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Unemployment and Its Natural Rate

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Types of Unemployment

• In United States, people are considered unemployed if they are not working and actively seeking a job– Unemployment can arise for a variety of reasons, each

with its own policy implications– This is why economists have found it useful to classify

unemployment into four different categories– Frictional unemployment– Seasonal unemployment– Structural unemployment– Cyclical unemployment

» Each arises from a different cause and has different consequences

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Frictional Unemployment

• Short-term joblessness experienced by people who are between jobs or who are entering the labor market for first time or after an absence

• Because frictional unemployment is, by definition, short-term, it causes little hardship to those affected by it

• By spending time searching rather than jumping at the first opening that comes their way– People find jobs for which they are better suited and in

which they will ultimately be more productive

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Seasonal Unemployment

• Joblessness related to changes in weather, tourist patterns, or other seasonal factors

• Is rather benign– Short-term– Workers are often compensated in advance for

unemployment they experience in off-season• To prevent any misunderstandings, government

usually reports the seasonally-adjusted rate of unemployment– Rate that reflects only those changes beyond normal for

the month

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IDENTIFYING UNEMPLOYMENT

• Long-run versus Short-run Unemployment:– Long-run: The natural rate of unemployment – Short-run: The cyclical rate of unemployment

• Natural Rate of Unemployment– The amount of unemployment that the economy normally

experiences and does not go away on its own even in the long run.

• Cyclical Unemployment– Associated with with short-term ups and downs of the

business cycle and refers to the year-to-year fluctuations in unemployment around its natural rate.

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• 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?

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How Is Unemployment Measured?

• Unemployment is measured by the Bureau of Labor Statistics (BLS).– It surveys 60,000 randomly selected households every month.– The survey is called the Current Population Survey.

• Based on the answers to the survey questions, the BLS places each adult (over 16) years old into one of three categories:– Employed– Unemployed– Not in the labor force

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Employed, Unemployed, Not in the Labor Force, Labor Force

• Employed: A person is considered employed if he or she has spent most of the previous week working at a paid job.

• Unemployed: A person is unemployed if he or she is on temporary layoff, is looking for a job, or is waiting for the start date of a new job.

• Not in the Labor Force: A person who fits neither of these categories, such as a full-time student, homemaker, or retiree, is not in the labor force.

• Labor Force– The labor force is the total number of workers and the BLS

defines the it as the sum of the employed and the unemployed.

Figure 1 The Breakdown of the Population

Copyright©2003 Southwestern/Thomson Learning

AdultPopulation

(211.9 million)

Labor Force(141.8 million)

Employed(135.1 million)

Not in labor force(70.1 million)

Unemployed (6.7 million)

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Three indicators of labor market conditions• The unemployment rate, or

unemployed/labor force. Figure 20.1 makes clear the relation between unemployment and real GDP.

• The labor force participation rate, or labor force/working-age population. It fluctuates with real GDP as does unemployment.

• The employment-to-population ratio, or employed/working-age population. These ratios are given in Figure 20.3.

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Figure 20.1 (Macro 7)The Unemployment Rate

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Figure 20.2How to Find Labor Market Indicators

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Figure 20.3 Employment-to-Population Ratio for

Men, Women, and Everyone

Table 1 The Labor-Market Experiences of Various Demographic Groups

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Adjustments

• Because the labor force is composed of both full-time workers and a significant number of part-time workers, the number employed needs to be supplemented by other measures that reflect this fact. Aggregate hours = (average hours per worker) x (labor force participation) x (working-age population).

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Unemployment and GDP

• Increases in unemployment reduce real GDP as the labor input to production falls because fewer workers are employed. So an increase in the natural rate reduces potential real GDP, provided there are no accompanying changes in productivity to be accounted for.

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2. The Nature of Unemployment

• People become unemployed because they are job losers, job leavers, or new entrants. See Figure 20.4.

• Job losers are unemployed because of the dynamism of the economy: As jobs are created and destroyed, workers are often left unemployed in the process. As a consequence, job vacancies and unemployment exist at the same time, a reflection of this dynamism. However, job losers increase during recessions and decline during booms, as seen in Figure 20.4.

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Figure 20.4(Macro 7) Job Losers, Job Leavers, New Entrants and Re-entrants (January 2000)

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Unemployment• Job leavers, or quits, are relatively constant over

the cycle due to the opposing forces of reduced quits and fewer job vacancies in a recession.

• New entrants are a large fraction of the unemployed, especially on a seasonal basis.

• Most of the unemployed (85 percent) are unemployed for less than 6 months. See Figure However, the long-term unemployed (the other 15 percent) increase during recessions and decrease during booms.

• The rate of unemployment varies dramatically across groups in society, with very high unemployment rates among minority teenagers.

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Figure 20.10(Macro 7) Unemployment Rates for Young Adults (ages 20-24)

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Figure 20.11(Macro 7) Percentage of 20-24-year-olds Still Living with Parents

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Advantages of Household Survey• The unemployment rate and employment-

population ratios come from a monthly household survey which has the following advantages: – Time-consistent and large survey– Time lag in obtaining data is short.– Data is available on a disaggregated basis.– The unemployment rate provides information

about the business cycle.

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Disadvantages of Household Survey

• The monthly household survey has the following disadvantages: – Part-time workers are counted as fully employed even if

they wanted to work as a full-time worker.– Unemployed persons must be actively seeking work.– It does not measure persons who are subemployed.– Persons may provide false information.– All unemployed persons are counted equally. – The data contain no information about minimum

acceptable wages.

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Issues in Measuring Unemployment

• It is difficult to distinguish between a person who is unemployed and a person who is not in the labor force.– Discouraged workers, people who would like to work but

have given up looking for jobs after an unsuccessful search, don’t show up in unemployment statistics.

– Other people may claim to be unemployed in order to receive financial assistance, even though they aren’t looking for work.

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Stock-Flow Model• At any point in time, there is a measurable stock of people in each of the three boxes that represent categories of labor force status.

Population Not in the Labor Force

Unemployed

Employed

• But these stocks are simultaneously being depleted by flows in and out of each category.

• Changes in the rates of these flows can significantly affect the unemployment rate.

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Labor Market Flows

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Determining Full Employment• Some unemployment is voluntary and some

unemployment is involuntary.• The natural rate of unemployment is:

– The unemployment rate at which there is neither excess demand nor excess supply in the labor market, or

– The unemployment rate that will occur in the long run if the expected and actual rates of inflation are equal.

• The natural rate of unemployment changes over time.

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Question for Thought

1. Do you expect the natural rate of unemployment to (a) increase, (b) decrease, or (c) remain at the present level over the next decade? Explain your reasoning.

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Macroeconomic Output and Employment Determination

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Aggregate Demand

• Aggregate demand for goods and services indicates the total quantity of goods and services that domestic consumers, businesses, government, and foreign buyers will collectively desire to purchase at each price level.

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Aggregate Demand• The aggregate demand curve slopes downward

because of the– Interest rate effect

• A lower price level will reduce money demand and thus interest rates.• The lower interest rate will increase spending on goods such as

housing.

– Wealth or real balances effect• A lower price level will increase the real value of assets whose value is

fixed in nominal terms and thus raise spending.

– Foreign purchases effect• A lower price level will reduce the price of U.S. goods relative to

foreign goods and so foreigners will increase their spending on U.S. goods.

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Aggregate Supply• Aggregate supply of goods and services is the

relationship between the price level and total quantity of real output that firms are willing to produce and offer for sale. – The aggregate supply curve is upward sloping below the

natural rate of output.• Since wages are inflexible downward, a decrease in demand will result

in layoffs and reduce output.

– The aggregate supply curve is vertical at the natural rate of output.

• Greater demand increases can’t increase output since the economy is at full-employment.

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Real Output Determination

• The intersection of the aggregate demand and supply curves D and SkAASSc c produces equilibrium price and real output levels P0 and Qn.

Real Output

Price Level

Sc

D

Qn

P0

Sk

A

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Employment Determination

• In the aggregate labor market, the equilibrium wage rate and level of total employment are determined by the intersection of the aggregate labor demand supply curves.

• Employment level En is the natural rate of employment; it is the amount of labor needed to produce the natural level of real output.

Employment

Wage rateSL

DL

En

W0

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3. Determination of Employment and Unemployment

• The relationship between labor demand and supply is given in Figure 20.6, determining the equilibrium quantity of full-employment labor and the real wage.

• Two broad trends in labor are the general increase in real wages and employment. This is associated with a shift in the demand for labor, as seen in Figure 20.7, due in part to the growth of service industries, which hire more women. Women are quite sensitive to changes in real wages, so the increased demand in service industries probably explains the higher participation rate by women.

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Figure 20.6 (Macro 7) Labor Supply, Labor Demand, and Equilibrium Employment

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Figure 20.7 (Macro 7) Explaining the Increase in the Employment-to-Population Ratio

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Other Explanations for Unemployment• In order to account for unemployment in a model

such as Figure 20.6, it is necessary to introduce some explanation outside of equilibrium. Two complementary explanations are job rationing and job search.

• Job rationing is depicted in Figure 21.8 in terms of excess supply that is always present, not allowing for the normal downward price (real wage) adjustment due to: (1) the minimum wage law and its effect on teenage unemployment; (2) insiders sometimes preventing outsiders from being employed; (3) employers paying efficiency wages.

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Figure 20.8 (Macro 7) Excess Supply of Labor and Unemployment

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Policy implications of the demand and supply model of the labor market

• The policy implications of the demand and supply model of the labor market are discussed in terms of the effect on employment and the natural rate of unemployment.

• Taxes such as a payroll tax affect the demand for labor, as seen in Figure 20.13. For example, an increase in the social security tax will reduce the demand for labor by the amount of the tax, reducing the real wage and employment.

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Figure 20.13 (Macro 7) Effects of a Tax on Wages

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Why does unemployment occur?

• In an ideal labor market, wages would adjust to balance the supply and demand for labor, ensuring that all workers would be fully employed.

• Frictional unemployment refers to the unemployment that results from the time that it takes to match workers with jobs. In other words, it takes time for workers to search for the jobs that are best suit their tastes and skills.

• Structural unemployment is the unemployment that results because the number of jobs available in some labor markets is insufficient to provide a job for everyone who wants one.

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Frictional Unemployment and Job Search

• Job search – the process by which workers find appropriate

jobs given their tastes and skills. – results from the fact that it takes time for

qualified individuals to be matched with appropriate jobs.

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Job Search

• This unemployment is different from the other types of unemployment.– It is not caused by a wage rate higher than equilibrium.– It is caused by the time spent searching for the “right” job.

• Search unemployment is inevitable because the economy is always changing.

• Changes in the composition of demand among industries or regions are called sectoral shifts.

• It takes time for workers to search for and find jobs in new sectors.

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Public Policy and Job Search• Government programs can affect the time it takes unemployed

workers to find new jobs.– Government-run employment agencies

• Government-run employment agencies give out information about job vacancies in order to match workers and jobs more quickly.

– Public training programs• Public training programs aim to ease the transition of workers from

declining to growing industries and to help disadvantaged groups escape poverty.

– Unemployment insurance• Unemployment insurance is a government program that partially

protects workers’ incomes when they become unemployed. – Offers workers partial protection against job losses. – Offers partial payment of former wages for a limited time to those

who are laid off.

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Effects of Unemployment Insurance

• Unemployment insurance increases the amount of search unemployment.

• It reduces the search efforts of the unemployed.

• It may improve the chances of workers being matched with the right jobs.

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Structural Unemployment

• Structural unemployment occurs when the quantity of labor supplied exceeds the quantity demanded.

• Structural unemployment is often thought to explain longer spells of unemployment.

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Public Policy and Job Search

• Why is there Structural Unemployment?– Minimum-wage laws

• When the minimum wage is set above the level that balances supply and demand, it creates unemployment.

– Unions – Efficiency wages

Figure 4 Unemployment from a Wage Above the Equilibrium Level

Copyright©2003 Southwestern/Thomson Learning

Quantity ofLabor

0

Surplus of labor =Unemployment

Laborsupply

Labordemand

Wage

Minimumwage

LD LS

WE

LE

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UNIONS AND COLLECTIVE BARGAINING

• A union is a worker association that bargains with employers over wages and working conditions.

• In the 1940s and 1950s, when unions were at their peak, about a third of the U.S. labor force was unionized.

• A union is a type of cartel attempting to exert its market power.

• The process by which unions and firms agree on the terms of employment is called collective bargaining.

• A strike will be organized if the union and the firm cannot reach an agreement.

• A strike refers to when the union organizes a withdrawal of labor from the firm.

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• A strike makes some workers better off and other workers worse off.

• Workers in unions (insiders) reap the benefits of collective bargaining, while workers not in the union (outsiders) bear some of the costs.

• By acting as a cartel with ability to strike or otherwise impose high costs on employers, unions usually achieve above-equilibrium wages for their members.

• Union workers earn 10 to 20 percent more than nonunion workers.

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Are Unions Good or Bad for the Economy?

• Critics argue that unions cause the allocation of labor to be inefficient and inequitable.– Wages above the competitive level reduce the quantity of

labor demanded and cause unemployment.– Some workers benefit at the expense of other workers.

• Advocates of unions contend that unions are a necessary antidote to the market power of firms that hire workers.

• They claim that unions are important for helping firms respond efficiently to workers’ concerns.

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THE THEORY OF EFFICIENCY WAGES• Efficiency wages are above-equilibrium wages paid by firms in

order to increase worker productivity. • The theory of efficiency wages states that firms operate more

efficiently if wages are above the equilibrium level.• A firm may prefer higher than equilibrium wages for the

following reasons:– Worker Health: Better paid workers eat a better diet and thus are

more productive.– Worker Turnover: A higher paid worker is less likely to look for

another job.• A firm may prefer higher than equilibrium wages for the

following reasons:– Worker Effort: Higher wages motivate workers to put forward their

best effort.– Worker Quality: Higher wages attract a better pool of workers to

apply for jobs.

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Summary• The unemployment rate is the percentage of those who

would like to work but don’t have jobs.• The Bureau of Labor Statistics calculates this statistic monthly.• The unemployment rate is an imperfect measure of

joblessness.• In the U.S. economy, most people who become unemployed

find work within a short period of time.• Most unemployment observed at any given time is

attributable to a few people who are unemployed for long periods of time.

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Summary• One reason for unemployment is the time it takes for workers

to search for jobs that best suit their tastes and skills.• A second reason why our economy always has some

unemployment is minimum-wage laws.• Minimum-wage laws raise the quantity of labor supplied and

reduce the quantity demanded.• A third reason for unemployment is the market power of

unions.• A fourth reason for unemployment is suggested by the theory

of efficiency wages.• High wages can improve worker health, lower worker turnover,

increase worker effort, and raise worker quality.