Chapter 7-the Natural Rate Of Unemployment

The natural rate of unemployment is the unemployment that happens when the economy's production is at the long run level. It is the average rate of unemployment around which the economy fluctuates. The natural rate of unemployment is mainly determined by the economy's productive capacity and it's institutions.

In a recession, the unemployment rate will rise higher than the natural rate. In a boom, the unemployment rate will fall below natural rate.

The steady state is job loss=job finding. In other words, it's when inflow=outflow. The labor market is in steady state when the unemployment rate is constant.

Labor (L) is exogenous and fixed. During any given month, s (rate of job separation) and f (rate of job finding) is exogenous.

Market is in equilibrium when the MPL=real wage. There is no unemployment.

Wage rigidity and job search.

Frictional unemployment is the time it takes workers to find a job. It occurs when wages are flexible and there are enough jobs to go around. It occurs because workers have different abilities, preferences, jobs, and skill requirements. The geographic mobility of workers is imperfect and the flow of information about job vacancies and job candidates is imperfect.

Sectoral shifts are the changes in composition of demand among industries or regions. It results in frictional unemployment. Example: Technological change-more jobs repairing computers and less jobs repairing typewriters. Example: A new international trade agreement-Labor demand increases in export sector and decreases in import sector.

Government unemployment agencies release job info about job openings to better match workers and jobs. Public training programs help workers who were displaced from declining industries learn new skills.

UI is a mandatory insurance program that offers benefits to unemployed workers, funded by taxpayers. It pays part of the worker's former wages for a limited time. UI increases search unemployment because it reduces the opportunity cost of being fired and the urgency of finding work. The longer a worker is eligible for UI, the longer the duration of unemployment.

UI helps unemployed workers and their families maintain a minimum standard of living. By allowing workers more time to search, UI can lead to better matches between workers and jobs, which leads to better productivity and higher incomes.

Structural unemployment happens when the number of jobs available is not enough to match the number of people who want to work. This is a disequilibrium in the job market. Structural unemployment is caused by wage rigidity and job rationing.

If real wage is stuck above equilibrium level, there aren't enough wages to go around. Thus, firms must ration jobs among workers.

Minimum wage laws, labor unions, and efficiency wages all cause wage rigidity.

The minimum wage is usually higher than the equilibrium wage of unskilled workers. Increases in minimum wage can decrease employment of teen workers. Minimum wage can only explain a small part of unemployment since most worker's wages are well above the minimum wage.

Advocates believe it is a way of raising income among the working poor. Opponents believe that higher labor costs will decrease employment, which will eventually hurt the working poor. It is also poorly targeted, most minimum wage earners are teenagers from middle class families.

Labor unions exercise monopoly power to secure higher wages for their members. When union wages exceed the minimum wage, unemployment results. Insiders want to keep wages high while outsiders prefer equilibrium wages so there are enough jobs for them. Unions benefit insiders but make outsiders worse off.

The efficiency wage theory says that higher wages increase productivity by attracting higher quality job applicants, increasing worker effort, reducing turnover, and improving health of workers. Firms will willingly pay higher than equilibrium wages to increase productivity, this causes structural unemployment.

Well-paid workers work more hard and efficiently. If workers were paid minimum wage, they wouldn't be too concerned about losing their jobs.

Firms would choose where the effort limit is (highest possible)

The labor demand curve is the MPL given a certain level of effort. If real wage goes down, effort will go down, productivity will go down, and demand will go down.

Real wage cannot clear the market because if real wage decreases, the demand will go down (shift left) and the gap will remain. This means that there will always be unemployment.

High investment leads to higher labor demand, so the unemployment rate is lower than natural rate temporarily.

Cyclical unemployment happens when people are unemployed because the economy is functioning below it's productive capacity. In other words, it's unemployment due to business cycles.

Full employment is when all unemployment is structural or frictional, there is no cyclical unemployment.

frictional

cyclical

frictional

structural

Most unemployment in the short run is frictional, and most unemployment in the long run is due to sectoral shifts or structural.

Most unemployment is short term but most of the time spent unemployed are due to long term reasons (sectoral shifts and structural).

Discourage workers are unemployed people who cannot find jobs and leave the labor force. They reduce the unemployment rate.

Marginally attached workers are persons not in the labor force who want and are available for work and who have looked, but not recently. Discouraged workers are part of this category.

There was an increase in retired workers, disabled workers, and discouraged workers. There is an increase of students not wanting a job since theyre in school.

This is due to temporary shock in Europe when technological progress has shifted labor demand from unskilled to skilled workers, and generous unemployment benefits.

US workers work longer hours, and their employment/population ratio is higher. Europe has higher unemployment and and earlier retirement.

European has a high tax system which led to a higher underground economy so many work hours are not reported. Their unions are also more powerful. Income effect is much lower in europe than in america.