0. 7
Unemployment
This presentation has lots of data. Some of it is in the textbook (or updated versions of what’s in the textbook), plus some additional data, including data that supports some of the textbook’s key points about the causes of the natural rate of unemployment.
Yet, it is one of the shorter chapters. It is also less difficult than the preceding chapters. So, most professors are able to cover this material more quickly than usual.

1. 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 1

2. 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.

3. Actual and natural rates of unemployment, U.S., 1960–2014
Unemployment rate
Natural rate of unemployment
Similar to Figure 7-1 in the textbook.
The actual unemployment rate fluctuates considerably over the short run. These fluctuations are the focus of Part IV of the book.
For this chapter, though, our goal is to understand the behavior of the natural rate of unemployment, essentially 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%. (Therefore, estimates of the natural rate may become less accurate toward the end of the sample period.)

4. 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

5. Assumptions: 1. L is exogenously fixed. 2. During any given month,
s = rate of job separations, fraction of employed workers that become separated from their jobs
f = rate of job finding, fraction of unemployed workers that find jobs
s and f are exogenous
This slide spells out the three variables we assume to be exogenous:
the labor force, the rate of job separations, and the rate of job finding.

6. The transitions between employment and unemployment
s ×E
Employed
Unemployed
Figure 7-2, p. 179
(Note: The size of the boxes containing the words “employed” and “unemployed” are not proportional to the number of people in each category.)
f ×U

7. 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
In order for the unemployment rate to be constant, the number of people who become unemployed in each month must equal the number of formerly unemployed people who find jobs.

8. 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,

9. 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:

10. Policy implication
A policy will reduce the natural rate of unemployment only if it lowers s or increases f.

11. 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

12. 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

13. Sectoral shifts
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
These scenarios result in frictional unemployment
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.”

14. CASE STUDY: Structural change over the long run
All figures are industry shares in U.S. GDP. “Other industry” includes construction, mining, electricity, water, and gas.
From 1960 to 2009, there are huge changes in all four categories. Manufacturing falls by about half.
Even the “tiny” category of agriculture drops by about three-fourths.
As a result of these huge structural shifts, the types of jobs available now are vastly different than just two generations ago.
Source: World Development Indicators, World Bank.
[2009 is the latest available as of 2012(!)]

15. More examples of sectoral shifts
Industrial revolution (1800s): agriculture declines, manufacturing soars
Energy crisis (1970s): demand shifts from larger cars to smaller ones
Health care spending as % of GDP: 1960: : : : 17.9
Most of the examples on this and the previous slides are big changes that have occurred over many years. These examples give students a good idea of what sectoral shifts are. Perhaps more important for the natural rate, though, are the many smaller changes that occur more frequently. Ours is a dynamic economy: the structure of demand is shifting almost continuously, due to changes in preferences, technology, and the location of production. As a result, there is a near-continual flow of newly frictionally unemployed workers.
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 as described above.
Source of health expenditure data:
In our dynamic economy, smaller sectoral shifts occur frequently, contributing to frictional unemployment.

16. Public policy and job search
Govt programs affecting unemployment include:
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.

17. Unemployment insurance (UI)
UI pays part of a worker’s former wages for a limited time after the worker loses his/her job.
UI increases search 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 average spell of unemployment.
The text includes a nice case study on unemployment insurance (pp.182-3). It discusses evidence that unemployment insurance reduces the job finding rate.

18. 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.

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

20. Unemployment from real wage rigidity
Supply
Labor
Real wage
If real wage is stuck above its eq’m level, there aren’t enough jobs to go around.
Unemployment
Demand
Rigid real wage
Amount of labor hired
Figure 7-3 on p.183.
Abbreviation: “eq’m” = equilibrium
Amount of labor willing to work

21. Unemployment from real wage rigidity
If real wage is stuck above its eq’m level, 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.

22. Reasons for wage rigidity
1. Minimum wage laws
2. Labor unions
3. Efficiency wages

23. 1. The minimum wage
The min. wage may exceed the eq’m wage of unskilled workers, especially teenagers.
Studies: a 10% increase in min. wage reduces teen employment 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.

24. 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.187 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 recent data on union membership and wage ratios by industry in the U.S. The data are consistent with the theory.

25. Union membership and wage ratios by industry, 2011
# employed (1000s)
U % of total
wage ratio
Private sector (total)
104,737
6.9
37.0
7.5
13.0
2.1
1.1
20.4
4.9
10.5
7.2
14.0
122.6
121.1
114.9
112.6
99.1
90.2
123.5
102.4
107.2
96.4
151.7
Government (total)
20,450
Construction
6,244
Mining
780
Manufacturing
13,599
Retail trade
The wage ratio equals the average weekly earnings of union members divided by that of non-union members. (Here, “union members” does not include non-union members who are represented by unions; however, including them in these calculations does not substantively change the results.)
For example, in Transportation, 20.4% of workers are in unions, and on average they earn 23.5% more per week than non-union members in that industry.
In 2011, 11.8% of all workers in the U.S. were members of unions. The data on this slide show two things:
union workers typically earn more than non-union workers (about 22% more on average).
2) the greater the percentage of union workers in an industry, the higher the wage ratio (the correlation is about 0.5)
Source: BLS.gov
Note: Due to space constraints on the slide, a few industries were omitted.
14,582
Transportation
4,355
Finance, insurance
6,111
Professional services
12,171
Education
4,020
Health care
15,835
wage ratio = 100 × (union wage) / (nonunion wage)

26. 3. Efficiency wages
Theories in which higher wages increase worker productivity by:
attracting higher quality job applicants
increasing worker effort, reducing “shirking”
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.

27. NOW YOU TRY 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 5-10 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. 27

28. The Median Duration of Unemployment
The duration of unemployment typically rises in recessions—but its rise in 2008–2010 is unprecedented.
Weeks
This graph replicates Figure 7-4 on p It’s new to the 8th edition, which also includes some nice discussion of different perspectives on the recent rise in long-term unemployment. There are good quotes from Robert Barro and Paul Krugman.

29. TREND: The natural rate rises over 1960–84, then falls over 1985–2005
The purpose of this slide is to establish the trend behavior of the natural rate in recent decades: rising until the early 80s, then falling from the mid-80s through the early 2000s.
(It is probably too soon to say what happened to the trend in , due to the steep recession and to the fact that the natural rate data used in this graph were estimated as the average of unemployment rates from 10 years before to 10 years after each date, with future unemployment rates set at 5.5 percent.)
The following slides will show that the theories in this chapter are (mostly) consistent with the trend behavior of the natural rate.
The graph on this slide is similar to Figure 7-1 (near the beginning of this PowerPoint presentation), with modifications to the vertical scale and colors to highlight the trend behavior.

30. EXPLAINING THE TREND: The minimum wage
The real minimum wage and natural u-rate have similar trends. $
trend
minimum wage in 2012 dollars
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:
[Two sources of data on the federal minimum wage are slightly different in the late 1960s. These small differences have no significant impact on the trend, or the message of this graph.]
minimum wage in current dollars

31. EXPLAINING THE TREND: Union membership
Since early 1980s, the natural rate and union membership have both fallen.
But, from 1950s to about 1980, the natural rate rose while union membership fell.
Union membership selected years
year
percent of labor force
1930
12.0
1945
35.0
1954
1970
27.0
1983
20.1
2013
11.3
A table on an earlier slide showed a positive correlation between the union wage premium and union members’ share of the labor force across industries.
We would expect a similar relationship over time in the aggregate data: as the ratio of union members to all workers rises (falls), the union wage premium and hence natural rate of unemployment should also rise (fall).
The data since the early 1980s are consistent with this expectation. However, the data from the 1950s to the early 1980s are not: the natural rate rose, but union membership declined.
Does the inconsistency from the 1950s to the early 1980s mean the theory is irrelevant? Not necessarily, as other determinants of the natural rate were not constant during the period.
source:
AFL-CIO website,
and Current Population Survey, Bureau of Labor Statistics

32. EXPLAINING THE TREND: Sectoral shifts
2006–2012: oil price volatility increases – will the natural u-rate rise again?
1986–2005: oil prices less volatile, so fewer sectoral shifts
1970–1986: volatile oil prices create jarring sectoral shifts
Price per barrel of oil, in 2011 dollars
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 shifts.” However, we know that large changes in oil prices are one important source of sectoral shifts. 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 1965.
During , the real price of oil fluctuated between $20 and $ Also during this time, the natural rate of unemployment was rising.
During , the real price of oil was in the $20-40 range 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.
source: Dow Jones & Company
obtained from:

33. 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 more details on this, see the book.

34. Unemployment in Europe, 1960–2012
Percent of labor force
Figure 7-5 on p.195.
Source: Bureau of Labor Statistics,

35. Why unemployment rose in Europe but not the U.S.
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.

36. Percent of workers covered by collective bargaining, selected countries
United States
13%
United Kingdom 35
Switzerland 48
Spain 80
Sweden 92
Germany 63
France 95
Greece 85
Table 7-1
Source: OECD.

37. CHAPTER SUMMARY
1. The natural rate of unemployment
definition: the long-run average or “steady state” rate of unemployment
depends on the rates of job separation and job finding
2. Frictional unemployment
due to the time it takes to match workers with jobs
may be increased by unemployment insurance 37

38. 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 38

39. CHAPTER SUMMARY rose from 1960 to early 1980s, then fell
5. Behavior of the natural rate in the U.S.
rose from 1960 to early 1980s, then fell
possible explanations: trends in real minimum wage, union membership, prevalence of sectoral shifts, and aging of the Baby Boomers 39

40. CHAPTER SUMMARY has risen sharply since 1970
6. European unemployment
has risen sharply since 1970
probably due to generous unemployment benefits, strong union presence, and a technology-driven shift in demand away from unskilled workers 40