1. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-1 Chapter 18 Unemployment: Causes and Consequences Created by: Erica Morrill, M.Ed Fanshawe College

2. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-2 Chapter Focus  Types of unemployment  Wage rigidity  Voluntary unemployment  Imperfect information  Unemployment insurance

3. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-3 Types of Unemployment  Frictional  Structural  Demand-Deficient  Seasonal  Involuntary (associated with wage rigidity)

4. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-4 Search Unemployment  Imperfect information on both sides of the labour market  Undertaking a job search has costs and benefits  determine if it is worthwhile to initiate the job search  determine when to discontinue

5. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-5 Optimal Job Search  Marginal expected benefit equals marginal expected cost  Diminishing returns  Duration - less likely a better offer will be received  “Stopping Rule”- minimum acceptable wage

6. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-6 Figure 18.1 Optimal Job Search Search duration Present value of total costs and expected total benefits SeSe Search duration Present value of MC and expected MB SeSe C B MC MB

7. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-7 Figure 18.2 Wage Distributions Under Imperfect and Perfect Information Wage rate Number of Jobs WAWA Wage rate Number of Jobs WeWe Imperfect Information Full Information

8. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-8 Factors Determining Optimal Search  Wage offers and duration of job  Increase in benefits/decrease in costs  Dissemination of information  Vacancies/offers  Value of leisure/# of other searchers  Social and labour market policies  Aggregate economic conditions

9. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-9 Implicit Contracts  Firms and workers are already engaged in employment relationship  Explains responses to changes in production demand  rigid wages  layoffs/rehires  Reflects risk-sharing

10. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-10 Implicit Contract Theory  Employees purchase income insurance from the employer  The employer can then deal with:  moral hazard  adverse selection

11. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-11 Figure 18.3 a Implicit Contracts Employment N Real Wage W NoNo S NbNb D b = MPP N X P b D a = MPP N X P a WaWa W b =k Wages and Employment with Market-Clearing

12. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-12 Figure 18.3 b Implicit Contracts Employment N Real Wage W NoNo NbNb S D a = MPP N X P a WaWa D b = MPP N X P b Nb*Nb* Wages and Employment with Implicit Contracts k W*

13. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-13 Efficiency Wages: Implications for Unemployment  Effect of wages on incentives and productivity  Above market wages are used to enhance productivity  S-shaped function

14. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-14 Efficiency Wages: Implications for Unemployment  Unemployment and rigid wages can coexist  Firms refuse to cut wages because of the adverse work incentives  Wage curve  Higher unemployment leads to a greater penalty for shirking thus firms do not have to pay higher wages

15. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-15 Insider-Outsider Theory  Wage setting is determined by bargaining  Costly for the firm to replace workers  Workers have bargaining power to raise wages even with excess labour supply  Explains the existence of high unemployment and real-wage growth

16. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-16 Sectoral Shifts and Unemployment  Sectors of the economy are growing at different rates  Unemployment occurs as labour reallocates from the slower sectors to the fast growing sectors

17. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-17 Rationale for Unemployment Insurance  Moral hazard and adverse selection reduce the profitability of selling insurance  Private sector may not provide the socially optimal amount of unemployment insurance  Therefore, governments introduced unemployment insurance as part of social policy

18. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-18 Effects of Unemployment Insurance  Incident and duration of employment  Layoffs  Employment instability  Labour supply  Interregional mobility

19. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-19 Incident and Duration of Employment  Lower cost of job search  increasing the duration of the unemployed search  Ineligible workers are motivated to accept employment quickly to then qualify for benefits

20. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-20 Layoffs  UI lowers the cost of adjusting to fluctuations in demand  layoffs relative to other methods  Without UI  employers who rely on layoffs would have to pay a compensating wage to attract employees

21. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-21 Employment Instability  UI may encourage the use of layoffs as opposed to reductions in hours of work  This bias can be offset by:  experience-rated UI programs  UI assisted work sharing programs

22. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-22 Labour Supply  UI impacts labour force participation  Higher UI causes  some to reduce weeks worked to the minimum required  others to increase weeks worked in order to qualify  Labour force participation rises because no one leaves but new workers enter  Measure unemployment increases

23. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-23 Interregional Mobility  Regional extended benefits discourage interregional mobility  by providing benefits for longer periods in regions with high unemployment

24. © 2002 McGraw-Hill Ryerson Ltd.Chapter 18-24 End of Chapter Eighteen