Chapter 7 - Unemployment and the Labour Market Flashcards
Labor Market and Unemployment: What is the symbol for unemployment rate, natural unemployment rate, Recession, and Boom. What happens at Long Run Equilibrium?
Unemployment rate, U
Natural rate of unemployment, Un
Recession: U>Un and Y< Y bar
Boom: U<Un> Y bar
Long Run Equilibrium: U = Un and Y = Ybar</Un>
Explain Natural Rate of Unemployment: Why is there always unemployment, even at full employment (Un):
- Frictional Unemployment
Job Search is time consuming, because job search is a matching process
Mostly explains short unemployment * - Structural Unemployment
Due to Real Wage Rigidity
Mostly explains long unemployment *
Unemployment *: An uninterrupted period of weeks in which an individual was unemployed
Explain why Job Search is time consuming draw the diagram
. Frictional Unemployment
Job Search is time consuming, because job search is a matching process
Jobs need different qualifications
Workers have different skills, and preferences
Jobs and workers are in different locations, and workers are not perfectly mobile
Information is imperfect
Sectoral shifts
What happens because of Real Wage Rigidities and Structural Unemployment? Draw the Graph
Due to Real Wage Rigidity and Job Rationing. If the real wage for some reasons, cannot adjust properly to clear the labor market, unemployment is created
Draw the diagram With Frictional Unemployment if we ignore changes in participation rate
If we ignore changes in participation rate(when employed and/or unemployed workers can leave the labor market):
# of employed people who loss jobs = s * E
f*U = # of unemployed people who find jobs
What is the equilibrium formula for frictional unemployment.
L is the labor force
U = Unemployed:
E = Employed:
L=U+E or E=L−U
In equilibrium:
The number of people finding jobs each month (f×U) equals the number of people losing jobs each month (s×E).
f: The job-finding rate (fraction of unemployed people who find jobs each month).
s: The job-separation rate (fraction of employed people who lose their jobs each month).
f×U=s×E
Main formula: f×u = s×(1−u) so
Solving for u: u=s / s+f
If s increases (more people lose jobs): ∂s/∂u>0: Unemployment increases
If f increases (more people find jobs): ∂f/∂u<0: Unemployment decreases
With Frictional Unemployment what Public Policies would afffect job finding rate (f), job separation rate (s), and unemployment rate (u)?
Any shock or government policy that affects job finding rate (f) or job separation rate (s), would affect the unemployment rate, u
Some Examples of government policies:
1. Establishing government employment agencies to disseminate information about job openings to better match workers and jobs to reduce the frictional unemployment (and reduce the natural rate)
2. Public job training programs, which helps workers displaced from declining industries get skills needed for jobs in growing industries to reduce the frictional unemployment (an reduce the natural rate)
Frictional Unemployment and Public Policies: What is Employment Insurance (EI)?
Employment Insurance (EI) is designed to reduce the hardship of unemployment but it increases the frictional unemployment (and increases the natural rate)
The unemployed, receiving EI, are less pressed to find a new employment, and more likely to turn down an offer
Job finding Rate Falls
Given EI payments workers are less likely to seek jobs with more stable employment prospect to take possible better opportunities
Job Separation rate rises
More generous EI (higher payments and/or longer period of payments) leads to higher unemployment
Frictional Unemployment and Public Policies: What is the benefits of Employment Insurance (EI)? What do Economists propose to EI system to reduce negative impact on unemployment?
Benefits of EI
Reducing the hardship of unemployment
Reducing the workers income uncertainty
Allowing workers to reject unattractive job offers, so increasing the possibility of better matches between jobs and workers
Economists often propose reforms to EI system to reduce the negative impact on unemployment
One proposal is called 100% experience rated system which requires a firm to bear the full costs of its workers unemployment benefits
Most of the current programs are partial experience rated, as firms pay only part of the workers unemployment benefits that they lay off
Firms have incentive to lay off the workers, when there demand for labor is temporarily low
High temporary layoffs
Costly for government
Structural Unemployment and Minimum Wage: What are the negative impacts of minimum wage laws?
These laws have the biggest negative impact on the teenage unemployment, because teenage workers:
are among the least experienced and skilled workers with low marginal product of labor
take some “compensation” in form of gaining experience and on-job-training instead of direct pay.
Structural Unemployment and Minimum Wage: Why is minimum wage not the best way to help the working poor?
Minimum wage is not the best way to help the working poor:
It raises firm labor cost, so raises unemployment
It is poorly targeted. It affects teenage and young workers
It provides a very meager lifestyle. A full-time worker with minimum wage earns an income below the official poverty line
Many economists believe a refundable income tax credit is better than minimum wage to help poor workers. A plan that reduces low-income workers’ taxes. They can even receive payments from government, if their taxes fall below their credit.
Examples: Canada: Working income tax benefit , US: Earned income tax credit
These programs help in solving, simultaneously, high unemployment problem, and lagging productivity growth problem.
Best way for the transition from welfare to work.
Structural Unemployment and Minimum Wage: Explain Labour Unions & Collective Bargaining, Conflict of Interests, Insiders, Outsiders
Labor unions tend to increase labor compensation above market level.
Conflict of Interest: Between insiders and outsiders.
Insiders: employed union workers whose interest is to push wages high (more influential group)
Outsiders: unemployed non-union workers who prefer equilibrium wages, so there would be enough jobs for them.
Bargaining may happen in different levels: plant, industry, or national.
What is Efficiency Wage Theory?
Efficiency Wage: Efficiency Wage Theory: Based on this theory, the productivity of labor is increasing on the wage rate. So, employers are willing to pay higher wages above market level to enjoy higher productivity of labor
What are the 4 different efficiency efficiency wages
Health and Nutritional Issues: In poor countries with high poverty rate and malnutrition, some firms may pay higher than market clearing wage rate in order to improve the quality of the life and in turn the productivity of their labor force
Reducing the labor force turnover rate: This case is more relevant to advanced countries, where the labor force turnover is high, which raises labor costs for firms. So firms are willing to pay higher wages to make jobs more attractive for employees. Turnover = # of separation / # of workers
Adverse Selection (Hidden Information): Labor market is subject to adverse selection (so market failure), due to uncertainty that employers have about the quality (productivity of candidate workers (asymmetric information).
Asymmetric information: Akerlof’s Lemon Market and uncertainty about quality.
The employers offer to pay a higher wages/salaries then a possible market equilibrium to increase the average quality (productivity_ of workers in the pool of applicants. So, the firm gets a higher chance of hiring more productive labor
Moral Hazard (Hidden Action):
This may arise because of imperfect monitoring due to difficult and costly monitoring
Given that employers cannot perfectly verify the work quality of workers, workers may cut corners
A stick and carrot Strategy:
Employers on one hand tend to pay higher wages/salaries than market equilibrium in order to reduce the incentives for shirking, and increase the opportunity cost of losing the job
On the other hand employers run random checks and fire the worker who are caught shirking
What is Okun’s Law?
What is Okun’s Law?
Okun’s Law: This relation shows a negative correlation between real ouptut/income (GDP) growth and change in unemployment:
Ut - U t-1 = -B(gyt -gybar)
Annual change i the unemployment rate, growth rate of real output, normal rate:long run growth rate of real output
