Chapter 6:
Unemployment
Historical Data (US)
Historical Data (EU)
Variations in Unemployment
Demographic Groups, 1997
Age
White-M White-F Black-M
Black-F
16-19
14.3
12.8
36.5
28.7
20+
3.6
3.7
8.5
8.8
Civilian Labor Force
Individuals between 16 and 64, 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 = No. of unemployed workers
as a % of the 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 Unemployment
Unemployment of individuals who are searching
for jobs or waiting between jobs
Supply-side effect and transitional
Structural Unemployment
Unemployment due to fundamental economic
changes that eliminate some jobs, while creating
other jobs for which qualified workers may not be
readily available
Normal due to technological advancement and
changes in consumer preferences
Cyclical Unemployment
Unemployment caused by contraction in economic
activities (i.e., recession)
Needs public policy to increase employment
Natural Rate of Unemployment
An average rate around which the actual
unemployment rate fluctuates
The average of last and next 10 years
unemployment rate
Future unemployment rate is set at 5.5%
Duration of Unemployment
Short-term if frictional
Long-term if structural or cyclical
Evidence from 1974 is mixed
– 60% of the spells of unemployment ended within one
month
– 69% of the weeks of unemployment occurred in
spells that lasted two or more months
Duration of Unemployment
If policy goal is to reduce the natural rate of
unemployment, we need long-term investment in
job creation (education, training, etc.)
If policy goal is to reduce the unemployment rate,
we need short-term investment in job retention
and information
Unemployment Rate
L = Labor Force
E = Employment
U = unemployment
L=E+U
So,
E = L – U and U = L – E
U/L = Unemployment Rate
Job Loss
s = the rate of job separation: the fraction of
“employed” workers who lose jobs each month
sE = the number of “employed” workers who lose
jobs each month
Job Gain
f = the rate of job finding: the fraction of
“unemployed” workers who find jobs each month
fU = the number of “unemployed” workers who
find jobs each month
Employment-Unemployment Transition
The rates of job separation and job finding determine
the rate of unemployment.
Job Separation (s)
Unemployed
Employed
Job Finding (f)
Steady State Unemployment Rate
In a steady-state labor market: fU = sE
Write:
fU = s(L – U)
fU = sL – sU
sU + fU = sL
(s + f)U = sL
U/L = s / s+f
Example
s = 0.01: on average, jobs last 100 months
f = 0.20: on average, unemployment lasts 5
months
U/L = 0.01/0.21 = 4.8%
Policy Implications
Public policy to reduce the rate of job separation
and/or increase the rate of job finding will lower
the natural rate of unemployment
Public policy to lower the natural rate of
unemployment must either reduce the rate of job
separation or increase the rate of job finding
Policy and Frictional Unemployment
Job Fairs:
– provide information on job openings, which
lowers f and increases U/L
Policy and Frictional Unemployment
Unemployment Benefits: U/L could increase
– Some unemployed workers may refuse job offers and wait for
higher ones, lowering f
– Some employed workers may not care losing jobs since their
incomes are partially compensated, increasing s
Wage Rigidity and Unemployment
Real Wage
Supply
Unemployment
W2
A
B
W1
Demand
L2
Amount of labor hired
L1
Labor
Amount of labor willing to work
Wait Unemployment
Unions setting wages higher than the market
wage
Some union members must remain unemployed
Unemployed union members must “wait” for job
openings
Minimum Wage law
Workers are paid a wage rate above the market
rate
– Help those who are employed
– Hurt those who are unemployed
Efficiency Wage
Firms pay wages above the market values to
– Maintain a stable labor force
– Attract qualified workers
– Improve productivity and profitability