1. Chapter 6
Unemployment
CHAPTER 6 Unemployment

2. So far we assumed that there is no unemployment (ch. 3)
So far we assumed that there is no unemployment (ch.3). However, the unemployment rate is never zero in a country
USA: Used to be 5-6 %, 9.5% in 2010
Turkey: 11.9% in 2010
Urban: 14.2%, Rural: 7.3%. Why?
CHAPTER 6 Unemployment

3. Unemployment In Turkey
KOÇ ÜNİVERSİTESİ - Makroekonomi

4. Labor Market & Unemployment
KOÇ ÜNİVERSİTESİ - Makroekonomi

5. In this chapter, you will learn…
…about the natural rate of unemployment:
what it means
what causes it
understanding its behavior in the real world
CHAPTER 6 Unemployment

6. Natural rate of unemployment
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.
The natural rate of unemployment is the “normal” unemployment rate the economy experiences when it is neither in a recession nor a boom.
The natural rate of unemployment is the “normal” unemployment rate the economy experiences when it is neither in a recession nor a boom.
CHAPTER 6 Unemployment

7. Actual and natural rates of unemployment in the U.S., 1960-200612
Unemployment rate 10 8
Percent of labor force
Natural rate of unemployment 6 4
Figure 6-1, p.160.
The actual unemployment rate fluctuates considerably over the short run. These fluctuations will be the focus of chapters 9-13 later in the book.
For this chapter, though, our goal is to understand the red line: the so-called “natural rate of unemployment,” or the long-run trend in the unemployment rate.
Source: BLS
Obtained from
Unemployment data are based on seasonally-adjusted, monthly unemployment rates for the civilian non-institutional population of the U.S.
The actual u-rate for each quarter is an average of the three monthly unemployment rates in that quarter.
The natural u-rate in a given quarter is estimated by averaging all unemployment rates from 10 years earlier to 10 years later; future unemployment rates are set at 5.5%. 2
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
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8. U.S. Unemployment Rate
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9. A first model of the natural rate
Notation:
L = # of workers in labor force
E = # of employed workers
U = # of unemployed
U/L = unemployment rate
Section 6-1
CHAPTER 6 Unemployment

10. Assumptions: 1. L is exogenously fixed. 2. During any given month,
s = fraction of employed workers that become separated from their jobs
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
CHAPTER 6 Unemployment

11. The transitions between employment and unemployment
f U
s E
Employed
Unemployed
Figure 6-2, p. 161
(note: The size of the boxes containing the words “employed” and “unemployed” are not proportional to the number of people in each category.)
=> Number of people finding jobs (∆E )= fU
Number of people losing jobs (∆U)= sE
CHAPTER 6 Unemployment

12. The steady state condition
Definition: the labor market is in steady state, or long-run equilibrium, if the unemployment rate is constant.
The steady-state condition is:
s E = f U
# of unemployed people who find jobs
# of employed people who lose or leave their jobs
CHAPTER 6 Unemployment

13. Finding the “equilibrium” U rate
f U = s E
= s (L – U )
= s L – s U
Solve for U/L:
(f + s) U = s L
so,
Labor Force = Number of Employed + Number of Unemployed
L = E U
CHAPTER 6 Unemployment

14. As s↑, U/L↑ ( )
As f↑, U/L↓ ( )
CHAPTER 6 Unemployment

15. Example: Each month, Find the natural rate of unemployment:
1% of employed workers lose their jobs (s = 0.01)
19% of unemployed workers find jobs (f = 0.19)
Find the natural rate of unemployment:
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16. Policy implication
A policy will reduce the natural rate of unemployment only if it lowers s or increases f.
CHAPTER 6 Unemployment

17. Why is there unemployment?
If job finding were instantaneous (f = 1), 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
CHAPTER 6 Unemployment

18. Job search & frictional unemployment
frictional unemployment: caused by the time it takes workers to search for a job
occurs even when wages are flexible and there are enough jobs to go around
occurs because
workers have different abilities, preferences
jobs have different skill requirements
geographic mobility of workers not instantaneous
flow of information about vacancies and job candidates is imperfect
CHAPTER 6 Unemployment

19. Sectoral shifts & frictional unemployment
def: Changes in the composition of demand among industries or regions.
example: Technological change more jobs repairing computers, fewer jobs repairing typewriters
example: A new international trade agreement labor demand increases in export sectors, decreases in import-competing sectors
Result: frictional unemployment
Frictional unemployment arises not only due to workers attempts to find a better match but also due to employers’ attempts to obtain the workers who can meet their changing needs
Sometimes the unemployment caused by sectoral shifts is severe. Due to increasing imports of cheaper foreign-made textiles (particularly since the expiration in 2005 of long-standing quotas on textiles from China), the U.S. textile industry has been in decline for years. Tens of thousands of workers in this industry have lost jobs.
Many of these workers are in their 50s and have worked in this industry for decades. Such workers are unlikely to have the skills necessary to get jobs available in newly booming industries, and they are less likely to invest in the acquisition of the necessary skills for these jobs. Hence, such workers are at greater risk for becoming “discouraged workers.”
CHAPTER 6 Unemployment

20. Notes
Sectoral shifts are distinct from recessions (which also cause unemployment).
In recessions, there is a general fall in demand across industries, and the unemployment that results is cyclical.
Sectoral shifts, though, are changes in the composition of demand across industries, and lead to frictional unemployment
CHAPTER 6 Unemployment

21. Public policy and job search
Govt programs affecting unemployment
Govt employment agencies: disseminate info about job openings to better match workers & jobs.
Public job training programs: help workers displaced from declining industries get skills needed for jobs in growing industries.
You might want to “hide” (omit) this slide from your presentation if you plan on doing the class discussion in Slide 27, which asks students to think of things the government can do to try to reduce the natural rate of unemployment.
CHAPTER 6 Unemployment

22. Unemployment insurance (UI)
UI pays part of a worker’s former wages for a limited time after losing his/her job.
UI increases frictional unemployment, because it reduces
the opportunity cost of being unemployed
the urgency of finding work f
Studies: The longer a worker is eligible for UI, the longer the duration of the average spell of unemployment.
Proposed solution: Make the employer pay for the insurance (so that the incentives to fire workers decrease)
CHAPTER 6 Unemployment

23. Benefits of UI By allowing workers more time to search,
UI may lead to better matches between jobs and workers,
which would lead to greater productivity and higher incomes.
CHAPTER 6 Unemployment

24. Why is there unemployment?
The natural rate of unemployment:
Two reasons why f < 1:
1. job search
2. wage rigidity
DONE 
Next 
CHAPTER 6 Unemployment

25. Unemployment from real wage rigidity
Supply
Labor
Real wage
If real wage is stuck above its eq’m level, then there aren’t enough jobs to go around.
Unemployment
Demand
Rigid real wage
Amount of labor hired
Figure 6-3 on p.166.
Abbreviation: “eq’m” = equilibrium
Amount of labor willing to work
CHAPTER 6 Unemployment

26. Unemployment from real wage rigidity
If real wage is stuck above its eq’m level, then there aren’t enough jobs to go around.
Then, firms must ration the scarce jobs among workers.
Structural unemployment: The unemployment resulting from real wage rigidity and job rationing.
Other texts define “structural unemployment” as unemployment that results from a mismatch between the skills or locations of workers and the skill or location requirements of job openings. This would occur, for example, if there were a decrease in demand for domestic steel (and hence steel workers) and a simultaneous increase in demand for financial consulting services (and hence employees of such firms).
However, if wages are perfectly flexible, then the decrease in demand for steel workers would simply cause their wage to fall until all were again employed, and the increase in demand for workers in financial firms would simply increase until equilibrium in that labor market was reestablished. So, the critical ingredient for structural unemployment is wage rigidity. Hence Mankiw’s definition.
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27. Reasons for wage rigidity
1. Minimum wage laws
2. Labor unions
3. Efficiency wages
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28. 1. The minimum wage
The min. wage may exceed the eq’m wage of unskilled workers, especially teenagers (whose MPL is low).
Studies: a 10% increase in min. wage reduces teen unemployment by 1-3%
But, the min. wage cannot explain the majority of the natural rate of unemployment, as most workers’ wages are well above the min. wage.
CHAPTER 6 Unemployment

29. The advantage of the minimum wage is that it raises the income of the working poor (at the expense of increasing unemployment).
The disadvantage of the minimum wage is that it decreases employment (it decreases on the job training that these low-skilled workers would get).
One solution: Instead of minimum wage, provide income tax credit to the working poor i.e. let workers get hired at the market clearing wage (< min wage) but don’t tax their incomes as much.
CHAPTER 6 Unemployment

30. 2. Labor unions
Unions exercise monopoly power to secure higher wages for their members.
When the union wage exceeds the eq’m wage, unemployment results.
Insiders: Employed union workers whose interest is to keep wages high.
Outsiders: Unemployed non-union workers who prefer eq’m wages, so there would be enough jobs for them.
See p.165 for more discussion about insiders and outsiders.
The theory has two implications we can confront with data:
1) Union members’ average earnings should be higher than non-union members’ average earnings.
2) The difference between union and non-union wages should be higher in industries that are more heavily unionized (and hence, in which unions have more market power) than in less heavily unionized industries.
The following slide shows 2005 data on union membership and wage ratios by industry in the U.S. The data are consistent with the theory.
CHAPTER 6 Unemployment

31. 3. Efficiency wage theory
Theories in which higher wages increase worker productivity by:
attracting higher quality job applicants
increasing worker effort, reducing “shirking”
high wages decrease the likelihood that the workers may act improperly when they are not monitored
reducing turnover, which is costly to firms
improving health of workers (in developing countries)
Firms willingly pay above-equilibrium wages to raise productivity.
Result: structural unemployment.
CHAPTER 6 Unemployment