1. Unemployment

2. 1. Unemployment The concept of unemployment is somewhat ambiguous since in theory virtually anyone would be willing to be employed in return for a generous enough compensation package. The concept of unemployment is somewhat ambiguous since in theory virtually anyone would be willing to be employed in return for a generous enough compensation package. →Economists define unemployment in terms of an individual’s willingness to be employed at some prevailing market wage. u （ unemployment rate ） =U/L Government statistic: U (temporary layoff waiting to be recalled, actively search for work in the previous week or month )

3. Note: Limitations of unemployment rate data Note: Limitations of unemployment rate data →For a number of reasons, they do not necessarily provide an accurate reflection of the economic hardship that members of a group are suffering.

4. 1. Individuals who are not actively searching for work, including those who search unsuccessfully and then gave up, are not counted among the unemployed. e.g., discouraged worker. 2. Unemployment statistics tell us nothing about the earnings levels of those who are employed. 3. A substantial fraction of the unemployed come from families in which other earners are present and the unemployed are often not the primary source of their family support. 4. Unemployed receive some income support such as government unemployment compensation. 5. Unemployment rate data tell us little about the fraction of the population that is employed.

5. 2. Types of Unemployment and Their Causes (1)Frictional Unemployment W Employment S0S0 D0D0 E0E0 W0W0 D 0 : Labor Demand S 0 : Labor Supply (W 0, E 0 ): Equilibrium Wage and Employment Level Even in a market-equilibrium or full-employment situation there will still be some frictional unemployment, because some people will be “between jobs”. Frictional unemployment arises because labor markets are inherently dynamic, because information flows are imperfect, and because it takes time for unemployed workers and employers with job vacancies to find each other.

6. (2) Structural Unemployment Structural unemployment arises when changes in the pattern of labor demand cause a mismatch between the skills demanded and supplied in a given area or cause an imbalance between the supplies and demands for workers across areas. W Employment S 0A D 0A D 1A E 1A E 0A W 0A W Employment S 0B D 0B D 1B W 0B W 1B E 0B E 1B →Unemployment of E 0A – E 1A workers would be created in the short run.

7. If wages were completely flexible and if costs of occupational or geographic mobility were low, market adjustments would quickly eliminate this type of unemployment. If wages were completely flexible and if costs of occupational or geographic mobility were low, market adjustments would quickly eliminate this type of unemployment. Note: It has been argued that structural unemployment may also arise if some employers are paying above market-clearing (or efficiency) wages to reduce employee turnover and/or shirking and to increase productivity. Note: It has been argued that structural unemployment may also arise if some employers are paying above market-clearing (or efficiency) wages to reduce employee turnover and/or shirking and to increase productivity.

8. (3) Demand-Deficient Unemployment Demand-deficient unemployment occurs when a decline in aggregate demand in the output market causes the aggregate demand for labor to decline in the face of downward inflexibility in real wages. W W0W0 W2W2 E S0S0 D0D0 D1D1 E0E0 E2E2 E1E1 If real wages are inflexible downward, E fall to E 1, and E 0 – E 1 workers will become unemployed. →Flows into unemployment increase while flows into employed decline. One appropriate government response to demand-deficient unemployment is to pursue macroeconomic policies to increase aggregate demand; these policies include increasing the level of government spending, reducing taxes, and increasing the rate of growth of the money supply.

9. Why employers respond to a cyclical decline in demand by temporarily laying off some of their work force rather than reducing real wages. Why employers respond to a cyclical decline in demand by temporarily laying off some of their work force rather than reducing real wages. a.Rigid money wage: employers are not free to unilaterally cut money wages because of the presence of unions. b.The asymmetry of the information between employers and employees makes layoffs the preferred policy. c.In the presence of investments in firm-specific human capital, layoffs affect only the least-experienced workers, the workers in whom the firm has invested the smallest amount of resources. →The firm will find choosing the layoff strategy a more profitable →The firm will find choosing the layoff strategy a more profitable alternative. alternative. d.A system of layoffs in which the newest employees are laid off first provides an implicit contract (a guarantee or form of insurance to experienced workers) that they will be immune to all but the severest declines in demand. →They will be willing to pay for the stability by accepting lower →They will be willing to pay for the stability by accepting lower wages. wages.

10. (4) Seasonal Unemployment Seasonal unemployment is similar to demand- deficient unemployment in that it is induced by fluctuations in the demand for labor. However, the fluctuations can be regularly anticipated and follow a systematic pattern over the course of a year. Seasonal unemployment is similar to demand- deficient unemployment in that it is induced by fluctuations in the demand for labor. However, the fluctuations can be regularly anticipated and follow a systematic pattern over the course of a year. e.g., Agricultural employee e.g., Agricultural employee To attract workers to such seasonal industries, firm will have to pay workers higher wages to compensate them for being periodically unemployed. To attract workers to such seasonal industries, firm will have to pay workers higher wages to compensate them for being periodically unemployed. →The existence of compensating wage differentials makes it difficult to evaluate whether this type of unemployment is voluntary or involuntary in nature. →The existence of compensating wage differentials makes it difficult to evaluate whether this type of unemployment is voluntary or involuntary in nature.

11. 3. Job Search Many theories claim to explain the existence and persistence of unemployment in competitive markets. Any given worker can choose from among many different job offers. Because it takes time to learn about the opportunities provided by different employers, search activities prolong the duration of the unemployment spell. The worker, however, is willing to endure a longer unemployment spell because it might lead to a higher-paying job. In fact, search unemployment is a human capital investment in information. Many theories claim to explain the existence and persistence of unemployment in competitive markets. Any given worker can choose from among many different job offers. Because it takes time to learn about the opportunities provided by different employers, search activities prolong the duration of the unemployment spell. The worker, however, is willing to endure a longer unemployment spell because it might lead to a higher-paying job. In fact, search unemployment is a human capital investment in information.

12. (1) The Wage Offer Distribution To simplify the analysis, we assume that search activities are conducted only by unemployed workers. The wage offer distribution gives the frequency distribution describing the various offers available to a particular unemployed worker in the labor market. To simplify the analysis, we assume that search activities are conducted only by unemployed workers. The wage offer distribution gives the frequency distribution describing the various offers available to a particular unemployed worker in the labor market. The unemployed worker knows the shape of the wage offer distribution. Search activities, however, are costly. Each time the worker applies for a new job, he incurs transportation and other types of search costs. Moreover, he is also forgoing earnings: He could have been working at a lower-paying job. The worker’s economic trade-offs are clear: The longer he searches, the more likely he will get a high wage offer; the longer he searches, however, the more it costs to find that job. The unemployed worker knows the shape of the wage offer distribution. Search activities, however, are costly. Each time the worker applies for a new job, he incurs transportation and other types of search costs. Moreover, he is also forgoing earnings: He could have been working at a lower-paying job. The worker’s economic trade-offs are clear: The longer he searches, the more likely he will get a high wage offer; the longer he searches, however, the more it costs to find that job.

13. (2) The Asking Wage The asking wage is the threshold wage that determines if the unemployed worker accepts or rejects incoming job offers. There is a clear link between a worker’s asking wage and the length of the unemployment spell the worker will experience. Workers who have low asking wages will find acceptable jobs very quickly and the unemployment spell will be short. Workers with high asking wages will take a long time to find an acceptable job and the unemployment spell will be very long. The asking wage is the threshold wage that determines if the unemployed worker accepts or rejects incoming job offers. There is a clear link between a worker’s asking wage and the length of the unemployment spell the worker will experience. Workers who have low asking wages will find acceptable jobs very quickly and the unemployment spell will be short. Workers with high asking wages will take a long time to find an acceptable job and the unemployment spell will be very long.

14. Dollars MR MC Wage Offer at Hand The Determination of the Asking Wage 0 $5 $10$20$25 The marginal revenue curve gives the gain from an additional search. It is downward sloping because the better the offer at hand, the less there is to gain from an additional search. The marginal cost curve gives the cost of an additional search. It is upward sloping because the better the job offer at hand, the greater the opportunity cost of an additional search. The asking wage equates the marginal revenue and the marginal cost of search.

15. The worker’s asking wage will respond to changes in the benefits and costs of search activities. Workers with high discount rates are present- oriented, and hence perceive the future benefits from search to be low. The worker’s asking wage will respond to changes in the benefits and costs of search activities. Workers with high discount rates are present- oriented, and hence perceive the future benefits from search to be low. A major component of search costs is the opportunity cost resulting from rejecting a job offer and continuing the search. The unemployment insurance (UI) system, compensates workers who are unemployed and who are actively engaging in search activities. Unemployment insurance benefits, therefore, reduce the marginal cost of search. A major component of search costs is the opportunity cost resulting from rejecting a job offer and continuing the search. The unemployment insurance (UI) system, compensates workers who are unemployed and who are actively engaging in search activities. Unemployment insurance benefits, therefore, reduce the marginal cost of search. (3) Determinants of the Asking Wage

16. 4. Inflation and Unemployment Note: Because our focus is on the labor market, we shall emphasize the price of labor-the wage rate-when discussing the issue of inflation. Note: Because our focus is on the labor market, we shall emphasize the price of labor-the wage rate-when discussing the issue of inflation. (1) The Inflation/Unemployment Trade-Off The negative relationship between unemployment and wage inflation was dubbed the Phillips curve. The negative relationship between unemployment and wage inflation was dubbed the Phillips curve. Rate of Wage Inflation Unemployment During the 1970s the relationship appears to have broken down. →An interpretation is that while a trade-off between the rates of inflation and unemployment exists at a point in time, the position of the trade-off curve is determined by a number of other factors that can change over time.

17. Rate of Wage Inflation ( ) Unemployment Rate (U) U0U0 W0W0 W1W1 W2W2 It is also possible that the Phillips curve has become much flatter over recent years, so that the decrease in wage inflation accompanying a 1% point increase in the unemployment rate is now smaller than it once was. 1960s 1970s Early 1980s Progressively higher rates of wage inflation have become associated with any given level of unemployment.

18. (2) The Basic Model of the Inflation/Unemployment Trade-Off Wage E Supply Demand W0W0 W1W1 W2W2 W3W3 W4W4 i.e., the percentage rate of change of wage ( ) is proportional to the excess demand for labor (X) It is reasonable to assume that the speed at which The wage rate changes is related to the extend to which the labor market is in disequilibrium, as measured by the excess demand for labor.

19. W X W=αX W1W1 X1X1 Excess Supply X<0 Excess Demand X>0 Excess Demand for Labor (X) U X1X1 U1U1 U* Relationship Between the Excess Demand for Labor and the Unemployment Rate Because the excess demand for labor is usually not observable, it is necessary to replace it with an observable variable, such as the unemployment rate. U* is the unemployment rate that exists when the excess demand for labor is zero. i.e., natural or full-employment rate of unemployment.

20. U W1W1 U1U1 U* W Trade-off Between Wage Inflation and the Unemployment Rate