WEEK 8 - Unemployment

Question 1

What is the Natural Rate of employment?

Answer 1

“normal” unemployment rate the economy experiences when it is neither in a recession nor a boom.

• Created by Friedman
• In a recession, the actual unemployment rate rises above the natural rate.
• In a boom, the actual unemployment rate falls below the natural rate.

Question 2

What does the NAIRU stand for and apply?

Answer 2

non-accelerating inflation rate of unemployment.

represents the rate of unemployment in an economy where there no tendency for the rate of inflation to change

Question 3

What are the differences between the NAIRU and the Natural Rate of unemployment?

Answer 3

NAIRU:

• assumes that the labour market is imperfectly competitive due to the presence of trade unions who have the power to bargain the wage rate
• consistent with the presence of involuntary unemployment

Natural Rate of Unemployment:

• assumes perfectly competitive markets (characterised by market clearing, where the labour market is in equilibrium
• No involuntary unemployment (people choose to be unemployed)

Question 4

What are the notations behind the natural rate model?

Answer 4

• L = No of workes in labour force
• E = No of employed workers
• U = No of unemployed
• U/L = Unemployed Rate

Question 5

What are the assumptions of the natural rate model?

Answer 5

1. L is exogenously fixed.
2. During any given month,
   s = rate of job separations,fraction of employed workers that become separated from their jobs
   f = rate of job finding, fraction of unemployed workers that find jobss and f are exogenous

Question 6

How do we denote people becoming unemployed and people becoming employed?

Answer 6

• Employed to Unemployed
  : s x E
• Unemployed to Employed:
  f x U

SEE IN NOTES

Question 7

When is the labour market in a steady state?

Answer 7

If unemployment rate constant

Denoted by:

s x E = f x U

Question 8

How do we find the equilibrium ‘U rate’?

Answer 8

f x U = s x E
= s x (L - U)
= s x L - s x U

Solve for U/L:
(f + s) x U = s x L

So,

U/ L = s/s + f

SEE EXAMPLE IN NOTES

Question 9

When will a policy reduce the natural rate of unemployment?

Answer 9

Only if it lowers s or increases f

Question 10

Why is there unemployment?

Answer 10

If job finding was instantaneous, and everyone who wants a job gets one (f=1), then all spells of unemployment be brief and natural rate near 0

Two reasons why f<1:

1. Job search
2. Wage rigidity

Question 11

What is Frictional Unemployment?

Answer 11

caused by the time it takes workers to search for a job

occurs even when wages are flexible and there are enough jobs to go around

Question 12

Why does Frictional Unemployment occur?

Answer 12

a. number of individuals have jobs which they are ill-suited to
b. also be a skills mismatch
c. Geographic friction

Question 13

Why does Frictional Unemployment occur?

Answer 13

Because,
a. workers have different abilities, preferences

b. jobs have different skill requirements
c. geographic mobility of workers not instantaneous
d. flow of information about vacancies and job candidates is imperfect

Question 14

What is a sectoral shift?

Answer 14

Changes in the composition of demand among industries or regions

e.g.
Technological change more jobs repairing computers, fewer jobs repairing typewriters

Can lead to frictional unemployment and may require re-skilling

Question 15

EXAMPLE OF STRUCTURAL CHANGE OVER THE LONG RUN IN UK

Answer 15

1960

• 57.9% Services
• 28.0% Manufacturing

2009:

• 79.0% Services
• 12.8% Manufacturing

Question 16

MORE EXAMPLES OF SECTORAL SHIFTS

Answer 16

-Industrial Revolution (1800s):
agriculture declines, manufacturing soars

• Energy crisis (1970s): demand shifts from larger cars to smaller ones
• Health care spending as % of GDP: 1960: 5.2 2000: 13.8 1980: 9.1 2010: 17.9

Question 17

What are the Govt policies affecting unemployment?

Answer 17

Govt employment agencies disseminate info about job openings to better match workers & jobs.
Public job training programs
help workers displaced from declining industries get skills needed for jobs in growing industries.

Question 18

What is Unemployment Insurance (UI)?

Answer 18

UI pays part of a worker’s former wages for a limited time after the worker loses his/her job.

Question 19

Why does UI increase search unemployment?

Answer 19

Reduces

• the opportunity cost of being unemployed
• the urgency of finding work
• f
• More likely to turn down job offers from this, behaviour reduce the rate of job finding. In addition, because workers know that their incomes are partially protected by unemployment insurance, they are less likely to seek jobs with stable employment prospects and are less likely to bargain for guarantees of job security

Question 20

Benefits of UI?

Answer 20

• By allowing workers more time to search
• UI may lead to better matches between jobs and workers,
  which would lead to greater productivity and higher incomes.

Question 21

What can unemployment from real wage rigidity lead to?

Answer 21

• If wages stuck above equilibrium, not enough jobs to cover supply (Demand> Supply)
• So firms must choose and be picky leading to Structural unemployment

Question 22

What is Structural Unemployment?

Answer 22

The unemployment resulting from real wage rigidity and job rationing.

Question 23

What are the reasons for wage rigidity?

Answer 23

1. Minimum wage laws
2. Labour unions
3. Efficiency wages

Question 24

Why do minimum wage laws cause wage rigidity?

Answer 24

The min. wage may exceed the equilibrium wage of unskilled workers, especially teenagers.
Studies: a 10% increase in min. wage reduces teen employment by 1–3%

Question 25

Why do labour unions cause wage rigidity?

Answer 25

Through exercising monopoly power, unions can secure wages for their worker that are above the market clearing wage, causing unemployment

Insiders: Employed union workers whose interest is to keep wages high.

Outsiders: Unemployed non-union workers who prefer equilibrium wages, so there would be enough jobs for them.

Question 26

EMPIRICALS ABOUT LABOUR UNIONS

Answer 26

In 2011, 11.8% of all workers in the U.S. were members of unions. The data on this slide show two things:

1) union workers typically earn more than non-union workers (about 22% more on average).
2) the greater the percentage of union workers in an industry, the higher the wage ratio (the correlation is about 0.5)

Question 27

Why do Efficiency wages cause labour rigidity?

Answer 27

Theories in which higher wages increase worker productivity by:
attracting higher quality job applicants
increasing worker effort, reducing “shirking”
reducing turnover, which is costly to firms
improving health of workers (in developing countries)

Firms willingly pay above-equilibrium wages to raise productivity.
Result: structural unemployment.

Question 28

SOME DATA FOR UNEMPLOYMENT

Answer 28

• Natural rate of US unemployment:
  rising until the early 80s, then falling from the mid-80s through the early 2000s.
• the trend in the real US minimum wage rises until the mid-to-late 1970s, then falls. The real minimum wage takes inflation into account
• Unemployment in Europe:
  the unemployment rate in the four largest nations in Europe between 1970 and 2010. (FR,GER,UK,ITA) but with few distinctions based on employment law, unions etc. But econ’s are interconnected