Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition 1 Topic: Unemployment Macroeconomy in the Long Run

Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

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Topic: Unemployment

Macroeconomy in the Long Run


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Introduction

• Study unemployment:– Identify its causes– Improve public policies that affect the

unemployed

• Rate of unemployment = percentage of the labour force unemployed

• There is always some unemployment– What determines its level?


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Natural Rate of Unemployment

• Natural rate of unemployment = – The average rate of unemployment around

which the economy fluctuates– The steady-state rate of unemployment– Rate towards which the economy gravitates in

the long run


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Job loss, Job finding and the Natural rate of unemployment

• What determines the natural rate of unemployment?

• Notation: L = labour force E = number of employed workers U = number of unemployed workersL = E + URate of unemployment = U/L


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• Assume labour force is fixed• Focus on the transition of individuals between

employment and unemployment

s = rate of job separation: fraction of employed people who lose this job each month

f = rate of job finding: fraction of unemployed people who can find a job each month

• S and f determine the rate of unemployment



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Job loss, Job finding and the natural rate of unemployment

• If unemployment rate is staying the same i.e. not rising or falling = labour market is in steady state = – Number of people finding jobs = number of

people losing jobs

• fU = number of people finding jobs

• sE = number of people losing jobs

• Steady-state condition: fU = sE


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Job loss, Job Finding and the Natural Rate of Unemployment

• Finding the steady-state unemployment rate:– We know: E = L – U

i.e. number employed =

Labour force minus number unemployed– We know: fU = sE– Substitute (L – U) for E:

fU = s(L – U)


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Natural rate of unemployment

• To solve for the unemployment rate (U/L) in the steady state divide both sides of the equation by L:fU/L = s(1 – U/L)

• Solve for U/L:U/L = s/s+f

• Steady-state rate of unemployment (U/L) depends on the rates of job separation (s) and job finding (f)


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• Higher the rate of job separation = higher the unemployment rate

• Higher the rate of job finding = lower the unemployment rate

• To lower the natural rate of unemployment either:– Reduce rate of job separation or– Increase rate of job finding


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• Why is there unemployment?

• Model above assumes job finding is not instantaneous but why is it not?


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Job Search and Frictional Unemployment

• One reason for unemployment: takes time to match workers and jobs

• Frictional unemployment: – the time it takes workers to search for a job– It’s inevitable in a changing economy– As long as supply and demand of labour

among firms is changing, frictional unemployment will be present


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Public policy and frictional unemployment

• Public policy: seeks to decrease the natural rate of unemployment by reducing frictional unemployment:Examples:– Disseminating info on job vacancies– Retraining programs

• Unemployment Assistance/Benefit


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Real-Wage Rigidity and Wait Unemployment

• Second reason for unemployment: wage rigidity

• Wage rigidity = – The failure of wages to adjust until labour

supply equals labour demand– Wages are not always flexible


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Real-Wage Rigidity and Wait Unemployment

• Real-wage rigidity – reduces the rate of job finding and – Increases the level of unemployment

• Wait unemployment:– Unemployed not because they are searching

for jobs that suits their skills best but because at the going wage rate, supply of labour > demand for labour

– Waiting for jobs to become available


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Causes of wage rigidity

• Wait unemployment arises because firms fail to reduce wages

• Why?

• Three causes of wage rigidity:1. Minimum-wage laws

2. Monopoly power of unions

3. Efficiency wages


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1. Minimum-wage Laws

• Government prevents wages from falling to equilibrium levels

• In Ireland: National Minimum Wage Act, 2000:– From 1st May 2005, minimum wage = €7.65 per hour– Before May: €7.00 per hour– Applies to an experienced adult employee = an

employee who has any employment whatsoever in any two years over the age of 18

– Wage rate reviewed at regular intervals


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Minimum-Wage Laws

• For most employees it doesn’t apply because employer pays above the minimum wage

• But for some workers, e.g. unskilled or inexperienced workers the minimum wage raises their wage above its equilibrium level and reduces quantity demanded by firms


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Minimum-wage Laws

• Advocates of higher minimum-wage:– A means of raising the income of the working

poor– The cost of having more unemployment is

worth it to raise others out of poverty

• Opponents of higher minimum-wage:– Raises unemployment– Other ways of increasing incomes of the

working poor e.g. tax credits


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2. Unions and Collective Bargaining

• Monopoly power of unions :– Wages of unionised workers determined not by the

equilibrium of supply and demand but by collective bargaining

– Agreement often raises the wage rate above the equilibrium level

• Insiders: workers employed by a firm try to keep wages high

• Outsiders: the unemployed pay the cost of that because at a lower wage they may be hired


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Unions and Collective Bargaining

• In US wage bargaining takes place at the firm level – ‘outsiders’ have no influence

• In Ireland wage bargaining takes place at the national level – Social Partnership – unions, employers,

community and voluntary groups, farmers and government

– Includes ‘outsiders’ and ‘insiders’


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Unions and Collective Bargaining

• Social Partnership in Ireland (cont’d) - Six national agreements to date:– 1988 Programme for National Recovery– 1991 Programme for Economic and Social Progress– 1994 Programme for Competitiveness and Work– 1997 Partnership 2000– 2000 Programme for Prosperity and Fairness– 2003 Sustaining Progress


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3. Efficiency Wages

• Efficiency wage theories:– High wages make workers more productive – Influence of wages on worker efficiency may

explain failure of firms to cut wages despite an excess supply of labour

– Lower wages may reduce costs for firms but it would also lower worker productivity and thus a firm’s profits


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Efficiency Wages

• Theories:– Firms pay wages above equilibrium to

maintain a healthy workforce– Higher wages reduce labour turnover– Average quality of a firm’s workforce depends

on the wage it pays to its employees• Adverse selection

– Higher wages improves worker effort• Moral hazard


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Efficiency wages

• If a firm pays its workers a high wage, the firm operates more efficiently and the firm may find it more profitable to keep wages above the level that balances supply and demand


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Summary

• An economy’s steady-state unemployment rate depends on:– Rate of job separation and rate of job finding

• Two reasons for unemployment i.e. that job finding is not instantaneous:– Process of job search leading to frictional

unemployment– Wage rigidity leading to wait unemployment

• Wage rigidity arises from– Minimum-wage laws, unionisation and efficiency

wages


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Patterns of unemployment

• Duration of unemployment– Short-term unemployment more likely to be

frictional unemployment– Long-term unemployment more likely to be

wait unemployment

• Variations in unemployment rates across demographic groups e.g. younger vs. older people

Documents

Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition 1 Topic: Unemployment Macroeconomy in the Long Run