Labour Economics Pt. 1

Question 1

What is the motivation between the flow / matching approach to the labour market?

Answer 1

• people move between employment, unemployment and inactivity
• the labour market is dynamic and understanding its dynamics is important for policy makers

Question 2

What are the 3 labour market states?

Answer 2

N = employed
U = unemployed
I = inactive

Pop= N + U + I

Question 3

What are the labour market rates?

Answer 3

1. Labour force: LF = N + U
2. Unemployment rate: u = U/LF
3. Employment rate: n = N/POP
4. Non-participation rate: I/Pop = 1 - PR
5. Participation rate: PR= (U+N)/Pop = LF / Pop

Question 4

What is the job finding rate?

Answer 4

U -> N flow / U

It is the proportion of unemployed finding a job.

Question 5

What is the job-to-job flow rate? Or ‘labour market churn’?

Answer 5

How many people change jobs as a proportion of N.

Fact: highest level reached in 2021 during the ‘Great Resignation’

Question 6

Is there aa 1-to-1 relationship between n and u?

Answer 6

No. There is no 1 to 1 relationship between the 2. If u falls, n will rise only if PR remains constant.

Why?

• n=PR(1-u)
• u=1 - (n/PR)

Question 7

Which of the following variables are pro-cyclical? Which are counter-cyclical?

u, n, i, PR

Answer 7

Pro-cyclical (rising during recovery): N, PR

Counter-cyclical (drops during a recovery): u, i

Question 8

Labour force policies and greater impacts:

Answer 8

1. policies that reduce unemployment by reducing the Labour Force (early retirement)

Can reduce n too, because PS shifts down and WS shifts up.

2. policies that seek to increase the LF (e.g.: later retirement age)

Tend to increase employment.

Question 9

What is the search theory?

Answer 9

Unemployment (employment, inactivity) is in ‘flowing’ equilibrium when flows into & out of unemployment are equal.

This type of equilibrium is called ‘flow equilibrium’.

Question 10

What does flow equilibrium require?

Answer 10

H = S
Hires (flows from unemployment to employment)
Separations (flows from employment to unemployment)
Inactivity is ignored in this model.

Question 11

What is a matching function? What is its algebraic form?

Answer 11

A matching function is a mathematical relationship that describes the formation of new relationships.

H= α x m(U, V), where α= matching efficiency

H higher if:

1. α higher
2. U higher
3. V higher

Question 12

What is S’s algebraic form?

Answer 12

S = sN, where s is the exit rate from employment;

s assumed constant and exogenous

Question 13

What is the algebraic form of the flow equilibrium?

Answer 13

H = S

α x m(U,V) = sN

Question 14

What is the trade off in the flow equilibrium?

Answer 14

Since s = α x m (U/N, V,N) and s is a constant number,

there is an inverse relationship (trade-off) between U and V.

When U is high, V must be low. When V is high, U must be low.

Question 15

What does the Beveridge curve show?

Answer 15

The Beveridge curve shows the combinations of U/N and V/N for which the labour market is in flow equilibrium (s constant along the Beveridge curve).

Question 16

What are the variables on the Beveridge curve axis?

Answer 16

• V/N = v, the vacancy rate

- U/N = u, a variant of the unemployment rate (moves in similar ways to the U/LF unemployment rate)

Question 17

What shifts the Beveridge curve? What do shifts in the Beveridge curve imply?

Answer 17

Matching efficiency (alpha - α) shifts the Beveridge curve.

1. Shifts too the right - decrease in matching efficiency
   If the curve shifts to the right, for the same vacancy rate there is a higher unemployment rate. Thus, matching efficiency decreased.
2. Shifts to the left - increase in matching efficiency
   If the curve shifts to the left, there is a lower rate of unemployment for the same vacancy rate. Thus, matching efficiency increased.

Question 18

What does the flow equilibrium guarantee if satisfied?

Answer 18

The flow equilibrium, if satisfied, implies constant employment and unemployment.

Question 19

Why is the Beveridge curve negatively sloped?

Answer 19

Because an increase in both v and u increases the number of hires, and s must be constant. (When either u or v is high, the other variable must be small).

Question 20

What is the WS-PS model focused on? What about the search-matching model?

Answer 20

The WS-PS model is a stocks model, the search-matching model is a flow model.

Question 21

Impacts of the vacancy rate:

Answer 21

1. increase in v raises the job-finding rate and worker’s bargaining power
2. for a high v, firms need to offer higher wages to fill vacancies

Question 22

How is the WS curve affected by the vacancy rate v?

Answer 22

W/ Pc = b(u, v, zw)

if v increases, W/Pc shifts up, Positive relationship between the two. Since W/Pc is horizontal, W/Pc will not change: the impact will be felt in terms of numbers employed.

Question 23

What does a high vacancy rate imply?

Answer 23

A high vacancy rate implies a lower equilibrium employment and a higher equilibrium unemployment.

In the u, v space, WS=PS is upward sloping, showing this positive relationship between u and v. The two models can be combined in the (u, v) space.

Question 24

What changes the equilibrium rate of unemployment?

Answer 24

1. Wage push and price push factors (shifts in the WS-PS curves)
2. Shifts in the Beveridge curve (changes in the matching efficiency)

Question 25

Where does the WS-PS equilibrium occur?

Answer 25

As the vacancy rate changes, the WS-PS equilibrium occurs at different unemployment rates.

Question 26

What happens to the WS if the share of LTU rises?

Answer 26

The WS shifts up. With a higher share of LTU, U has a lower effect in magnitude on dampening upward wage pressure.

Question 27

Will the economy return to equilibrium after a WS shift upwards as in increase in the share of LTU?

Answer 27

Yes, the equilibrium will be reached again. How fast the recovery is depends on how skilled the LTU are and their labour force attachment.

Question 28

What is the one possible theoretical explanation for the unemployment hysteresis?

Answer 28

When unemployment is high, some unemployed may become LTU, increasing the share of LTU out of the total U. This shifts the WS curve up, as unemployment has a lower effect on lowering wage pressures from employees (since LTU are a weak substitute for the employed and they exert relatively little competitive pressure on the labour market).

Question 29

What is the (labour market) hysteresis?

Answer 29

• Hysteresis is the idea that the equilibrium of a dynamic system (like the labour market) depends on the path history of that system.
• A kind of “path dependence”
• U rate in Europe is consistent with hysteresis

Question 30

Which are the factors which affect unemployment paths?

Answer 30

1. Determinants of shifts in U around equilibrium: due to policy or shocks
2. Determinants of equilibrium U: factors shifting the WS-PS curves as well as the Beveridge curve
3. Hysteresis & persistence mechanisms

Question 31

Which are the factors shifting WS-PS & Beveridge curve?

Answer 31

(a) WS shifts up with rise in: union power, better coordination, fall in cost of job loss
(b) PS shifts down with a rise in tax wedge, fall in productivity, fall in competitive pressure in the product market, rise in oil prices.
(c) Beveridge curve shifts right when mismatch increases.