Chapter 22-Theory of Employment

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© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 1 of 25

Economic Goals

UnemploymentMeasuring UnemploymentComponents of the Unemployment RateThe Costs of Unemployment

InflationThe Costs of Inflation

Long-Run GrowthOutput and Productivity Growth

Looking Ahead

OUTLINE

Unemployment,Inflation, and

Long-Run Growth

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© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster

Economic Goals

1. Full Employment2. Stable Price3. Economic Growth4. Balanced Budget5. Balance of Payments

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Unemployment rate (%)

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LABOUR LAST DATE PREVIOUS HIGHEST LOWEST FORECAST UNIT

EMPLOYED PERSONS 38175.00 2013-09-30 37819.00 38545.00 18567.00 38201.64THOUSAND PERSONS

JOB VACANCIES 319720.00 2009-06-15 199942.00 319720.00 3036.00 307692.81 JOBS

UNEMPLOYMENT RATE 7.30 2013-06-30 7.50 13.90 6.30 7.40 PERCENT

UNEMPLOYED PERSONS 3002.00 2013-09-30 3086.00 4989.00 1720.00 2935.54THOUSAND PERSONS

WAGES 2613.30 2012-11-15 2509.00 2613.30 870.27 2351.02 INDEX POINTS

WAGES IN MANUFACTURING

1240.20 2012-11-15 1298.00 1391.40 638.86 1020.57 INDEX POINTS

POPULATION 95.80 2012-12-31 94.85 95.80 27.06 95.88 MILLION

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Unemployment

employed Any person 16 years old or older (1) who works for pay, either for someone else or in his or her own business for 1 or more hours per week, (2) who works without pay for 15 or more hours per week in a family enterprise, or (3) who has a job but has been temporarily absent with or without pay.

Measuring Unemployment

unemployed A person 16 years old or older who is not working, is available for work, and has made specific efforts to find work during the previous 4 weeks.

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Unemployment

not in the labor force A person who is not looking for work because he or she does not want a job or has given up looking.


labor force The number of people employed plus the number of unemployed.

labor force = employed + unemployed

population = labor force + not in labor force

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Unemployment

unemployment rate The ratio of the number of people unemployed to the total number of people in the labor force.


unemployedunemployment rate =

employed + unemployed

labor force participation rate The ratio of the labor force to the total population 16 years old or older.

labor forcelabor force participation rate =

population

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Unemployment

Components of the Unemployment Rate

Unemployment Rates in States and Regions

A Quiet Revolution: Women Join the Labor Force

If you are interested in learningmore about the economic history of American women, read the book Understanding the Gender Gap: An Economic History of American Women by Harvard University economist Claudia Goldin.

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Unemployment

Components of the Unemployment Rate

Discouraged-Worker Effects

discouraged-worker effect The decline in the measured unemployment rate that results when people who want to work but cannot find jobs grow discouraged and stop looking, thus dropping out of the ranks of the unemployed and the labor force.

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Unemployment

I. Components of the Unemployment Rate

The Duration of Unemployment

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Unemployment

2. The Costs of Unemployment

Some Unemployment Is Inevitable

When we consider the various costs of unemployment, it is useful to categorize unemployment into three types:

Frictional unemployment

Structural unemployment

Cyclical unemployment

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Unemployment

The Costs of Unemployment

Frictional, Structural, and Cyclical Unemployment

frictional unemployment The portion of unemployment that is due to the normal working of the labor market; used to denote short-run job/skill matching problems.

structural unemployment The portion of unemployment that is due to changes in the structure of the economy that result in a significant loss of jobs in certain industries.

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Unemployment


Frictional, Structural, and Cyclical Unemployment

natural rate of unemployment The unemployment that occurs as a normal part of the functioning of the economy. Sometimes taken as the sum of frictional unemployment and structural unemployment.

cyclical unemployment The increase in unemployment that occurs during recessions and depressions.

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Unemployment


Social Consequences

In addition to economic hardship, prolonged unemployment may also bring with it social and personal ills: anxiety, depression, deterioration of physical and psychological health, drug abuse (including alcoholism), and suicide.

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ASSUMPTIONS IN ATTAINING ECONOMIC EQUILIBRIUM

AE = Y

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Sectoral Flow of Economy and its Criteria

• 2 Sector Flow – HH and BF

• 3 Sectoral Flow– HH, BF and Govt

• 4 Sectoral Flow– HH, BF, Govt, Foreign Market

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Criteria

1. INCOME = SPENDING (SIMPLE ECONOMY)2. S = I

– S> I = RECESSION– S<I = INFLATION– Savings is discourage during recession (Figure of Planned and Savings vs Income)– Effect: Increase S, same I, decrease Y, reduce AE, Increase Unemployment– Investment is discourage during inflation– Read “Paradox of Thrift”

3. C + S + T = C + I + G (leakages = Injections) with Govt InterventionY = AEY = Yd

Since Yd = Y – TY = C + SY = C + S + TAE = C + I + G

Therefore AE = YC + S + T = C + I + GS + T = I + G

G > T = Budget Deficit

G< T = Budget Surplus

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Policies of Government

1. Monetary Policy• Contractionary• Expansionary• Mechanisms

2. Fiscal Policy• Contractionary• Expansionary• Mechanisms

• Multiplier effects• Any Change in I and G would result to increase in Y while an increase in T will cause a decrease in Y.

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Interaction Between Money and Goods Market

• Goods Market (effects of Tax and Govt spending)• Investment (crowding- out effect)• Money market (effects of interest rate). An in crease in Y of

consumers and price level change the Money demand. Change in RR, rediscount rate and stocks and bonds activities affects Money supply.

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RELATIONSHIP OF CHANGES IN MONEY AND GOODS MARKET TO UNEMPLOYMENT

• Change in goods market affects money market, and change in money market affects investment. • Change in investment leads to crowding out effect that limits the effects of change in government spending.• Any changes of the Y would affect the IS – LM model/• IS (investment-saving) and LM model indicates the relationship beetwen interest rate and Y when goods market is at

equilibrium. LM shows the relationship between interest rate and Y when money market is at equilibrium.• IS and LM model affects Aggregate Demand and Aggregate Supply.• Any change in AD and AS affects Price (inflation)• Inflation of price change negatively affects unemployment rate (Phillips Curve)• This is what we call the natural rate of inflation

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The Classical View of the Labor Market

Classical economists believe that the labor market always clears. If the demand for labor shifts from D0 to D1, the equilibrium wage will fall from W0 to W1. Anyone who wants a job at W1 will have one.

FIGURE 29.1 The Classical Labor Market

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The Classical Labor Market and the Aggregate Supply Curve

The classical idea that wages adjust to clear the labor market is consistent with the view that wages respond quickly to price changes. This means that the AS curve is vertical.

When the AS curve is vertical, monetary and fiscal policy cannot affect the level of output and employment in the economy.

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The Unemployment Rate and the Classical View

The unemployment rate is not necessarily an accurate indicator of whether the labor market is working properly.

The measured unemployment rate may sometimes seem high even though the labor market is working well.

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Explaining the Existence of Unemployment

Sticky Wages

sticky wages The downward rigidity of wages as an explanation for the existence of unemployment.

If wages “stick” at W0 instead of falling to the new equilibrium wage of W* following a shift of demand from D0 to D1, the result will be unemployment equal to L0 - L1.

FIGURE 29.2 Sticky Wages

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Sticky Wages

social, or implicit, contracts Unspoken agreements between workers and firms that firms will not cut wages.

Social, or Implicit, Contracts

relative-wage explanation of unemployment An explanation for sticky wages (and therefore unemployment): If workers are concerned about their wages relative to other workers in other firms and industries, they may be unwilling to accept a wage cut unless they know that all other workers are receiving similar cuts.

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Sticky Wages

explicit contracts Employment contracts thatstipulate workers’ wages, usually for a period of 1 to 3 years.

Explicit Contracts

cost-of-living adjustments (COLAs) Contract provisions that tie wages to changes in the cost of living. The greater the inflation rate, the more wages are raised.

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Efficiency Wage Theory

efficiency wage theory An explanation forunemployment that holds that the productivity of workers increases with the wage rate. If this is so, firms may have an incentive to pay wages above the market-clearing rate.

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Imperfect Information

Firms may not have enough information at their disposal to know what the market-clearing wage is. In this case, firms are said to have imperfect information.

If firms have imperfect or incomplete information, they may set wages wrong—wages that do not clear the labor market.

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Minimum Wage Laws

minimum wage laws Laws that set a floor for wage rates—that is, a minimum hourly rate for any kind of labor.

An Open Question

The aggregate labor market is very complicated, and there are no simple answers to why there is unemployment.

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The Short-Run Relationship Betweenthe Unemployment Rate and Inflation

The AS curve shows a positive relationship between the price level (P) and aggregate output (income) (Y).

FIGURE 29.3 The Aggregate Supply Curve

In the short run, the unemployment rate (U) and aggregate output (income) (Y) are negatively related.

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inflation rate The percentage change in the price level.

Phillips Curve A curve showing the relationship between the inflation rate and the unemployment rate.

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The Phillips Curve shows the relationship between the inflation rate and the unemployment rate.

FIGURE 29.5 The Phillips Curve

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• Keynesians who favored low unemployment targets argued for further government intervention in the form of wage and price controls• “Keynesian” models—short run models with various types of market imperfections• Long run models of a more “classical” character—rational expectations, policy neutrality• More emphasis on long run issues of government debt, growth, intergenerational issues

Documents

Chapter 22-Theory of Employment