Chapter 11

Unemployment and Labor

Force Participation

This outline is based on Cowen and Tabarrok (2011)

111 Defining Unemployment

The US Census Bureau conducts a monthly survey of approxi-

mately 60000 households to assess the state of the labor market

Current Population Survey

Unemployment is calculated as a percentage of the labor

force To be in the labor force you either have to be working

or actively looking for a job Children most students retirees

1

prisoners and others that are confined to medical or mental

institutions are not in the labor force

Here are some important definitions

Unemployed to be counted as unemployed a person must not

have a job but be actively looking for one

Employed To be employed you have to either

1 have a job outside of the home

2 have a job inside the home and be paid for doing it

Labor Force consists of people 16 years of age and older who

are either employed (working) or unemployed (not working

but looking)

Unemployed + Employed = Labor Force

We usually exclude people who are institutionalized (eg

penal and mental facilities homes for the aged) and the

Civilian Labor Force excludes active duty military person-

nel

Discouraged Worker A worker who wants to work but has

quit looking for a job

Marginally Attached Worker Persons not in the labor force

who want and are available for work and who have looked

2

for a job sometime in the prior 12 months (or since the

end of their last job if they held one within the past 12

months) but were not counted as unemployed because they

had not searched for work in the 4 weeks preceding the

survey Discouraged workers are a subset of the marginally

attached httpwwwblsgovblsglossaryhtmM

Underemployment These workers have part-time jobs but

would prefer full-time work It also includes discouraged

workers The government series is U-6 Total unemployed

plus all marginally attached workers plus total employed

part time for economic reasons (U6RATE) U-6 peaked at

171 in April 2010 It has fallen to 137 (August 2013)

Historically this is still quite high (average is 106 since

1994)

Unemployment Rate The unemployment rate represents the

number of unemployed as a percentage of the labor force

Labor force data are restricted to people 16 years of age

and older who currently reside in 1 of the 50 states or the

District of Columbia who do not reside in institutions and

who are not on active duty in the Armed Forces U-3

Unemployment Rate =Unemployed

Unemployed + Employedtimes 100

=Unemployed

Labor Forcetimes 100

3

prisoners and others that are confined to medical or mental

institutions are not in the labor force

Here are some important definitions

Unemployed to be counted as unemployed a person must not

have a job but be actively looking for one

Employed To be employed you have to either

1 have a job outside of the home

2 have a job inside the home and be paid for doing it

Labor Force consists of people 16 years of age and older who

are either employed (working) or unemployed (not working

but looking)

Unemployed + Employed = Labor Force

We usually exclude people who are institutionalized (eg

penal and mental facilities homes for the aged) and the

Civilian Labor Force excludes active duty military person-

nel

Discouraged Worker A worker who wants to work but has

quit looking for a job

Marginally Attached Worker Persons not in the labor force

who want and are available for work and who have looked

2

for a job sometime in the prior 12 months (or since the

end of their last job if they held one within the past 12

months) but were not counted as unemployed because they

had not searched for work in the 4 weeks preceding the

survey Discouraged workers are a subset of the marginally

attached httpwwwblsgovblsglossaryhtmM

Underemployment These workers have part-time jobs but

would prefer full-time work It also includes discouraged

workers The government series is U-6 Total unemployed

plus all marginally attached workers plus total employed

part time for economic reasons (U6RATE) U-6 peaked at

171 in April 2010 It has fallen to 137 (August 2013)

Historically this is still quite high (average is 106 since

1994)

Unemployment Rate The unemployment rate represents the

number of unemployed as a percentage of the labor force

Labor force data are restricted to people 16 years of age

and older who currently reside in 1 of the 50 states or the

District of Columbia who do not reside in institutions and

who are not on active duty in the Armed Forces U-3

Unemployment Rate =Unemployed

Unemployed + Employedtimes 100

=Unemployed

Labor Forcetimes 100

3

for a job sometime in the prior 12 months (or since the

end of their last job if they held one within the past 12

months) but were not counted as unemployed because they

had not searched for work in the 4 weeks preceding the

survey Discouraged workers are a subset of the marginally

attached httpwwwblsgovblsglossaryhtmM

Underemployment These workers have part-time jobs but

would prefer full-time work It also includes discouraged

workers The government series is U-6 Total unemployed

plus all marginally attached workers plus total employed

part time for economic reasons (U6RATE) U-6 peaked at

171 in April 2010 It has fallen to 137 (August 2013)

Historically this is still quite high (average is 106 since

1994)

Unemployment Rate The unemployment rate represents the

number of unemployed as a percentage of the labor force

Labor force data are restricted to people 16 years of age

and older who currently reside in 1 of the 50 states or the

District of Columbia who do not reside in institutions and

who are not on active duty in the Armed Forces U-3

Unemployment Rate =Unemployed

Unemployed + Employedtimes 100

=Unemployed

Labor Forcetimes 100

3

Figure 111 Employment to Population

Part-Time in the US part-time is working between 1 and 34

hours per week

Employment-Population Ratio this is another measure of

the condition of the labor force

Employment-Population Ratio =Employed

Working Age Population

4

Links to Updated FRED Graphs

Unemployment U-3 httpresearchstlouisfedorg

fred2graphg=sX2

Employment-to-Population httpresearchstlouisfed

orgfred2graphg=sX4

LFP httpresearchstlouisfedorgfred2graphg=

sX6

Unemployment U-6 httpresearchstlouisfedorg

fred2graphg=sWJ

Hours Worked httpresearchstlouisfedorgfred2

graphg=sX8

Hours Worked Usually during recessions hours worked de-

cline Such was the case after the financial crisis of 2007

See Figure 112

How can the unemployment rate fall when em-

ployment goes down

Recently wersquove seen reductions in the unemployment rate (nor-

mally a good thing) that were viewed as a bad sign for the labor

market This happens if those looking but unable to find a job

drop out of the labor force Here is a simple example

5

Links to Updated FRED Graphs

Unemployment U-3 httpresearchstlouisfedorg

fred2graphg=sX2

Employment-to-Population httpresearchstlouisfed

orgfred2graphg=sX4

LFP httpresearchstlouisfedorgfred2graphg=

sX6

Unemployment U-6 httpresearchstlouisfedorg

fred2graphg=sWJ

Hours Worked httpresearchstlouisfedorgfred2

graphg=sX8

Hours Worked Usually during recessions hours worked de-

cline Such was the case after the financial crisis of 2007

See Figure 112

How can the unemployment rate fall when em-

ployment goes down

Recently wersquove seen reductions in the unemployment rate (nor-

mally a good thing) that were viewed as a bad sign for the labor

market This happens if those looking but unable to find a job

drop out of the labor force Here is a simple example

5

Figure 112 Hours Worked ndash 2006 to present

6

Figure 113 Civilian Unemployment Rate

7

Figure 114 Population Labor Force Employment and Unemployed since

1947 Notice that after the financial crisis (2007-2008) that the growth rates

of the labor force and the population begin to diverge Employment dipped

and more Americans are being lsquosupportedrsquo by fewer workers Also notice how

the number of unemployed (right-hand scale) is fairly variable rising sharply

at the beginning of recessions and falling rather slowly once they end The

rate of decline appears to be fairly constant after each recession

8

Suppose we have 6 people employed and 4 others unemployed

The unemployment rate is

4

6 + 4times 100 = 40

Now suppose one of the 4 unemployed drops out of the labor

force3

6 + 3times 100 = 33

Magically the unemployment rate drops to 33 even though

the number of people actually employed has stayed the same

If the economy canrsquot generate enough jobs then eventually

the labor force will shrink and the unemployment rate along

with it This is one reason why we look at other indicators of

the state of the labor market to guage its health

Why are people Unemployed

1 Lose your job

2 Quit your job

3 New entrant into the labor force

4 Re-enter the labor force after being out of it for a while

9

112 Frictional Unemployment

Frictional unemployment is short-term unemployment caused by

the ordinary difficulties of matching employee to employer

bull This type of unemployment is usually short in duration

bull Innovation and competition drive progress Progress cre-

ates new jobs and destroys old jobs Good restaurants dis-

place bad ones

bull This type of unemployment is due to things like changing

jobs turnover new entrants into the labor force and so on

bull A certain amount of this kind of unemployment is a good

thing For the overall health of the economy it is impor-

tant that people are constantly being matched with things

for which they are better suited and its helpful for employ-

ers to be able to replace workers with ones that fit better

Freedom of choice on supply and demand sides of the labor

market create frictional unemployment

113 Structural Unemployment

Structural unemployment persistent long-term unemployment

caused by long-lasting shocks or permanent features of an econ-

10

omy that make it more difficult for some workers to find jobs

Shocks (unexpected economic events) could be technological

due to conflict weather or other natural disasters

1 One cause is large economy-wide shocks that occur rela-

tively quickly Adjusting to these shocks can create long-

lasting unemployment as the economy takes time to restruc-

ture

2 Labor regulations can lead to structural unemployment

(a) Unemployment Benefits ndash the higher the benefit the

more it pays to stay unemployed

(b) Minimum Wages ndash this limits new low skilled entrants

into the labor force

(c) Unions ndash insiders vs outsiders Insiders already work

for a firm and have some influence over the wage rate

They act to prevent lower wages which reduces a firms

willingness to hire and train new workers

(d) Employment-at-will This doctrine allows people to be

hired and fired at any time for any reason It con-

tributes to lower levels of structural unemployment

Countries with more rigid labor markets tend to have

much higher unemployment rates

11

Figure 115 Hiring and Firing The more costly it is to do the more unem-

ployment a country experiences

12

With this kind of unemployment the number of job openings

may be equal to the number of job applicants But the available

applicants are not qualified for the available jobs

114 Cyclical Unemployment

This is unemployment due to fluctuations of GDP around its

potential When we are in a recession GDP is below potential

and people who would like to work cannot find jobs

The normal level of unemployment (structural + frictional)

is consistent with an economy that creates new jobs and destroys

old ones due mainly to progress This is called the natural rate

of unemployment

Fluctuations of the actual unemployment rate around this

natural rate is blamed on cyclical factors (business cycle) which

at least in recession represents are real opportunity cost to the

economy as a whole

Estimates of the Natural Rate and its variation

The Congressional Budget Office estimates it to be 55 Economists

from the San Francisco Fed estimated it to be 67 in early 2011

13

(Weidner and Williams 2011)

The natural rate of unemployment depends on things like

institutions (unionization unemployment benefits labor market

regulations retraining opportunities etc) and things that affect

friction like labor mobility information exchanges work ethic

and so on

The natural rate rose in the 1960s and 70s as there was a

large influx of new entrants into the labor force (first time job

seekers and women enter the LF in large numbers) It takes new

entrants longer to match up with available jobs

In the most recent recession relaxing eligibility for SNAP

extension of unemployment benefits and other programs have

increased incentives to wait for better opportunitiesndashthus in-

creasing the level of structural unemployment in the US

115 Labor Force Participation

There are numerous things that affect a countryrsquos LFP Essen-

tially itrsquos a matter of demographics and incentives See Figure

116

1 Life-Cycle effects (changing demographics) more teenagers

14

are avoiding the LF Retirement ages and preferences also

have a big impact

2 Retirement benefits ndash how these are structured and who

qualifies has a big effect on when a person decides to retire

3 Cultural changes ndash feminism divorce rates widely available

inexpensive birth control etc

4 The degree of mismatch between job seekers and employers

has widened According to Weidner and Williams (2011)

ldquo[t]he construction finance and real estate sectors have

shrunk after the bursting of the housing bubble and the sub-

sequent financial crisis The skills of workers who used to be

employed in those sectors may not be easily transferable to

growing sectors such as education and health care (see Riss-

man 2009 and Barnichon et al 2010 httpwwwfrbsf

orgpublicationseconomicspapers2010wp10-32bk

pdf) Similarly the housing bust has left millions of home-

owners underwater on their mortgages which locks them

in to their homes and may make it more difficult for them

to move to higher growth areas These sectoral and geo-

graphic mismatches between workers and job openings may

be making it harder for employers to fill vacanciesrdquo

5 Tax rates ndash high marginal tax rates discourage work item

Weidner and Williams (2011) claim that another explana-

tion for the current increase ldquoinvolves the sizable increase

15

Figure 113 Civilian Unemployment Rate

7

Figure 114 Population Labor Force Employment and Unemployed since

1947 Notice that after the financial crisis (2007-2008) that the growth rates

of the labor force and the population begin to diverge Employment dipped

and more Americans are being lsquosupportedrsquo by fewer workers Also notice how

the number of unemployed (right-hand scale) is fairly variable rising sharply

at the beginning of recessions and falling rather slowly once they end The

rate of decline appears to be fairly constant after each recession

8

Suppose we have 6 people employed and 4 others unemployed

The unemployment rate is

4

6 + 4times 100 = 40

Now suppose one of the 4 unemployed drops out of the labor

force3

6 + 3times 100 = 33

Magically the unemployment rate drops to 33 even though

the number of people actually employed has stayed the same

If the economy canrsquot generate enough jobs then eventually

the labor force will shrink and the unemployment rate along

with it This is one reason why we look at other indicators of

the state of the labor market to guage its health

Why are people Unemployed

1 Lose your job

2 Quit your job

3 New entrant into the labor force

4 Re-enter the labor force after being out of it for a while

9

112 Frictional Unemployment

Frictional unemployment is short-term unemployment caused by

the ordinary difficulties of matching employee to employer

bull This type of unemployment is usually short in duration

bull Innovation and competition drive progress Progress cre-

ates new jobs and destroys old jobs Good restaurants dis-

place bad ones

bull This type of unemployment is due to things like changing

jobs turnover new entrants into the labor force and so on

bull A certain amount of this kind of unemployment is a good

thing For the overall health of the economy it is impor-

tant that people are constantly being matched with things

for which they are better suited and its helpful for employ-

ers to be able to replace workers with ones that fit better

Freedom of choice on supply and demand sides of the labor

market create frictional unemployment

113 Structural Unemployment

Structural unemployment persistent long-term unemployment

caused by long-lasting shocks or permanent features of an econ-

10

omy that make it more difficult for some workers to find jobs

Shocks (unexpected economic events) could be technological

due to conflict weather or other natural disasters

1 One cause is large economy-wide shocks that occur rela-

tively quickly Adjusting to these shocks can create long-

lasting unemployment as the economy takes time to restruc-

ture

2 Labor regulations can lead to structural unemployment

(a) Unemployment Benefits ndash the higher the benefit the

more it pays to stay unemployed

(b) Minimum Wages ndash this limits new low skilled entrants

into the labor force

(c) Unions ndash insiders vs outsiders Insiders already work

for a firm and have some influence over the wage rate

They act to prevent lower wages which reduces a firms

willingness to hire and train new workers

(d) Employment-at-will This doctrine allows people to be

hired and fired at any time for any reason It con-

tributes to lower levels of structural unemployment

Countries with more rigid labor markets tend to have

much higher unemployment rates

11

Figure 115 Hiring and Firing The more costly it is to do the more unem-

ployment a country experiences

12

With this kind of unemployment the number of job openings

may be equal to the number of job applicants But the available

applicants are not qualified for the available jobs

114 Cyclical Unemployment

This is unemployment due to fluctuations of GDP around its

potential When we are in a recession GDP is below potential

and people who would like to work cannot find jobs

The normal level of unemployment (structural + frictional)

is consistent with an economy that creates new jobs and destroys

old ones due mainly to progress This is called the natural rate

of unemployment

Fluctuations of the actual unemployment rate around this

natural rate is blamed on cyclical factors (business cycle) which

at least in recession represents are real opportunity cost to the

economy as a whole

Estimates of the Natural Rate and its variation

The Congressional Budget Office estimates it to be 55 Economists

from the San Francisco Fed estimated it to be 67 in early 2011

13

(Weidner and Williams 2011)

The natural rate of unemployment depends on things like

institutions (unionization unemployment benefits labor market

regulations retraining opportunities etc) and things that affect

friction like labor mobility information exchanges work ethic

and so on

The natural rate rose in the 1960s and 70s as there was a

large influx of new entrants into the labor force (first time job

seekers and women enter the LF in large numbers) It takes new

entrants longer to match up with available jobs

In the most recent recession relaxing eligibility for SNAP

extension of unemployment benefits and other programs have

increased incentives to wait for better opportunitiesndashthus in-

creasing the level of structural unemployment in the US

115 Labor Force Participation

There are numerous things that affect a countryrsquos LFP Essen-

tially itrsquos a matter of demographics and incentives See Figure

116

1 Life-Cycle effects (changing demographics) more teenagers

14

are avoiding the LF Retirement ages and preferences also

have a big impact

2 Retirement benefits ndash how these are structured and who

qualifies has a big effect on when a person decides to retire

3 Cultural changes ndash feminism divorce rates widely available

inexpensive birth control etc

4 The degree of mismatch between job seekers and employers

has widened According to Weidner and Williams (2011)

ldquo[t]he construction finance and real estate sectors have

shrunk after the bursting of the housing bubble and the sub-

sequent financial crisis The skills of workers who used to be

employed in those sectors may not be easily transferable to

growing sectors such as education and health care (see Riss-

man 2009 and Barnichon et al 2010 httpwwwfrbsf

orgpublicationseconomicspapers2010wp10-32bk

pdf) Similarly the housing bust has left millions of home-

owners underwater on their mortgages which locks them

in to their homes and may make it more difficult for them

to move to higher growth areas These sectoral and geo-

graphic mismatches between workers and job openings may

be making it harder for employers to fill vacanciesrdquo

5 Tax rates ndash high marginal tax rates discourage work item

Weidner and Williams (2011) claim that another explana-

tion for the current increase ldquoinvolves the sizable increase

15

Figure 114 Population Labor Force Employment and Unemployed since

1947 Notice that after the financial crisis (2007-2008) that the growth rates

of the labor force and the population begin to diverge Employment dipped

and more Americans are being lsquosupportedrsquo by fewer workers Also notice how

the number of unemployed (right-hand scale) is fairly variable rising sharply

at the beginning of recessions and falling rather slowly once they end The

rate of decline appears to be fairly constant after each recession

8

Suppose we have 6 people employed and 4 others unemployed

The unemployment rate is

4

6 + 4times 100 = 40

Now suppose one of the 4 unemployed drops out of the labor

force3

6 + 3times 100 = 33

Magically the unemployment rate drops to 33 even though

the number of people actually employed has stayed the same

If the economy canrsquot generate enough jobs then eventually

the labor force will shrink and the unemployment rate along

with it This is one reason why we look at other indicators of

the state of the labor market to guage its health

Why are people Unemployed

1 Lose your job

2 Quit your job

3 New entrant into the labor force

4 Re-enter the labor force after being out of it for a while

9

112 Frictional Unemployment

Frictional unemployment is short-term unemployment caused by

the ordinary difficulties of matching employee to employer

bull This type of unemployment is usually short in duration

bull Innovation and competition drive progress Progress cre-

ates new jobs and destroys old jobs Good restaurants dis-

place bad ones

bull This type of unemployment is due to things like changing

jobs turnover new entrants into the labor force and so on

bull A certain amount of this kind of unemployment is a good

thing For the overall health of the economy it is impor-

tant that people are constantly being matched with things

for which they are better suited and its helpful for employ-

ers to be able to replace workers with ones that fit better

Freedom of choice on supply and demand sides of the labor

market create frictional unemployment

113 Structural Unemployment

Structural unemployment persistent long-term unemployment

caused by long-lasting shocks or permanent features of an econ-

10

omy that make it more difficult for some workers to find jobs

Shocks (unexpected economic events) could be technological

due to conflict weather or other natural disasters

1 One cause is large economy-wide shocks that occur rela-

tively quickly Adjusting to these shocks can create long-

lasting unemployment as the economy takes time to restruc-

ture

2 Labor regulations can lead to structural unemployment

(a) Unemployment Benefits ndash the higher the benefit the

more it pays to stay unemployed

(b) Minimum Wages ndash this limits new low skilled entrants

into the labor force

(c) Unions ndash insiders vs outsiders Insiders already work

for a firm and have some influence over the wage rate

They act to prevent lower wages which reduces a firms

willingness to hire and train new workers

(d) Employment-at-will This doctrine allows people to be

hired and fired at any time for any reason It con-

tributes to lower levels of structural unemployment

Countries with more rigid labor markets tend to have

much higher unemployment rates

11

Figure 115 Hiring and Firing The more costly it is to do the more unem-

ployment a country experiences

12

With this kind of unemployment the number of job openings

may be equal to the number of job applicants But the available

applicants are not qualified for the available jobs

114 Cyclical Unemployment

This is unemployment due to fluctuations of GDP around its

potential When we are in a recession GDP is below potential

and people who would like to work cannot find jobs

The normal level of unemployment (structural + frictional)

is consistent with an economy that creates new jobs and destroys

old ones due mainly to progress This is called the natural rate

of unemployment

Fluctuations of the actual unemployment rate around this

natural rate is blamed on cyclical factors (business cycle) which

at least in recession represents are real opportunity cost to the

economy as a whole

Estimates of the Natural Rate and its variation

The Congressional Budget Office estimates it to be 55 Economists

from the San Francisco Fed estimated it to be 67 in early 2011

13

(Weidner and Williams 2011)

The natural rate of unemployment depends on things like

institutions (unionization unemployment benefits labor market

regulations retraining opportunities etc) and things that affect

friction like labor mobility information exchanges work ethic

and so on

The natural rate rose in the 1960s and 70s as there was a

large influx of new entrants into the labor force (first time job

seekers and women enter the LF in large numbers) It takes new

entrants longer to match up with available jobs

In the most recent recession relaxing eligibility for SNAP

extension of unemployment benefits and other programs have

increased incentives to wait for better opportunitiesndashthus in-

creasing the level of structural unemployment in the US

115 Labor Force Participation

There are numerous things that affect a countryrsquos LFP Essen-

tially itrsquos a matter of demographics and incentives See Figure

116

1 Life-Cycle effects (changing demographics) more teenagers

14

are avoiding the LF Retirement ages and preferences also

have a big impact

2 Retirement benefits ndash how these are structured and who

qualifies has a big effect on when a person decides to retire

3 Cultural changes ndash feminism divorce rates widely available

inexpensive birth control etc

4 The degree of mismatch between job seekers and employers

has widened According to Weidner and Williams (2011)

ldquo[t]he construction finance and real estate sectors have

shrunk after the bursting of the housing bubble and the sub-

sequent financial crisis The skills of workers who used to be

employed in those sectors may not be easily transferable to

growing sectors such as education and health care (see Riss-

man 2009 and Barnichon et al 2010 httpwwwfrbsf

orgpublicationseconomicspapers2010wp10-32bk

pdf) Similarly the housing bust has left millions of home-

owners underwater on their mortgages which locks them

in to their homes and may make it more difficult for them

to move to higher growth areas These sectoral and geo-

graphic mismatches between workers and job openings may

be making it harder for employers to fill vacanciesrdquo

5 Tax rates ndash high marginal tax rates discourage work item

Weidner and Williams (2011) claim that another explana-

tion for the current increase ldquoinvolves the sizable increase

15

Suppose we have 6 people employed and 4 others unemployed

The unemployment rate is

4

6 + 4times 100 = 40

Now suppose one of the 4 unemployed drops out of the labor

force3

6 + 3times 100 = 33

Magically the unemployment rate drops to 33 even though

the number of people actually employed has stayed the same

If the economy canrsquot generate enough jobs then eventually

the labor force will shrink and the unemployment rate along

with it This is one reason why we look at other indicators of

the state of the labor market to guage its health

Why are people Unemployed

1 Lose your job

2 Quit your job

3 New entrant into the labor force

4 Re-enter the labor force after being out of it for a while

9

112 Frictional Unemployment

Frictional unemployment is short-term unemployment caused by

the ordinary difficulties of matching employee to employer

bull This type of unemployment is usually short in duration

bull Innovation and competition drive progress Progress cre-

ates new jobs and destroys old jobs Good restaurants dis-

place bad ones

bull This type of unemployment is due to things like changing

jobs turnover new entrants into the labor force and so on

bull A certain amount of this kind of unemployment is a good

thing For the overall health of the economy it is impor-

tant that people are constantly being matched with things

for which they are better suited and its helpful for employ-

ers to be able to replace workers with ones that fit better

Freedom of choice on supply and demand sides of the labor

market create frictional unemployment

113 Structural Unemployment

Structural unemployment persistent long-term unemployment

caused by long-lasting shocks or permanent features of an econ-

10

omy that make it more difficult for some workers to find jobs

Shocks (unexpected economic events) could be technological

due to conflict weather or other natural disasters

1 One cause is large economy-wide shocks that occur rela-

tively quickly Adjusting to these shocks can create long-

lasting unemployment as the economy takes time to restruc-

ture

2 Labor regulations can lead to structural unemployment

(a) Unemployment Benefits ndash the higher the benefit the

more it pays to stay unemployed

(b) Minimum Wages ndash this limits new low skilled entrants

into the labor force

(c) Unions ndash insiders vs outsiders Insiders already work

for a firm and have some influence over the wage rate

They act to prevent lower wages which reduces a firms

willingness to hire and train new workers

(d) Employment-at-will This doctrine allows people to be

hired and fired at any time for any reason It con-

tributes to lower levels of structural unemployment

Countries with more rigid labor markets tend to have

much higher unemployment rates

11

Figure 115 Hiring and Firing The more costly it is to do the more unem-

ployment a country experiences

12

With this kind of unemployment the number of job openings

may be equal to the number of job applicants But the available

applicants are not qualified for the available jobs

114 Cyclical Unemployment

This is unemployment due to fluctuations of GDP around its

potential When we are in a recession GDP is below potential

and people who would like to work cannot find jobs

The normal level of unemployment (structural + frictional)

is consistent with an economy that creates new jobs and destroys

old ones due mainly to progress This is called the natural rate

of unemployment

Fluctuations of the actual unemployment rate around this

natural rate is blamed on cyclical factors (business cycle) which

at least in recession represents are real opportunity cost to the

economy as a whole

Estimates of the Natural Rate and its variation

The Congressional Budget Office estimates it to be 55 Economists

from the San Francisco Fed estimated it to be 67 in early 2011

13

(Weidner and Williams 2011)

The natural rate of unemployment depends on things like

institutions (unionization unemployment benefits labor market

regulations retraining opportunities etc) and things that affect

friction like labor mobility information exchanges work ethic

and so on

The natural rate rose in the 1960s and 70s as there was a

large influx of new entrants into the labor force (first time job

seekers and women enter the LF in large numbers) It takes new

entrants longer to match up with available jobs

In the most recent recession relaxing eligibility for SNAP

extension of unemployment benefits and other programs have

increased incentives to wait for better opportunitiesndashthus in-

creasing the level of structural unemployment in the US

115 Labor Force Participation

There are numerous things that affect a countryrsquos LFP Essen-

tially itrsquos a matter of demographics and incentives See Figure

116

1 Life-Cycle effects (changing demographics) more teenagers

14

are avoiding the LF Retirement ages and preferences also

have a big impact

2 Retirement benefits ndash how these are structured and who

qualifies has a big effect on when a person decides to retire

3 Cultural changes ndash feminism divorce rates widely available

inexpensive birth control etc

4 The degree of mismatch between job seekers and employers

has widened According to Weidner and Williams (2011)

ldquo[t]he construction finance and real estate sectors have

shrunk after the bursting of the housing bubble and the sub-

sequent financial crisis The skills of workers who used to be

employed in those sectors may not be easily transferable to

growing sectors such as education and health care (see Riss-

man 2009 and Barnichon et al 2010 httpwwwfrbsf

orgpublicationseconomicspapers2010wp10-32bk

pdf) Similarly the housing bust has left millions of home-

owners underwater on their mortgages which locks them

in to their homes and may make it more difficult for them

to move to higher growth areas These sectoral and geo-

graphic mismatches between workers and job openings may

be making it harder for employers to fill vacanciesrdquo

5 Tax rates ndash high marginal tax rates discourage work item

Weidner and Williams (2011) claim that another explana-

tion for the current increase ldquoinvolves the sizable increase

15

112 Frictional Unemployment

Frictional unemployment is short-term unemployment caused by

the ordinary difficulties of matching employee to employer

bull This type of unemployment is usually short in duration

bull Innovation and competition drive progress Progress cre-

ates new jobs and destroys old jobs Good restaurants dis-

place bad ones

bull This type of unemployment is due to things like changing

jobs turnover new entrants into the labor force and so on

bull A certain amount of this kind of unemployment is a good

thing For the overall health of the economy it is impor-

tant that people are constantly being matched with things

for which they are better suited and its helpful for employ-

ers to be able to replace workers with ones that fit better

Freedom of choice on supply and demand sides of the labor

market create frictional unemployment

113 Structural Unemployment

Structural unemployment persistent long-term unemployment

caused by long-lasting shocks or permanent features of an econ-

10

omy that make it more difficult for some workers to find jobs

Shocks (unexpected economic events) could be technological

due to conflict weather or other natural disasters

1 One cause is large economy-wide shocks that occur rela-

tively quickly Adjusting to these shocks can create long-

lasting unemployment as the economy takes time to restruc-

ture

2 Labor regulations can lead to structural unemployment

(a) Unemployment Benefits ndash the higher the benefit the

more it pays to stay unemployed

(b) Minimum Wages ndash this limits new low skilled entrants

into the labor force

(c) Unions ndash insiders vs outsiders Insiders already work

for a firm and have some influence over the wage rate

They act to prevent lower wages which reduces a firms

willingness to hire and train new workers

(d) Employment-at-will This doctrine allows people to be

hired and fired at any time for any reason It con-

tributes to lower levels of structural unemployment

Countries with more rigid labor markets tend to have

much higher unemployment rates

11

Figure 115 Hiring and Firing The more costly it is to do the more unem-

ployment a country experiences

12

With this kind of unemployment the number of job openings

may be equal to the number of job applicants But the available

applicants are not qualified for the available jobs

114 Cyclical Unemployment

This is unemployment due to fluctuations of GDP around its

potential When we are in a recession GDP is below potential

and people who would like to work cannot find jobs

The normal level of unemployment (structural + frictional)

is consistent with an economy that creates new jobs and destroys

old ones due mainly to progress This is called the natural rate

of unemployment

Fluctuations of the actual unemployment rate around this

natural rate is blamed on cyclical factors (business cycle) which

at least in recession represents are real opportunity cost to the

economy as a whole

Estimates of the Natural Rate and its variation

The Congressional Budget Office estimates it to be 55 Economists

from the San Francisco Fed estimated it to be 67 in early 2011

13

(Weidner and Williams 2011)

The natural rate of unemployment depends on things like

institutions (unionization unemployment benefits labor market

regulations retraining opportunities etc) and things that affect

friction like labor mobility information exchanges work ethic

and so on

The natural rate rose in the 1960s and 70s as there was a

large influx of new entrants into the labor force (first time job

seekers and women enter the LF in large numbers) It takes new

entrants longer to match up with available jobs

In the most recent recession relaxing eligibility for SNAP

extension of unemployment benefits and other programs have

increased incentives to wait for better opportunitiesndashthus in-

creasing the level of structural unemployment in the US

115 Labor Force Participation

There are numerous things that affect a countryrsquos LFP Essen-

tially itrsquos a matter of demographics and incentives See Figure

116

1 Life-Cycle effects (changing demographics) more teenagers

14

are avoiding the LF Retirement ages and preferences also

have a big impact

2 Retirement benefits ndash how these are structured and who

qualifies has a big effect on when a person decides to retire

3 Cultural changes ndash feminism divorce rates widely available

inexpensive birth control etc

4 The degree of mismatch between job seekers and employers

has widened According to Weidner and Williams (2011)

ldquo[t]he construction finance and real estate sectors have

shrunk after the bursting of the housing bubble and the sub-

sequent financial crisis The skills of workers who used to be

employed in those sectors may not be easily transferable to

growing sectors such as education and health care (see Riss-

man 2009 and Barnichon et al 2010 httpwwwfrbsf

orgpublicationseconomicspapers2010wp10-32bk

pdf) Similarly the housing bust has left millions of home-

owners underwater on their mortgages which locks them

in to their homes and may make it more difficult for them

to move to higher growth areas These sectoral and geo-

graphic mismatches between workers and job openings may

be making it harder for employers to fill vacanciesrdquo

5 Tax rates ndash high marginal tax rates discourage work item

Weidner and Williams (2011) claim that another explana-

tion for the current increase ldquoinvolves the sizable increase

15

omy that make it more difficult for some workers to find jobs

Shocks (unexpected economic events) could be technological

due to conflict weather or other natural disasters

1 One cause is large economy-wide shocks that occur rela-

tively quickly Adjusting to these shocks can create long-

lasting unemployment as the economy takes time to restruc-

ture

2 Labor regulations can lead to structural unemployment

(a) Unemployment Benefits ndash the higher the benefit the

more it pays to stay unemployed

(b) Minimum Wages ndash this limits new low skilled entrants

into the labor force

(c) Unions ndash insiders vs outsiders Insiders already work

for a firm and have some influence over the wage rate

They act to prevent lower wages which reduces a firms

willingness to hire and train new workers

(d) Employment-at-will This doctrine allows people to be

hired and fired at any time for any reason It con-

tributes to lower levels of structural unemployment

Countries with more rigid labor markets tend to have

much higher unemployment rates

11

Figure 115 Hiring and Firing The more costly it is to do the more unem-

ployment a country experiences

12

With this kind of unemployment the number of job openings

may be equal to the number of job applicants But the available

applicants are not qualified for the available jobs

114 Cyclical Unemployment

This is unemployment due to fluctuations of GDP around its

potential When we are in a recession GDP is below potential

and people who would like to work cannot find jobs

The normal level of unemployment (structural + frictional)

is consistent with an economy that creates new jobs and destroys

old ones due mainly to progress This is called the natural rate

of unemployment

Fluctuations of the actual unemployment rate around this

natural rate is blamed on cyclical factors (business cycle) which

at least in recession represents are real opportunity cost to the

economy as a whole

Estimates of the Natural Rate and its variation

The Congressional Budget Office estimates it to be 55 Economists

from the San Francisco Fed estimated it to be 67 in early 2011

13

(Weidner and Williams 2011)

The natural rate of unemployment depends on things like

institutions (unionization unemployment benefits labor market

regulations retraining opportunities etc) and things that affect

friction like labor mobility information exchanges work ethic

and so on

The natural rate rose in the 1960s and 70s as there was a

large influx of new entrants into the labor force (first time job

seekers and women enter the LF in large numbers) It takes new

entrants longer to match up with available jobs

In the most recent recession relaxing eligibility for SNAP

extension of unemployment benefits and other programs have

increased incentives to wait for better opportunitiesndashthus in-

creasing the level of structural unemployment in the US

115 Labor Force Participation

There are numerous things that affect a countryrsquos LFP Essen-

tially itrsquos a matter of demographics and incentives See Figure

116

1 Life-Cycle effects (changing demographics) more teenagers

14

are avoiding the LF Retirement ages and preferences also

have a big impact

2 Retirement benefits ndash how these are structured and who

qualifies has a big effect on when a person decides to retire

3 Cultural changes ndash feminism divorce rates widely available

inexpensive birth control etc

4 The degree of mismatch between job seekers and employers

has widened According to Weidner and Williams (2011)

ldquo[t]he construction finance and real estate sectors have

shrunk after the bursting of the housing bubble and the sub-

sequent financial crisis The skills of workers who used to be

employed in those sectors may not be easily transferable to

growing sectors such as education and health care (see Riss-

man 2009 and Barnichon et al 2010 httpwwwfrbsf

orgpublicationseconomicspapers2010wp10-32bk

pdf) Similarly the housing bust has left millions of home-

owners underwater on their mortgages which locks them

in to their homes and may make it more difficult for them

to move to higher growth areas These sectoral and geo-

graphic mismatches between workers and job openings may

be making it harder for employers to fill vacanciesrdquo

5 Tax rates ndash high marginal tax rates discourage work item

Weidner and Williams (2011) claim that another explana-

tion for the current increase ldquoinvolves the sizable increase

15

Figure 115 Hiring and Firing The more costly it is to do the more unem-

ployment a country experiences

12

With this kind of unemployment the number of job openings

may be equal to the number of job applicants But the available

applicants are not qualified for the available jobs

114 Cyclical Unemployment

This is unemployment due to fluctuations of GDP around its

potential When we are in a recession GDP is below potential

and people who would like to work cannot find jobs

The normal level of unemployment (structural + frictional)

is consistent with an economy that creates new jobs and destroys

old ones due mainly to progress This is called the natural rate

of unemployment

Fluctuations of the actual unemployment rate around this

natural rate is blamed on cyclical factors (business cycle) which

at least in recession represents are real opportunity cost to the

economy as a whole

Estimates of the Natural Rate and its variation

The Congressional Budget Office estimates it to be 55 Economists

from the San Francisco Fed estimated it to be 67 in early 2011

13

(Weidner and Williams 2011)

The natural rate of unemployment depends on things like

institutions (unionization unemployment benefits labor market

regulations retraining opportunities etc) and things that affect

friction like labor mobility information exchanges work ethic

and so on

The natural rate rose in the 1960s and 70s as there was a

large influx of new entrants into the labor force (first time job

seekers and women enter the LF in large numbers) It takes new

entrants longer to match up with available jobs

In the most recent recession relaxing eligibility for SNAP

extension of unemployment benefits and other programs have

increased incentives to wait for better opportunitiesndashthus in-

creasing the level of structural unemployment in the US

115 Labor Force Participation

There are numerous things that affect a countryrsquos LFP Essen-

tially itrsquos a matter of demographics and incentives See Figure

116

1 Life-Cycle effects (changing demographics) more teenagers

14

are avoiding the LF Retirement ages and preferences also

have a big impact

2 Retirement benefits ndash how these are structured and who

qualifies has a big effect on when a person decides to retire

3 Cultural changes ndash feminism divorce rates widely available

inexpensive birth control etc

4 The degree of mismatch between job seekers and employers

has widened According to Weidner and Williams (2011)

ldquo[t]he construction finance and real estate sectors have

shrunk after the bursting of the housing bubble and the sub-

sequent financial crisis The skills of workers who used to be

employed in those sectors may not be easily transferable to

growing sectors such as education and health care (see Riss-

man 2009 and Barnichon et al 2010 httpwwwfrbsf

orgpublicationseconomicspapers2010wp10-32bk

pdf) Similarly the housing bust has left millions of home-

owners underwater on their mortgages which locks them

in to their homes and may make it more difficult for them

to move to higher growth areas These sectoral and geo-

graphic mismatches between workers and job openings may

be making it harder for employers to fill vacanciesrdquo

5 Tax rates ndash high marginal tax rates discourage work item

Weidner and Williams (2011) claim that another explana-

tion for the current increase ldquoinvolves the sizable increase

15

With this kind of unemployment the number of job openings

may be equal to the number of job applicants But the available

applicants are not qualified for the available jobs

114 Cyclical Unemployment

This is unemployment due to fluctuations of GDP around its

potential When we are in a recession GDP is below potential

and people who would like to work cannot find jobs

The normal level of unemployment (structural + frictional)

is consistent with an economy that creates new jobs and destroys

old ones due mainly to progress This is called the natural rate

of unemployment

Fluctuations of the actual unemployment rate around this

natural rate is blamed on cyclical factors (business cycle) which

at least in recession represents are real opportunity cost to the

economy as a whole

Estimates of the Natural Rate and its variation

The Congressional Budget Office estimates it to be 55 Economists

from the San Francisco Fed estimated it to be 67 in early 2011

13

(Weidner and Williams 2011)

The natural rate of unemployment depends on things like

institutions (unionization unemployment benefits labor market

regulations retraining opportunities etc) and things that affect

friction like labor mobility information exchanges work ethic

and so on

The natural rate rose in the 1960s and 70s as there was a

large influx of new entrants into the labor force (first time job

seekers and women enter the LF in large numbers) It takes new

entrants longer to match up with available jobs

In the most recent recession relaxing eligibility for SNAP

extension of unemployment benefits and other programs have

increased incentives to wait for better opportunitiesndashthus in-

creasing the level of structural unemployment in the US

115 Labor Force Participation

There are numerous things that affect a countryrsquos LFP Essen-

tially itrsquos a matter of demographics and incentives See Figure

116

1 Life-Cycle effects (changing demographics) more teenagers

14

are avoiding the LF Retirement ages and preferences also

have a big impact

2 Retirement benefits ndash how these are structured and who

qualifies has a big effect on when a person decides to retire

3 Cultural changes ndash feminism divorce rates widely available

inexpensive birth control etc

4 The degree of mismatch between job seekers and employers

has widened According to Weidner and Williams (2011)

ldquo[t]he construction finance and real estate sectors have

shrunk after the bursting of the housing bubble and the sub-

sequent financial crisis The skills of workers who used to be

employed in those sectors may not be easily transferable to

growing sectors such as education and health care (see Riss-

man 2009 and Barnichon et al 2010 httpwwwfrbsf

orgpublicationseconomicspapers2010wp10-32bk

pdf) Similarly the housing bust has left millions of home-

owners underwater on their mortgages which locks them

in to their homes and may make it more difficult for them

to move to higher growth areas These sectoral and geo-

graphic mismatches between workers and job openings may

be making it harder for employers to fill vacanciesrdquo

5 Tax rates ndash high marginal tax rates discourage work item

Weidner and Williams (2011) claim that another explana-

tion for the current increase ldquoinvolves the sizable increase

15

(Weidner and Williams 2011)

The natural rate of unemployment depends on things like

institutions (unionization unemployment benefits labor market

regulations retraining opportunities etc) and things that affect

friction like labor mobility information exchanges work ethic

and so on

The natural rate rose in the 1960s and 70s as there was a

large influx of new entrants into the labor force (first time job

seekers and women enter the LF in large numbers) It takes new

entrants longer to match up with available jobs

In the most recent recession relaxing eligibility for SNAP

extension of unemployment benefits and other programs have

increased incentives to wait for better opportunitiesndashthus in-

creasing the level of structural unemployment in the US

115 Labor Force Participation

There are numerous things that affect a countryrsquos LFP Essen-

tially itrsquos a matter of demographics and incentives See Figure

116

1 Life-Cycle effects (changing demographics) more teenagers

14

are avoiding the LF Retirement ages and preferences also

have a big impact

2 Retirement benefits ndash how these are structured and who

qualifies has a big effect on when a person decides to retire

3 Cultural changes ndash feminism divorce rates widely available

inexpensive birth control etc

4 The degree of mismatch between job seekers and employers

has widened According to Weidner and Williams (2011)

ldquo[t]he construction finance and real estate sectors have

shrunk after the bursting of the housing bubble and the sub-

sequent financial crisis The skills of workers who used to be

employed in those sectors may not be easily transferable to

growing sectors such as education and health care (see Riss-

man 2009 and Barnichon et al 2010 httpwwwfrbsf

orgpublicationseconomicspapers2010wp10-32bk

pdf) Similarly the housing bust has left millions of home-

owners underwater on their mortgages which locks them

in to their homes and may make it more difficult for them

to move to higher growth areas These sectoral and geo-

graphic mismatches between workers and job openings may

be making it harder for employers to fill vacanciesrdquo

5 Tax rates ndash high marginal tax rates discourage work item

Weidner and Williams (2011) claim that another explana-

tion for the current increase ldquoinvolves the sizable increase

15

are avoiding the LF Retirement ages and preferences also

have a big impact

2 Retirement benefits ndash how these are structured and who

qualifies has a big effect on when a person decides to retire

3 Cultural changes ndash feminism divorce rates widely available

inexpensive birth control etc

4 The degree of mismatch between job seekers and employers

has widened According to Weidner and Williams (2011)

ldquo[t]he construction finance and real estate sectors have

shrunk after the bursting of the housing bubble and the sub-

sequent financial crisis The skills of workers who used to be

employed in those sectors may not be easily transferable to

growing sectors such as education and health care (see Riss-

man 2009 and Barnichon et al 2010 httpwwwfrbsf

orgpublicationseconomicspapers2010wp10-32bk

pdf) Similarly the housing bust has left millions of home-

owners underwater on their mortgages which locks them

in to their homes and may make it more difficult for them

to move to higher growth areas These sectoral and geo-

graphic mismatches between workers and job openings may

be making it harder for employers to fill vacanciesrdquo

5 Tax rates ndash high marginal tax rates discourage work item

Weidner and Williams (2011) claim that another explana-

tion for the current increase ldquoinvolves the sizable increase

15

Figure 116 Labor Force Participation Rates Seasonally Adjusted The rate

of 633 in early 2013 is the lowest since October 1978 LFPR peaked at

673 in the spring of 2000

in long-term unemployment over the past few years Work-

ers out of jobs for extended periods may experience higher

rates of unemployment owing to deterioration of skills and

weakening labor market attachmentrdquo

16

116 Model of the Labor Market

This market coordinates the supply of and demand for labor

Demand for labor comes from firms who hire labor to produce

products As the price of labor falls firms will increase employ-

ment Supply comes from households who generally increase

their willingness to seek employment as wage rates rise (as wage

offers surpass reservation wages people are drawn into the labor

force)

The price in this market is the real wage rate It is the wage

offered divided by the overall price level This is shown in Figure

117

Real Wage =Nominal Wage

Price Level

1161 Two Ways to account for unemployment

Figure 118 shows how wages above equilibrium can lead to un-

employment

Job Rationing For some reason the actual real wage is stuck

above the equilibrium wage This creates unemployment

At wH the number of people wanting to work exceeds the

17

Figure 117 Labor Market w is the equilibrium real wage rate and Em-

ployment the level of employment During a boom demand increases and

real wage rates and employment rise During recession demand falls and

real wage rates and employment fall

18

Figure 118 Labor Market wh is above the equilibrium real wage rate

creating unemployment There are 3 reasons why this might happen

available number of jobs Firms get to choose who to hire

hence they are rationing jobs

1 Minimum Wages ndash firms are leagally prohibited from

offering lower wages This tends to inhibit new entry

into the labor forcendashand why youths in certain areas

have very high unemployment rates

2 Insiders vs Outsiders ndash insiders already work for the

19

firm and have some influence over the wage rate They

act to prevent the wage from falling to its equilibrium

(labor unions for example) Outsiders would be willing

to fill these jobs if allowed for lower pay

3 Efficieny Wage ndash Firms pay above the equilibrium wage

as an incentive to reduce turnover (which can be expen-

sive especially if the workers need training) Henry

Ford offered his workers twice the going rate to work

the assembly line This discouraged turnover and en-

couraged more conscientious workers to come to work

every day

Job Search In this view the market is never quite in equi-

librium Constant changes in entry job availability and

creative destruction keep the market from achieving equi-

librium When this happens people will tend to hold out

for higher paying jobs rather than accept the first lower

paying job offer that comes along Hence w tends to get

stuck above the equilibrium wage

20

Bibliography

Cowen Tyler and Alex Tabarrok (2011) Modern Principles of

Economics 2nd edn Worth New York

Weidner Justin and John C Williams (2011) lsquoWhat is the

new normal unemployment ratersquo FRBSF Economic Letter

2011-05

URL httpwwwfrbsforgeconomic-

researchpublicationseconomic-letter2012decembernew-

normal-unemployment-rateel2011-05pdf

21

• Unemployment and Labor Force Participation
• • Defining Unemployment
  • Frictional Unemployment
  • Structural Unemployment
  • Cyclical Unemployment
  • Labor Force Participation
  • Model of the Labor Market
  • • Two Ways to account for unemployment

116 Model of the Labor Market

This market coordinates the supply of and demand for labor

Demand for labor comes from firms who hire labor to produce

products As the price of labor falls firms will increase employ-

ment Supply comes from households who generally increase

their willingness to seek employment as wage rates rise (as wage

offers surpass reservation wages people are drawn into the labor

force)

The price in this market is the real wage rate It is the wage

offered divided by the overall price level This is shown in Figure

117

Real Wage =Nominal Wage

Price Level

1161 Two Ways to account for unemployment

Figure 118 shows how wages above equilibrium can lead to un-

employment

Job Rationing For some reason the actual real wage is stuck

above the equilibrium wage This creates unemployment

At wH the number of people wanting to work exceeds the

17

Figure 117 Labor Market w is the equilibrium real wage rate and Em-

ployment the level of employment During a boom demand increases and

real wage rates and employment rise During recession demand falls and

real wage rates and employment fall

18

Figure 118 Labor Market wh is above the equilibrium real wage rate

creating unemployment There are 3 reasons why this might happen

available number of jobs Firms get to choose who to hire

hence they are rationing jobs

1 Minimum Wages ndash firms are leagally prohibited from

offering lower wages This tends to inhibit new entry

into the labor forcendashand why youths in certain areas

have very high unemployment rates

2 Insiders vs Outsiders ndash insiders already work for the

19

firm and have some influence over the wage rate They

act to prevent the wage from falling to its equilibrium

(labor unions for example) Outsiders would be willing

to fill these jobs if allowed for lower pay

3 Efficieny Wage ndash Firms pay above the equilibrium wage

as an incentive to reduce turnover (which can be expen-

sive especially if the workers need training) Henry

Ford offered his workers twice the going rate to work

the assembly line This discouraged turnover and en-

couraged more conscientious workers to come to work

every day

Job Search In this view the market is never quite in equi-

librium Constant changes in entry job availability and

creative destruction keep the market from achieving equi-

librium When this happens people will tend to hold out

for higher paying jobs rather than accept the first lower

paying job offer that comes along Hence w tends to get

stuck above the equilibrium wage

20

Bibliography

Cowen Tyler and Alex Tabarrok (2011) Modern Principles of

Economics 2nd edn Worth New York

Weidner Justin and John C Williams (2011) lsquoWhat is the

new normal unemployment ratersquo FRBSF Economic Letter

2011-05

URL httpwwwfrbsforgeconomic-

researchpublicationseconomic-letter2012decembernew-

normal-unemployment-rateel2011-05pdf

21

• Unemployment and Labor Force Participation
• • Defining Unemployment
  • Frictional Unemployment
  • Structural Unemployment
  • Cyclical Unemployment
  • Labor Force Participation
  • Model of the Labor Market
  • • Two Ways to account for unemployment

Figure 117 Labor Market w is the equilibrium real wage rate and Em-

ployment the level of employment During a boom demand increases and

real wage rates and employment rise During recession demand falls and

real wage rates and employment fall

18

Figure 118 Labor Market wh is above the equilibrium real wage rate

creating unemployment There are 3 reasons why this might happen

available number of jobs Firms get to choose who to hire

hence they are rationing jobs

1 Minimum Wages ndash firms are leagally prohibited from

offering lower wages This tends to inhibit new entry

into the labor forcendashand why youths in certain areas

have very high unemployment rates

2 Insiders vs Outsiders ndash insiders already work for the

19

firm and have some influence over the wage rate They

act to prevent the wage from falling to its equilibrium

(labor unions for example) Outsiders would be willing

to fill these jobs if allowed for lower pay

3 Efficieny Wage ndash Firms pay above the equilibrium wage

as an incentive to reduce turnover (which can be expen-

sive especially if the workers need training) Henry

Ford offered his workers twice the going rate to work

the assembly line This discouraged turnover and en-

couraged more conscientious workers to come to work

every day

Job Search In this view the market is never quite in equi-

librium Constant changes in entry job availability and

creative destruction keep the market from achieving equi-

librium When this happens people will tend to hold out

for higher paying jobs rather than accept the first lower

paying job offer that comes along Hence w tends to get

stuck above the equilibrium wage

20

Bibliography

Cowen Tyler and Alex Tabarrok (2011) Modern Principles of

Economics 2nd edn Worth New York

Weidner Justin and John C Williams (2011) lsquoWhat is the

new normal unemployment ratersquo FRBSF Economic Letter

2011-05

URL httpwwwfrbsforgeconomic-

researchpublicationseconomic-letter2012decembernew-

normal-unemployment-rateel2011-05pdf

21

• Unemployment and Labor Force Participation
• • Defining Unemployment
  • Frictional Unemployment
  • Structural Unemployment
  • Cyclical Unemployment
  • Labor Force Participation
  • Model of the Labor Market
  • • Two Ways to account for unemployment

Figure 118 Labor Market wh is above the equilibrium real wage rate

creating unemployment There are 3 reasons why this might happen

available number of jobs Firms get to choose who to hire

hence they are rationing jobs

1 Minimum Wages ndash firms are leagally prohibited from

offering lower wages This tends to inhibit new entry

into the labor forcendashand why youths in certain areas

have very high unemployment rates

2 Insiders vs Outsiders ndash insiders already work for the

19

firm and have some influence over the wage rate They

act to prevent the wage from falling to its equilibrium

(labor unions for example) Outsiders would be willing

to fill these jobs if allowed for lower pay

3 Efficieny Wage ndash Firms pay above the equilibrium wage

as an incentive to reduce turnover (which can be expen-

sive especially if the workers need training) Henry

Ford offered his workers twice the going rate to work

the assembly line This discouraged turnover and en-

couraged more conscientious workers to come to work

every day

Job Search In this view the market is never quite in equi-

librium Constant changes in entry job availability and

creative destruction keep the market from achieving equi-

librium When this happens people will tend to hold out

for higher paying jobs rather than accept the first lower

paying job offer that comes along Hence w tends to get

stuck above the equilibrium wage

20

Bibliography

Cowen Tyler and Alex Tabarrok (2011) Modern Principles of

Economics 2nd edn Worth New York

Weidner Justin and John C Williams (2011) lsquoWhat is the

new normal unemployment ratersquo FRBSF Economic Letter

2011-05

URL httpwwwfrbsforgeconomic-

researchpublicationseconomic-letter2012decembernew-

normal-unemployment-rateel2011-05pdf

21

• Unemployment and Labor Force Participation
• • Defining Unemployment
  • Frictional Unemployment
  • Structural Unemployment
  • Cyclical Unemployment
  • Labor Force Participation
  • Model of the Labor Market
  • • Two Ways to account for unemployment

firm and have some influence over the wage rate They

act to prevent the wage from falling to its equilibrium

(labor unions for example) Outsiders would be willing

to fill these jobs if allowed for lower pay

3 Efficieny Wage ndash Firms pay above the equilibrium wage

as an incentive to reduce turnover (which can be expen-

sive especially if the workers need training) Henry

Ford offered his workers twice the going rate to work

the assembly line This discouraged turnover and en-

couraged more conscientious workers to come to work

every day

Job Search In this view the market is never quite in equi-

librium Constant changes in entry job availability and

creative destruction keep the market from achieving equi-

librium When this happens people will tend to hold out

for higher paying jobs rather than accept the first lower

paying job offer that comes along Hence w tends to get

stuck above the equilibrium wage

20

Bibliography

Cowen Tyler and Alex Tabarrok (2011) Modern Principles of

Economics 2nd edn Worth New York

Weidner Justin and John C Williams (2011) lsquoWhat is the

new normal unemployment ratersquo FRBSF Economic Letter

2011-05

URL httpwwwfrbsforgeconomic-

researchpublicationseconomic-letter2012decembernew-

normal-unemployment-rateel2011-05pdf

21

• Unemployment and Labor Force Participation
• • Defining Unemployment
  • Frictional Unemployment
  • Structural Unemployment
  • Cyclical Unemployment
  • Labor Force Participation
  • Model of the Labor Market
  • • Two Ways to account for unemployment

Bibliography

Cowen Tyler and Alex Tabarrok (2011) Modern Principles of

Economics 2nd edn Worth New York

Weidner Justin and John C Williams (2011) lsquoWhat is the

new normal unemployment ratersquo FRBSF Economic Letter

2011-05

URL httpwwwfrbsforgeconomic-

researchpublicationseconomic-letter2012decembernew-

normal-unemployment-rateel2011-05pdf

21

• Unemployment and Labor Force Participation
• • Defining Unemployment
  • Frictional Unemployment
  • Structural Unemployment
  • Cyclical Unemployment
  • Labor Force Participation
  • Model of the Labor Market
  • • Two Ways to account for unemployment