Unemployment Flashcards
Inflation v unemployment trade off
- Policy makers reduce unemployment at a cost of higher inflation: prices rise over time as more people earn more money
- In bad times, employers can get workers to work at lower wages
Problems (of unemployment
- Reduces consumption, income
- Increase anxiety of losing your job
Concepts
- Employed -> working in a paid job
- Unemployed -> not employed but looking for a job
- Labour force -> all employed plays unemployed persons
- Rate of unemployment -> percentage of the labour force that is unemployed
- Even in bosoms there is unemployment, tends to be stable on average over time
Observations
- The unemployment rate is counter-cyclical (increases in recessions, decreases in booms)
- The long-run average varies a lot from country to country
“Cyclical” v “Natural” unemployment
- Natural rate of unemployment
The “normal” unemployment rate the economy experiences when it is neither in a recession or a boom - Prevails when the economy is neither is boom more recession (a.k.a average rate)
- Never zero: more workers than are employed would like to work
- Varies across countries and economies
- Depends only on structural parameters (i.e., separation & finding rate)
- Cyclical unemployment
The difference the actual and the natural rate (difference in cycles)
Unemployment is normal
- Most people change from N into UE, before finally changing into E due to search and matching friction
- N = unemployed and not searching
- Subsidies can encourage more people to enter (N —> L) into the labour market L, and most also falls into the UE group due to frictions
- People can move from active participation to inactive (L —> N)
Our Task
- Our previous analysis of economic fluctuations helps us to understand the fluctuations of unemployment around the natural rate (the cyclical component of the rate of unemployment)
- But what determines the natural rate of unemployment?
Labour Markets
- Separations:
Dismissals, redundancies, firm closures, quits, etc. - Search:
Of workers for firms, of firms for workers (vacancies)
Matches
The search and matching process takes time and effort
A basic model of the natural rate
L = No. of workers in labour force (fixed) (exogenous) —> Employed + Unemployed
E = Number of employed workers (endogenous) —> People who are in a paid job
U = Number of unemployed (endogenous) —> people who are unemployed and looking for as job
Unemployment rate: U/L
1) Working population consists of one more group: Out of Labour Force = E + U + N
2) Out of Labour Force (N) are people not unemployed but not actively finding a job
3) Individuals can move from L to N (i.e., go back to school)
Separations and Findings
- S is separation (E —> UE) = rate of job separation
Fraction of employed workers that become separated from their jobs in a given period (e.g. 1% per month) - Includes both quitting and layoff of workers
- f is job finding (UE —> E) = rate of job finding
Fraction of unemployed workers that find jobs in a given period (e.g. 20% per month) - Dependent on the number of vacancies posted by firms
- Household’s needs vacancies to be employed
- Subjected to search and matching friction
The job finding rate is the percentage of people who becomes employed, and people only get employed if there is a vacancy in the market: this is controlled by firms
S is the percentage who become unemployed. The effects of S are ambiguous and we can’t absolutely determine the overall effect of S
Computing the Natural Rate
- During booms, flows out of unemployed exceed flows in f x U > s x E
- During recessions, flows into unemployment exceed flows out f x U < s X E
- At the natural rate, flows in roughly equal flows out f x U = s x E
Solving for the Natural Rate (steady state)
s x E = f x U s x (L - U) = f x U s x L = (s + f) x U U/L = s/(s + f)
Implications
The natural rate of unemployment is larger if:
S is larger
F is smaller
Unemployment and Economic Fluctuations
In a recession by typical decrease in AD, unemployment rate increases because:
1) Job finding rate decreases -> harder to find a job as firm’s close and scale down production meaning lesser vacancies
2) Separation rate decreases -> some people leave their jobs due to contractions of labour market and/or lower wages, but a lot of people would rather stay in their job
Labour Market Policies and Insitutions
- Some separations and delays in job finding are inevitable, and so is some unemployment
- But policies and institutions can improve the effectiveness of job search, the incentives to both separations and searching, and the willingness of firms to open vacancies
