economy as a function of the real wage and the capital stock
If the real wage can adjust to equate labor supply and labor demand, what is the real wage? In this equilibrium, what is the employment, output, and the total amount earned by workers?
Now suppose that Congress concerned about the welfare of the working class passes a law requiring firms to pay workers a real wage of 1 unit of output. How does this wage compare to the equilibrium real wage?
What happens to employment, output, and the total amount earned by the workers when the real wage is 1 unit of output?
CHAPTER 6 Unemployment

20. Labor Demand:
Equilibrium W/P=
CHAPTER 6 Unemployment

21. Minimum wage>Equilibrium wage  Unemployment Then,
=704 people become unemployed
CHAPTER 6 Unemployment