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Copyright © 2001 by Harcourt, Inc.

Macroeconomic Objectives:Unemployment

Chapter 10, 265-273

What is the “natural” rate of unemployment?

How can we measure unemployment? Why can it be difficult to do so?

What are the types of unemployment? How do we graph them?

How does unemployment affect the market?

Macroeconomic Objectives and the Economy

There are three macroeconomic objectives: Full employment of the nation’s

resources: labor, land, capital Price level stability—low inflation rate Economic growth

Why does this matter?

Key terms Unemployment—idle, or not fully used

resources; people of working age who are actively seeking employment but who are not employed Unemployment of other resources will be refered

to as such: “unemployment of capital”

Underemployment—people of working age with part-time jobs who want full-time jobs, or with jobs that do not make full use of their education

Both terms mean an economy is inefficient by “wasting” scarce resources by not using them fully

How is Unemployment Measured?

The labor force participation rate is the percentage of the adult population that is in the labor force; those who are employed and unemployed of working-age.

100populationAdult

forceLabor =rateion participat forceLabor

How is Unemployment Measured?

The unemployment rate is calculated as the percentage of the labor force that is unemployed in an entire nation

100forceLabor

unemployedNumber =ratent Unemployme

Ex: if unemployment rate is 5%, 5 out of every 100 people in the labor force are unemployed.

Describing Unemployment

Three Basic Questions: How does government measure the

economy’s rate of unemployment? What problems arise in interpreting

the unemployment data? How long are the unemployed

typically without work?

Official statistics underestimate true employment due to hidden unemployment, excluded groups: Discouraged workers, “drop-outs” of the labor

force (could not find a job) Full-time vs part-time (both considered

employed) No distinction on type of work done Early retirees, retraining programs, those

working in underground economies Different population groups within a nation

(region, gender, ethnicity, age, occupation, education levels)

Does the Unemployment Rate Measure What We Want It To?

Consequences of Unemployment Loss of real output (real GDP) Loss of income for unemployed workers Loss of tax revenue for the government Costs to the government of unemployed benefits (also

reduces tax revenue, govt-provided services such as public goods, merit goods)

Cost to government of social problems: Unequal distribution of income (some become poorer while

others maintain or increase income) Long period unemployment can result in a harder time finding

a job (may lose some skills, education, firms relying on fewer workers)

Personal problems: loss of income could mean indebtedness, stress, lower levels of health, family tensions, etc.

Social problems: high rates of unemployment, especially when unequally distributed, can lead to serious problems such as unrest, increased crime/violence, drug use, and homelessness

CHECK IT! Define unemployment and explain how it

differs from underemployment. How is the unemployment rate measured? Why are unemployment figures inaccurate? Identify some of the economic and social

consequences of unemployment. In an economy with a labor force of 27.3

million people and 3.1 million unemployed people, 0.5 million discouraged workers, and 1.5 million part-time workers, what is the unemployment rate?

Categories of Unemployment

The problem of unemployment is usually divided into two categories.

The long-run problem and the short-run problem: The natural rate of unemployment—all

unemployment other than that caused by the business cycle (the sum of structural, frictional, and seasonal unemployment)

The cyclical rate of unemployment

Natural unemployment: structural

Why are there always some people unemployed? This question is related to structural unemployment—unemployment as a result of changes in demand (mostly DEMAND-SIDE phenomenon) for:

types of labor skills and/or geographical location of industry/jobsDue to technological innovation, structure of economy (agriculture vs. service), leads to mismatches between labor skills needed by employers and labor skills provided by workersPhysical location of industry could result in fall in demand for labor in one region, and increase in another; firms could move abroad; inability of workers to move to these structurally expanding regions could result in unemployment

labor market rigidities—factors preventing supply and demand from operating in the labor market:

Minimum wage legislation (price floors)labor union activities, wage bargaining (higher equilibrium wages)Employment protection laws (higher cost to firms)Generous unemployment benefits (increase attractiveness to remaining unemployed, reduce incentives to work)

Solutions: improved job-search techniques, outplacement counseling, retraining programs, tuition grants, low-cost education loans, subsidies or tax credits to businesses for retraining, relocation subsidies and loans, venture capital funds to help workers start new business, etc

Structural unemployment from mismatches between labor demand and supply are can be shown by a product supply and demand graph (at left).

Demand shifts from D1 to D2 (decrease) and Supply falls from Q2 to Q1.

Smaller quantity supplied means that firms will need less labor; those who lack skills for another industry or cannot relocate have structural unemployment.

Economists argue that market rigidities can cause higher unemployment rates in countries with strong labor protection systems (like Europe)

compared to countries with weaker labor protection systems (like US).

Natural unemployment: frictional Why can’t unemployed people just get a job? This

question is related to frictional unemployment—when workers are “between jobs” due to being fired, a failed firm, search for a better job, or waiting to start a new job (SUPPLY-SIDE) Frictional unemployment is usually short-term; does not

involved lack of skills in demand (less serious than structural)

Certain amount inevitable in any growing/changing economy Main cause: incomplete information between employers

and workers about job vacancies and required qualifications

How to fix? Measures to reduce time workers spend between jobs and improving information flows (i.e., websites, advertisements, employment agencies)

Seasonal unemployment—when demand for labor in certain industries changes on a seasonal basis because of different needs

Structural unemployment is a demand-side phenomenon. It changes as individuals' tastes and preferences change and buyers switch from one product to another, the demand for labor to produce some goods increases, while the demand for labor to produce other goods falls. Second, as technology changes, and capital becomes relatively more productive and less expensive, businesses tend to substitute capital for labor. This "automation" of the production process reduces the demand for certain types of labor. Finally, in a large country like the United States, regional wage differentials may make skills obsolete in some areas, while the demand is high in other areas.

Frictional unemployment is a supply-side phenomenon. It changes as workers enter and reenter the labor force and/or quit one job to look for another. The number of new entrants and reentrants depends principally upon demographics, changing attitudes toward work, government draft policies, and military preparedness. Given that new entrants and re-entrants continually flow into the labor market and given that some workers are always switching jobs, an element of frictional unemployment is always evident in the unemployment statistics.

Cyclical unemployment Cyclical rate of unemployment is caused

by a downturn in the business cycle, when the economy is in a recessionary gap (mostly a Keynesian concept) Due to declining or low aggregate demand (AD);

also known as demand-deficient unemployment As real GDP falls due to fall in AD,

unemployment increases as firms lay off workers

When the economy produces real GDP at the level of potential output, cyclical unemployment ends

Cyclical unemployment A decrease in aggregate demand results in an overall

decline in the level of spending in the economy and reduces the overall demand for labor.

Decreased spending is due to an excess of saving over investment, taxation over government spending, or imports over exports.

Cyclical unemployment is generally short-term, depending on the nature of the downturn. Some downturns or recessions are long, but not

severe Others are more protracted, but short-lived. Only the depressions are both long and severe

Economy initially producing potential output Yp, no cyclical unemployment. Fall in aggregate demand (AD) causes AD1 to shift to AD2, creating a recessionary gap as real GDP falls to Yrec.

At Yrec, new unemployment is cyclical. Policies to increase AD and eliminate recessionary gap (i.e., fiscal and monetary policies) can attempt to solve this type of unemployment.

So, what is full employment? Full employment exists when everybody who is willing and able

to work at the going wage (the labor force) is fully and gainfully employed and no involuntary unemployment exists (“natural unemployment”).

However, some involuntary unemployment always exists. At minimum, this "permanent" amount of unemployment will be partly frictional and partly structural. Frictional unemployment can be reduced with a better flow of job

information, increased job satisfaction, and improved placement of job applicants in job vacancies.

Structural unemployment, by its very nature, can only be reduced with increased programs for retraining and relocating displaced workers.

Frictional and structural unemployment can be reduced only at an increased cost.

NOTE: Employment can be increased even further, if the labor force itself is enlarged by minimizing voluntary unemployment. Voluntary unemployment can be reduced by increasing the going wage rate and improving the quality of jobs. Induced unemployment can be reduced by changing the quantity and timing of unemployment benefits. Note further that any attempt to increase the labor force also involves increased costs.

Unemployment on AD-AS model

(new classical model)Combined version on p. 272 of your book