Lecture Macroeconomics: Lecture 9 - Prof. Dr.Qaisar Abbas

Review of the previous lecture

1. Key results from Solow model with tech progress
 steady state growth rate of income per person depends solely on
the exogenous rate of tech progress
 the U.S. has much less capital than the Golden Rule steady state

2. Ways to increase the saving rate
 increase public saving (reduce budget deficit)
 tax incentives for private saving


Review of the previous lecture
3. Productivity slowdown & “new economy”
 Early 1970s: productivity growth fell in the U.S. and other
countries.
 Mid 1990s: productivity growth increased, probably because of
advances in I.T.

4. Empirical studies
 Solow model explains balanced growth, conditional convergence
 Cross-country variation in living standards
due to differences in cap. accumulation and in production
efficiency


Lecture 9

Unemployment
Instructor: Prof.Dr.Qaisar Abbas

Lecture Outline

1. Natural rate of unemployment
2. Why is there unemployment?
3. Job search
4. Wage rigidity


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.
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
Assumptions
1.
L is exogenously fixed.
2.
During any given month,
s = fraction of employed workers that become separated from their
jobs,
f = fraction of unemployed workers that find jobs.

Natural rate of unemployment
s = rate of job separations
f = rate of job finding
(both exogenous)
The transitions between employment and unemployment


Natural rate of unemployment
The steady state condition: the labor market is in steady state, or long-run
equilibrium, if the unemployment rate is constant.
The steady-state condition is:

Solving for the “equilibrium” U rate
f

U

= s E
= s (L –U )
=s L – s U

Solve for U/L:
(f + s) U = s
so,

L


Natural rate of unemployment
Example:

Each month, 1% of employed workers lose their jobs (s = 0.01)
Each month, 19% of unemployed workers find jobs (f = 0.19)
Find the natural rate of unemployment:

U
L

s
s

f

0.01
0.01 0.19

0.05, or 5%

Policy implication
•A policy that aims to reduce the natural rate of unemployment will succeed only
if it lowers s or increases f.


How Is Unemployment Measured?
•Based on the answers to the survey questions, each adult is placed into one of
three categories:
Employed
Unemployed
Not in the labor force

•The BLS considers a person an adult if he or she is over 16 years old.

• A person is considered employed if he or she has spent most of the previous
week working at a paid job.

•A person is unemployed if he or she is on temporary layoff, is looking for a job,
or is waiting for the start date of a new job.

•A person who fits neither of these categories, such as a full-time student,
homemaker, or retiree, is not in the labor force.


How Is Unemployment Measured?
Labor Force
• The labor force is the total number of workers, including both the
employed and the unemployed.
• The BLS defines the labor force as the sum of the employed and the
unemployed.
The Breakdown of the Population


How Is Unemployment Measured?
•The unemployment rate is calculated as the percentage of the labor force that
is unemployed.

N u m b e r  u n e m p lo y e d
U n e m p lo y m e n t ra te =
100
L a b o r  f o r c e
•The labor-force participation rate is the percentage of the adult population that
is in the labor force.

L a b o r  f o r c e  p a r tic ip a tio n  r a te
L a b o r fo rc e
A d u lt p o p u la tio n

100


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
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


Why is there unemployment?
Sectoral shifts
def: changes in the composition of demand among industries or regions
example: Technological change
increases demand for computer repair persons, decreases demand for
typewriter repair persons

example: A new international trade agreement causes greater demand for
workers in the export sectors and less demand for workers in importcompeting sectors.
It takes time for workers to change sectors, so sectoral shifts cause frictional
unemployment.
more examples:
Late 1800s: decline of agriculture, increase in manufacturing
Late 1900s: relative decline of manufacturing, increase in service sector
1970s energy crisis caused a shift in demand away from huge gas
guzzlers toward smaller cars.
In our dynamic economy, smaller (though still significant) sectoral shifts occur
frequently, contributing to frictional unemployment.


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

Unemployment insurance (UI)
• UI pays part of a worker’s former wages for a limited time after losing his/her
job.
•UI increases search unemployment, because it:reduces the opportunity cost of
being unemployed, reduces the urgency of finding work hence, reduces f.
•The longer a worker is eligible for UI,
the longer the duration of the average spell of unemployment.
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.


Wage rigidity
Unemployment from real wage rigidity


Wage rigidity
Reasons for wage rigidity
1.Minimum wage laws
2.Labor unions
3.Efficiency wages (employers offer high wage as incentive for worker
productivity and loyalty)

The minimum wage
• The minimum wage is well below the eq’m wage for most workers, so it
cannot explain the majority of natural rate unemployment.
•

However, the minimum wage may exceed the eq’m wage of unskilled
workers, especially teenagers.

•

If so, then we would expect that increases in the minimum wage would
increase unemployment among these groups.


Wage rigidity

Labor unions
•Unions exercise monopoly power to secure higher wages for their members.
•When the union wage exceeds the eq’m wage, unemployment results.
•Employed union workers are insiders whose interest is to keep wages high.
•Unemployed non-union workers are outsiders and would prefer wages to
be lower (so that labor demand would be high enough for them to get jobs).


The duration of unemployment
# of weeks
unemployed

# of unemployed
persons as % of
total # of unemployed

amount of time these
workers spent
unemployed
as % of total time all
workers spent
unemployed

1-4

39%

6.5%

5-14

31%

20.5%

15 or more

30%

73.0%

• More spells of unemployment are short-term than medium-term or
long-term.
• Yet, most of the total time spent unemployed is attributable to the longterm unemployed.
•This long-term unemployment is probably structural and/or due to sectoral
shifts among vastly different industries.
•Knowing this is important because it can help us craft policies that are more
likely to succeed.


Summary
•

The natural rate of unemployment
 the long-run average or “steady state” rate of unemployment
 depends on the rates of job separation and job finding

•

Frictional unemployment

 due to the time it takes to match workers with jobs
 may be increased by unemployment insurance

•

Structural unemployment
 results from wage rigidity - the real wage remains above the equilibrium
level
 causes: minimum wage, unions, efficiency wages


Summary

•

Duration of unemployment
 most spells are short term
 but most weeks of unemployment are attributable to a small number of
long-term unemployed persons