Chapter 10: Unemployment IssuesChapter 10: Unemployment Issues

Cost of Unemployment

Economic Cost:

– Loss of income for the individual– Cost of searching for new jobs– Loss of goods and services for the society

• The economy drops off the PPC and ends up at a combination inside the production possibilities space

– Payment of unemployment benefit

Cost of Unemployment

Social Cost:

– Loss of self-esteem and confidence– Family problems (violence and divorce)– Health problems (hart attacks and suicide)– Criminal activities

Labor Force

Individuals between 16 and 65, who are employed for pay or unemployed

Individuals in prisons or mental hospitals, children, and retired are excluded

Unemployment

Members of the labor force who are:– 16 years of age or older– out of work– actively looking for work

Unemployment rate = Unemployed Workers as a % of Labor Force

Discouraged Workers

Members of the labor force who quit looking for jobs (e.g., the homeless)

Unemployment rate is underestimated by 2 to 3% because discouraged workers are excluded

Frictional UnemploymentFrictional UnemploymentUnemployment of individuals who are searching for jobs or waiting between jobs

Example: college graduates entering the labor market

Supply-side effect and transitional. Need information about job openings.

Structural UnemploymentUnemployment due to fundamental economic changes that eliminate some jobs, while creating other jobs for which qualified workers may not be readily available

Example: the occupation of “typing” is disappeared by introduction of personal computers

Normal due to technological advancement and changes in consumer preferences

Cyclical Unemployment

Unemployment caused by contraction in economic activities

Example: companies lay-off workers during a recession

Needs public policy to increase employment

Full Employment Unemployment

Rate of unemployment:

Taking into account frictional and structural unemployment

Consistent with price stability

Usually 3-5 percent

Unemployment Trend

During the expansion of the 1960s, UR fell from 6.7% in 1961 to 3.5% in 1969In energy crises of the 1970s, UR rose to as high as 8.5% in 1975 and 9.7% in 1981After 1981-82 recession, UR fell to as low as 8.3% in 1989Since 1991-92 recession where UR rose to 7.4%, it has declined to about 4%Since 9/11/01, UR has gone up to about 5.7%

Circular Flow of Income & ProductTwo sectors: households, businesses

Two markets: product, labor

Households sell labor to make income and buy good & services from businesses

Businesses buy labor to produce good & services and sell to households

Simple Model

Businesses Households

Labor Resources

Income Payments

Goods & Services

Consumption Expenditures

Product Market

Labor Market

Model with Injections & Leakages

Businesses Households

Labor Resources

Income Payments

Goods & Services

Consumption Expenditures

Gov’t Exp.

Exports

Investment

Savings

Taxes

Imports

Total Expenditures

Aggregate Demand:

– Consumption Expenditures, C– Investment Expenditures, I– Government Expenditures, G– Exports less Imports, X-M

Aggregate Demand: C+I+G+X-M

Price Level

Output of Goods & Services

D

D

105

110A

B

200 400

Total Income

Aggregate Supply:

– Consumption Expenditures, C– Personal Savings, S– Income Taxes, T

Aggregate Supply: C+S+T

Price Level

Output of Goods & Services

105

110

200 400

S

S

Full Employment

Aggregate Equilibrium

Aggregate Demand = Aggregate Supply

C + I + G + X - M = C + S + TI + G + X = S + T + MInjections = Leakages

Equilibrium at less than Full Employment

Price Level

Output of Goods & Services

105

110

200 400

S

S

D

D

Full employment output

Equilibrium output

Demand Side Fiscal Policy

To increase Aggregate Demand

Fiscal Policy:– Increase government expenditures– Reduce income taxes

Expansionary Demand Policy

Output of Goods & Services

105

110

200 400

S

S

D

D

Full employment output

D’

D’

Price Level

Full employmentHigher price

Supply Side Fiscal Policy

To increase Aggregate Supply,

– Reduce personal and corporate tax rate to increase savings, investment, employment, and tax revenues

– Lower government spending to balance the budget

Expansionary Supply Policy

Output of Goods & Services

105

110

200 400

S

S

D

D

Full employment output

S’95

Price Level

Full employmentLower price

Accommodating Policy

Output of Goods & Services

105

200 400

S

S

D

D

Full employment output

D’

D’

Price Level

S’

Full employmentPrice stability