11 - Unemployment Behaviour

Question 1

2 main hypotheses on unemployment behaviour

Answer 1

1) Natural rate of unemployment (Phelps, 1967 and Friedman, 1968)
- Any deviations from natural rate is temporary

2) Hysteresis (Blanchard and Summers, 1987)
- Any deviations from natural rate will be permanent

Question 2

Natural rate of unemployment graph

Answer 2

• ADL Curve Shows Negative relationship between wage and number of workers
• ASL curve shows positive relationship, as if you offer higher wages, the more people will want to work
• N curve = People in the working age, that don’t want to work. Economically inactive people (goes underneath the ASL curve, goes up next to it underneath)
• As wage decrease, gap increases between supply of labour and economically inactive people, higher the wages the more economically active people

Question 3

The hysteresis graph

Answer 3

• Same as natural rate of unemployment graph, but there’s 2 ADL curves
• A shock (covid) shifts AD curve inwards as it reduces demand for labour
• Unlike Natural rate of unemployment where it states when the shock improves the rate of unemployment will go back to its natural state, in the hysteresis the ASL curve shifts inwards creating a new rate of unemployment
• Showing shock is permanent as it doesn’t make it back to natural rate

Question 4

7 explanations for the change in labour supply in hysteresis

(Why labour supply doesn’t go back to its natural rate after a shock)
(Only need to know 4)

Answer 4

• path dependence and formation of preferences
• insider- outsider effect
• Depreciation of skills and search effectiveness
• path dependent stigma effects
• labour hoarding and labour market tightness
• institutional effects of cyclical unemployment
• capital formation and equilibrium rate of unemployment

Question 5

1) Path dependence and the formation of preferences

Answer 5

• Period of high cyclical unemployment may permanently change people’s preferences towards work, consumption and leisure

Question 6

2) Insider - outsider effects in wage determination

Answer 6

• People who remained employed (insiders) during the shock, were often able through their unions or close relationships with their employers, or because of possession of specific skill, to secure wage increases
• Insiders will protect their job, any new people will effect their chances getting promotion and may lower their wages
• Insiders put pressure on trade unions to increase their wages, if wages increase too much, motivation of firms to hire more people will reduce, So outsiders remain unemployed
• Solution = Reduce power of trade unions

Question 7

3) Depreciation of skills and search effectiveness

Answer 7

• The unemployed may find it difficult to maintain their skills. Just like physical capital, human capital is likely to depreciate in the absence of regular maintenance
• Long-term Unemployment may have a demoralising effect on search behaviour, contributing to a less efficient matching process
• when unemployed you don’t use your skills regularly, therefore will slowly lose them, will make it harder to find job later on
• Solution = - Efficient information system, help people find jobs quickly before they lose their skills
• Help people update their skills

Question 8

4) Path dependent stigma effects

Answer 8

• People care about their standing in society
• Individual disutility and stigma associated with unemployment depend on current as well as previous levels of unemployment
• Unemployment is very low in a country , (self-inflicted)
• Unemployment is very high in a country , (hit anyone)
• Unemployment is low in a country, get pressure from friends and family to find a job
• Unemployment is high in a country, no pressure to get a job, therefore high level of economically inactive people
• If there’s pressure, firms can offer lower wages, if there is not much pressure (high unemployment) firms offer high wages

Question 9

5) Labour hoarding and labour market tightness

Answer 9

• Lay off workers in periods of low demand may depend on how difficult it is to recruit workers
• If it’s costly to hire workers, a no lay-off strategy policy may be optimal as long as declines in demand are expected to be temporary
• Depends on labour market tightness
• Slack labour market = Lay-off strategy is optimal
• Tight labour market = Hoarding-Labour strategy is optimal
• Lay-off strategy = Don’t need that worker now, fire them, as there’s not enough demand, impact of shock is large
• Labour-hoarding = Even if you don’t need that worker you’ll keep them, even if demand is low. Impact of shock will not be very large

Question 10

6) Institutional effects of cyclical unemployment

Answer 10

• Labour market institutions, such as employment offices and training programs, usually do not adjust their capacity according to cyclical unemployment
• These institutions depend on government money
• Labour offices face hiring, training and firing costs that effectively prevent rapid expansions and contractions
• To help workers find another job, before they change their preferences

Question 11

7) Capital formation and equilibrium rate of unemployment

Answer 11

• During a recession capacity utilisation is reduced below its target level and that stimulates capital scrapping
• At the resulting lower level of capital there is a new and higher equilibrium rate of unemployment, which persists even when the deflationary forces come to an end
• There’s capital to labour ratio - Cannot hire more labour (workers) if you don’t have enough physical capital
• During a recession you don’t update your capital therefore cannot hire more workers until capital increased
• Help firm increase physical capital
• Solution = Reduce tax rates, government aid, change interest rates so firms can borrow more