1. 23-1 Economics: Theory Through Applications

2. 23-2 This work is licensed under the Creative Commons Attribution-Noncommercial-Share Alike 3.0 Unported License. To view a copy of this license, visit http://creativecommons.org/licenses/by-nc-sa/3.0/or send a letter to Creative Commons, 171 Second Street, Suite 300, San Francisco, California, 94105, USA

3. 23-3 Chapter 23 Jobs in the Macroeconomy

4. 23-4 Learning Objectives What is the unemployment rate and how is it measured? What are the differences and the similarities in unemployment rates in the United States and Europe? If the labor market functions perfectly, what is the rate of unemployment? How does unemployment arise? What key features of labor markets does the static model of labor supply and labor demand fail to capture? What are some of the key facts about worker labor market flows?

5. Learning Objectives What is search theory and how is it useful for understanding labor market outcomes? What are the efficiency gains from flexible labor markets? What are the facts about hours worked across countries? What are the explanations for these differences in hours worked? What are common forms of government intervention in labor markets? Why do governments intervene? 23-5

6. Figure 23.1- Employment Transitions over Your Lifetime 23-6

7. Unemployment 23-7

8. Figure 23.2 - Unemployment Rates in France, the United States, and the Euro Area, 1985-2011 23-8

9. Figure 23.3- Labor Market 23-9

10. Figure 23.4 - Unemployment in the Labor Market 23-10

11. Inflexible Real Wages 23-11

12. Figure 23.5 - Worker Stocks in the U.S. 23-12

13. Figure 23.6 - Worker Flows in the United States 23-13

14. Table 23.1 - Output Level per Day in Different Jobs 23-14

15. Table 23.2 - Revised Output Level per Hour from Assigning Jobs 23-15

16. Figure 23.7 - Hours in Europe Relative to the United States 23-16

17. Figure 23.8 - Annual Hours in Various Countries 23-17

18. Where Do Differences in Hours Worked Come From? 23-18

19. Figure 23.9 - Labor Supply 23-19

20. Figure 23.10 - Differences in Hours Supplied 23-20

21. Figure 23.11 - Responsive and Unresponsive Labor Supply 23-21

22. Key Terms Discouraged worker: A discouraged worker is someone who would like a job, but who has stopped searching and is therefore classified as out of the labor force rather than unemployed Civilian labor force: The civilian labor force is the sum of the employed and the unemployed individuals Unemployment rate: The unemployment rate equals the number of unemployed divided by the civilian labor force 23-22

23. Key Terms Employment rate: The employment rate equals the number of employed divided by the civilian labor force Unemployment insurance: Unemployment insurance is a payment from the government to unemployed individuals Labor market: The labor market is the market which brings together households who supply labor services and firms who demand labor as an input into the production process Real wage: The real wage is the nominal wage corrected for inflation 23-23

24. Key Terms Equilibrium: Equilibrium in a market refers to an equilibrium price and an equilibrium quantity such that supply equals demand at the equilibrium price Nominal wage: The nominal wage is the wage in dollars paid to workers per unit of time Price level: The price level is a measure of average prices in the economy Cyclical unemployment: Cyclical unemployment is the component of unemployment that depends on the business cycle 23-24

25. Key Terms Efficiency wages: Efficiency Wages are wages in excess of the equilibrium real wage that are paid by firms in order to provide incentives for their workers to perform their duties Worker flows: Workers flows depict the movements of workers across the state of employment, unemployment and out of the labor force Unemployment duration: The duration of unemployment is the amount of time a typical worker spends searching for a new job 23-25

26. Key Terms Search theory: Search theory is a framework for understanding the flows of workers across periods of employment and unemployment along with the creation of job vacancies by firms Comparative advantage: A person has a comparative advantage in the production of one good if the opportunity cost, measured by the lost output of the other good, is lower for that person than for the other Absolute advantage: A person has an absolute advantage in the production of a good if that person can produce more of that good in a unit of time than the other person 23-26

27. Key Terms Frictional unemployment: Frictional unemployment is the unemployment that occurs when workers are moving between jobs Discounted present value: Discounted present value is a device for measuring flows that occur over time – It tells you the value of something you will receive in the future, discounted back to the present Natural rate of unemployment: The natural rate of unemployment is defined as the amount of unemployment we expect in an economy that is operating at full employment 23-27

28. Key Terms Individual labor supply curve: The individual labor supply curve is drawn on a diagram with the real wage on the vertical axis and the number of hours supplied on the horizontal axis – It tells us how many hours of labor an individual supplies at different values of the real wage Consumption smoothing: Consumption smoothing is the idea that households like to keep their flow of consumption relatively steady over time, smoothing over income changes 23-28

29. Key Takeaways The unemployment rate is the fraction of the civilian labor force looking for a job but currently not employed – The BLS in the United States produces this number on a monthly basis During the early apart of the 1980s, the unemployment experience in the United States and Europe were very similar – Up until 2008, the unemployment rate in Europe had been significantly higher than the unemployment rate in the United States – Very recently, however, the US unemployment rate climbed to European levels In a perfectly functioning labor market, the unemployment rate would be zero 23-29

30. Key Takeaways Possible explanations of unemployment include rigidities in wages, the market power of unions, and incentive effects The static model of labor supply and labor demand fails to capture the dynamics nature of worker flows, the processes of creating and destroying jobs and lacks a theory of unemployment In the United States, labor markets are very fluid. Each month, a significant fraction of workers lose their jobs and each month a significant fraction of unemployed workers find jobs 23-30

31. Key Takeaways Search theory provides a framework for understanding the matching of workers and jobs and for wage determination through a bargaining process The economy is operating efficiently when workers are assigned to jobs based upon comparative advantage – Inflexible labor markets lead to inefficient allocations of workers to jobs and thus to an economy operating below potential output Average hours worked varies over countries – In the United States, average hours worked are larger than in Europe One way to explain differences in hours worked is through the higher marginal labor income taxes paid in Europe 23-31

32. Key Takeaways Most governments provide workers with unemployment insurance – In many countries, governments also impose costs on firms that fire workers and also restrict hours worked One rationale for intervention by governments is to provide insurance to workers that is not available in private markets Governments also take action in an attempt to increase employment rates 23-32