Chapter 14 Unemployment
A Recurring Problem
What's in This Chapter and Why
This chapter deals with unemploymentits costs, causes, and cures. In doing so, it emphasizes that
unemployment has both economic and noneconomic costs.
The chapter explains how the unemployment rate is calculated and emphasizes that the average
rate conceals many differences among demographic groups. The chapter also distinguishes among
three types of unemployment: frictional, structural, and cyclical. This distinction is important in
terms of both costs and policy. Various policies to reduce unemployment are considered. The
impact of the minimum wage on unemployment is discussed in this context.
Finally, unemployment in Europe is discussed. Various factors cause unemployment to be
higher in most European countries than in the United States.
Instructional Objectives
After completing this chapter, your students should know:
1. That unemployment has both economic and noneconomic costs and that these costs are
different for society and the individual.
2. How the unemployment rate is calculated and how unemployment rates vary among
demographic groups.
3. That three types of unemployment--frictional, structural, and cyclical--exist, and that these
differ in terms of both costs and policy implications.
4. How the full employment, or natural, unemployment rate is defined.
5. How stabilization policy can be applied to achieve and/or maintain full employment.
6. That stabilization policy is unlikely to reduce frictional and structural unemployment and that
other policies are, therefore, necessary.
7. That a significant increase in the minimum wage has an adverse effect on unemployment,
particularly among teenagers.
8. That for various reasons, the unemployment rate in most European countries is much higher
than the unemployment rate in the United States.
Key Terms
These terms are introduced in this chapter:
Unemployment rate
Civilian labor force
Frictional unemployment
Structural unemployment
Cyclical unemployment
Full employment rate of unemployment
Natural rate of unemployment
Stabilization policies
Suggestions for Teaching
Because this chapter covers an important social problem, it is a very important chapter. Three or
four class sessions will be required to cover it.
Instructors wishing to spend less time on this chapter could cover some of the sections less
systematically and omit the last section (unemployment in Europe).
Here, as elsewhere, instructors should take time to explain the importance of the problem to the
individual. With unemployment, it is relatively easy.
In covering stabilization policies, instructors may wish to mention that some economists
believe that stabilization policy is actually destabilizing. Similarly, instructors may wish to
mention that considerable disagreement exists regarding the potency of monetary and fiscal
policies.
Additional References
In addition to the references in the text, instructors may wish to read or assign one or more of the
following:
1. Charles Brown, Curtis Gilroy, and Andrew Kohen, "The Effect of the Minimum Wage on
Employment and Unemployment," Journal of Economic Literature 20 (June 1982), pp. 487528.
2. David Card and Alan B. Krueger, Myth and Measurement: The New Economics of the
Minimum Wage (Princeton, NJ: Princeton University Press, 1995).
3. Robert J. LaLonde, "The Promise of Public Sector-Sponsored Training Programs," Journal of
Economic Perspectives 9 (Spring 1995), pp. 149-168.
4. Stephen K. McNees, "The 1990-91 Recession in Historical Perspective," Federal Reserve Bank
of Boston, New England Economic Review (January/February 1992), pp. 3-22.
5. Daniel Rodriguez and Madeline Zavodnt, “Are Displaced Workers Now Finished at Age
Forty?” Federal Reserve Bank of Atlanta, Economic and Financial Review (Q 2 2000), pp. 3347.
6. Jason L. Saving, “The Effect of Welfare Reform and Technological Change on
Unemployment,” Federal Reserve Bank of Dallas, Economic and Financial Review (Q 2,
2000), pp. 26-34.
Outline
I. COSTS OF UNEMPLOYMENT
A. Economic Costs
1. For the individual, the greatest economic cost of unemployment is lost income.
2. For society, the greatest economic cost of unemployment is the decrease in goods and
services that occurs as a result of the unemployment.
B. Noneconomic Costs
1. For the individual, noneconomic costs include adverse effects on mental and physical
health, adverse effects on the family, higher rates of alcoholism and drug abuse, and
higher crime and suicide rates.
II. COUNTING THE UNEMPLOYED
A. The Unemployment Rate
1. The unemployment rate is the percentage of the civilian labor force that is
unemployed.
a. The civilian labor force is the number of persons employed plus the number of
persons unemployed.
b. Individuals are considered unemployed if they did not have a job, were available
for work, and actively sought employment in the past four weeks.
c. Persons 16 years of age and over who are neither employed nor unemployed are
not in the civilian labor force.
2. The unemployment rate differs among demographic groups.
a. Unemployment rates for teenagers, blacks, and Hispanics are higher than the
overall unemployment rate.
b. This variation in unemployment rates means that not all groups suffer equally
when the unemployment rate increases.
III. TYPES OF UNEMPLOYMENT
A. Frictional Unemployment
1. Frictional unemployment is temporary unemployment arising from the normal job
search process.
2. Frictional unemployment helps the economy function more efficiently.
B. Structural Unemployment
1. Structural unemployment is the result of structural changes in the economy caused by
technological progress and shifts in the demand for goods and services.
a. The structural changes eliminate some jobs in the economy and create others.
2. Persons who are structurally unemployed do not have marketable job skills and may
face prolonged periods of unemployment.
C. Cyclical Unemployment
1. Cyclical unemployment is unemployment caused by a drop in the level of economic
activity that occurs during the contraction phase of the business cycle.
IV. FULL EMPLOYMENT
A. The Full Employment Rate of Unemployment
1. The full employment rate of unemployment is the frictional rate of unemployment plus
the structural rate of unemployment.
2. The full employment rate of unemployment is the lowest rate of unemployment
consistent with a nonaccelerating inflation rate.
3. The full employment rate of unemployment is sometimes referred to as the natural rate
of unemployment.
4. The full employment or natural rate of unemployment will change over time due to
changes in the composition of the labor force and other factors.
a. Increases in the number of teenagers and women entering the labor force in the
1960s and 1970s caused the natural rate of unemployment to increase.
V. POLICIES TO REDUCE UNEMPLOYMENT
A. Reducing Cyclical Unemployment
1. Most economists believe that an increase in cyclical unemployment is caused by a
decrease in aggregate demand.
2. If wages and other input prices are "sticky," the economy can experience relatively
long periods of cyclical unemployment and policies will be needed to reduce the
unemployment.
3. Stabilization policies, government policies intended to maintain full employment and a
reasonably stable price level, can be used.
a. Expansionary fiscal and monetary policies can be used.
4. There is a tradeoff between reducing unemployment and increasing the price level.
a. If the economy is at full employment, expansionary policies will simply increase
the price level and leave output unchanged.
5. Despite the use of stabilization policies, we still observe cyclical movements in the
unemployment rate and price level.
a. These fluctuations occur because it is difficult to know how much to change
variables such as government spending when using stabilization policy and
because it is difficult to use stabilization policy in a timely manner.
B. Reducing Structural Unemployment
1. Policy suggestions to reduce structural unemployment include providing government
training programs to the structurally unemployed, paying subsidies to firms that
provide training to displaced workers, helping the structurally unemployed to relocate
to areas where jobs exist, and inducing prospective workers to continue or resume their
education.
C. Reducing Frictional Unemployment
1. Policy suggestions to reduce frictional unemployment include establishing a
computerized national job bank that would provide job seekers and prospective
employers with better information and implementing apprenticeship programs similar
to those used in Austria and Germany.
VI. UNEMPLOYMENT AND THE MINIMUM WAGE
A. Effect of the Minimum Wage
1. Increasing the wage creates a surplus of labor.
a. Increasing the minimum wage causes the quantity of labor that firms are willing to
hire to decrease and the quantity of labor willing to work to increase.
2. Only those workers who remain employed receive higher wages.
a. Over half of the low-wage workers in the United States are members of households
with above average family incomes. Thus, only a part of the increase in income
caused by the minimum wage benefits low-income families.
3. Because low-skill workers are laid off as the minimum wage increases, many lowincome families will be adversely affected.
a. Teenagers are among those most adversely affected by the minimum wage.
4. The structurally unemployed may be adversely affected because the minimum wage
provides employers less incentive to offer on-the-job training.
5. The excess supply of labor generated by the minimum wage provides employers with
the chance to discriminate if they so choose.
6. Society will lose because the nation's output of goods and services will fall.
VII. UNEMPLOYMENT IN EUROPE
A. Impediments to Hiring
1. In most European countries, minimum wages are higher than in the United States.
2. Labor unions in most European countries are more powerful than those in the United
States.
3. The relatively high social security and other payroll taxes that European firms must
pay discourage hiring.
4. Because it is costly to discharge workers, firms are reluctant to replace workers.
5. In many European countries, government regulations and controls make it difficult for
entrepreneurs to start or expand new firms.
B. Impediments to Accepting Employment
1. Unemployment benefits in most European countries are relatively higher and can be
drawn for a longer time than in the United States.
2. High tax rates combined with loss of unemployment and other benefits reduces the
incentive for unemployed persons to accept employment.
C. Conclusion
1. Unemployment rates in most European countries are higher than in the United States.
2. To lower unemployment rates, policymakers must reduce or eliminate impediments to
hiring and accepting employment.
Answers to Review Questions
1. Briefly discuss both the economic and noneconomic costs of unemployment to the
individual and society.
During periods of unemployment, the individual's economic position will deteriorate due to the
loss of income that would have been received in the absence of unemployment. Society will
also suffer an economic loss due to the decrease in output associated with unemployment.
During periods of high unemployment, the sacrifice of goods and services can be quite large.
During the Great Depression, the nation's output of goods and services fell by about 30 percent.
There are also noneconomic costs associated with unemployment. It has been suggested that
prolonged periods of unemployment can have adverse effects on both physical and mental
health. For example, studies show that increased unemployment rates are associated with
increased rates of alcoholism, drug use, crime, child abuse, and divorce. While these
noneconomic effects are difficult to quantify, they should be taken into account when
considering the cost that unemployment imposes on the individual and society.
2. Suppose you are given the following information about the Simplistic economy:
Persons over 65 years not actively seeking
employment
Persons over 65 years actively seeking
employment
Homemakers
School-age children under 16 years
Military personnel
Persons 16 years and older working
Persons 16 years and older not working
because of illness, labor disputes, vacation,
bad weather, or personal reasons
Persons between 16 and 65 years actively
seeking employment
20,000
4,000
40,000
60,000
15,000
85,000
5,000
6,000
a. Calculate the number of persons in the civilian labor force.
b. Calculate the number of persons who are unemployed.
c. Calculate the unemployment rate.
a. The civilian labor force is the number of persons 16 years of age or older who are working
plus those members of the labor force who are unemployed. A member of the labor force
is defined as working if he or she is employed either full-time or part-time as a paid
employee or is working a minimum of 15 hours as an unpaid employee. An individual is
also working if she has a job but did not work because of illness, bad weather, vacation,
labor-management disputes, or personal reasons. Members of the labor force are
unemployed if they are both available for work and have actively sought employment in
the previous four weeks.
Based upon this definition the civilian labor force for the Simplistic economy would be
100,000 (4,000 + 85,000 + 5,000 + 6,000).
b. Given the definition of unemployment, the number of unemployed in the Simplistic
economy is found to be 10,000 (4,000 + 6,000).
c. The unemployment rate gives the number of persons unemployed as a percentage of the
civilian labor force. It is calculated as the number of unemployed divided by the number
of persons in the civilian labor force. This ratio is then multiplied by 100 in order to
convert it to a percentage. Thus, the unemployment rate for the Simplistic economy is
(10,000/100,000) x 100, or 10 percent.
3. "A decrease in the unemployment rate will benefit society; however, these benefits will
not be shared equally by all groups in society." Explain why this statement is true.
To understand why this statement is true, the unemployment rates for different groups in
society must be examined. These disaggregated rates show that unemployment rates differ
among the various groups that make up society. For instance, teenagers are three times more
likely to experience unemployment than older persons. Also, blacks and Hispanics are more
likely to experience unemployment than are whites. Those with lower levels of education are
more likely to experience unemployment than those that have attained higher levels of
education. Presently, the unemployment rate between males and females is roughly equal;
however, this has not always been true. In the past females were more likely to suffer from
unemployment than males. Because there are unemployment differentials among groups, it
follows that a decrease in the overall unemployment rate will bestow different benefits upon
these groups. Those groups tending to have higher unemployment rates are likely to receive
more of a benefit from a decrease in the overall rate than those groups whose unemployment
rates tend to be lower.
4. List and briefly discuss the different types of unemployment. Should policy-makers
regard each type as equally detrimental to society?
Economists generally distinguish three types of unemployment: frictional, structural, and
cyclical. Frictional unemployment is the unemployment that arises due to the normal workings
of the labor market. This type of unemployment includes both individuals entering the labor
market for the first time and individuals who have quit jobs in order to search for better ones.
Because the job search process is time consuming, it is inevitable that these individuals
experience some brief periods of unemployment. For example, upon graduation from college
an individual will first identify potential employers. After making application, there is a
waiting period while the potential employer evaluates all applications received. After
evaluation, a personal interview will follow. The employer will generally interview several
candidates. Only after all candidates are interviewed will the final evaluation and selection be
made. Thus, the job search can be a lengthy process, resulting in temporary unemployment.
Structural unemployment is a second type of unemployment. It arises when jobs are
eliminated by changes in the structure of the economy. These structural changes occur because
technological progress destroys some jobs and creates others. For example, the advance in
robotics has caused some automobile workers to lose production line jobs. At the same time,
however, this advance has created a demand for technicians that can service the new machines.
The last type of unemployment is cyclical unemployment. This unemployment occurs when
the level of economic activity falls. As firms reduce output there is a corresponding decrease
in the number of workers employed. These actions occur during the contraction phase of the
business cycle. A classic example is the unemployment that occurred during the Great
Depression.
Each of these types of unemployment has different implications for society. Frictional
unemployment may actually help society. In this instance those who are unemployed have
marketable job skills. The unemployment occurring during the job search means the individual
is able to look for the type of job most desired. To the extent that the individual is able to
move into a more productive, higher paying job, the output of goods and services available to
society will increase. Hence, frictional unemployment serves a useful function and should not
be a major concern.
Structural unemployment is different. In this instance, those who are on the job market may
not have marketable skills. Individuals experiencing structural unemployment may need
substantial retraining, and thus may be facing extended periods of unemployment. Because of
this, structural unemployment can impose substantial costs on society. This type of
unemployment is generally considered a more serious problem than frictional unemployment.
Cyclical unemployment is different from both frictional and structural unemployment. With
the latter two, the problem is not a lack of jobs. Instead, the problem is to match jobs with
those who are seeking employment. With cyclical unemployment, the number of job seekers is
greater than the number of available jobs. Because there are not enough jobs to go around, not
all those wishing to work will find employment. This type of unemployment, like structural
unemployment, imposes a cost on society and is a more serious problem than frictional
unemployment.
5. "Full employment means that everyone who wants a job is able to find one." Is this
statement true or false? Defend your answer.
Full employment does not mean that everyone who wants a job is able to find one. To
understand why this is true, recall that there are three different types of unemployment:
frictional, structural, and cyclical. Frictional unemployment is the unemployment that occurs
when people move into the labor force or move between jobs. New workers will always enter
the labor force and the present members of the labor force will always change jobs; frictional
unemployment will always exist.
Structural unemployment occurs when there are technological changes. Technology is
dynamic and constantly changing, therefore structural unemployment is inevitable. Further,
the retraining that must take place in order make individuals employable may take substantial
time.
Finally, there is cyclical unemployment, the unemployment that occurs during the
contractionary phase of the business cycle. While business cycles will always exist, there are
certain policy tools available that may possibly mitigate the cyclical unemployment that occurs
during these cycles.
Full employment occurs when there is no cyclical unemployment. Because frictional and
structural unemployment are always present, full employment does not mean that there is zero
unemployment or that everyone who wants a job has one.
6. Why isn't the natural rate of unemployment constant over time? Is this rate likely to
increase of decrease over time? Defend your answer.
Economists sometimes refer to the full employment rate of unemployment as the natural rate of
unemployment. This natural rate is not constant over time. Recall that this rate is composed of
both frictional and structural unemployment. Since the composition of the labor force changes,
frictional and structural unemployment will change. These changes will cause changes in the
natural rate of unemployment. In the 1960s, for example, more women and teenagers began
entering the labor force. At that time, the unemployment rate for both groups was higher than
the overall unemployment rate. Hence, these changes caused the natural rate to rise.
It is generally thought that the natural rate of unemployment has peaked and is now falling.
The decline in birth rates means that fewer teenagers are entering the labor force. Although
their unemployment rate is still higher than the overall rate, teens now account for a smaller
proportion of the labor force and the natural rate has decreased. Also, the unemployment rate
for women has fallen. This drop has also led to a drop in the natural rate. Thus, the factors that
caused the natural rate to increase are working in the opposite direction and causing the natural
rate to fall.
7. "So long as the economy tends to move towards the equilibrium level of GDP, there is no
need to be concerned about unemployment." Is this statement true or false? Defend
your answer.
The tendency of the economy to move towards equilibrium does not imply that there should be
a lack of concern about unemployment. Equilibrium can occur at a level of output that is
inconsistent with full employment. This is illustrated in the graph below.
GDP Deflator
AS
AD
0
GDP 1 GDP fe
Real GDP
In this graph, full employment occurs at GDPfe where the aggregate supply curve becomes
vertical. Equilibrium output occurs at GDP1 where the aggregate demand curve intersects
the aggregate supply curve. GDPfe represents the output that could be produced if full
employment prevailed in the economy. GDP1 shows the output that will be produced in
equilibrium. Because GDP1 is less than GDPfe, there must be some unemployed resources.
Thus, the fact that the economy moves towards equilibrium does not imply that
unemployment is not a concern.
8.
Should government undertake stabilization policies if wage rates and other input prices
are flexible? Suppose wage rates and other input prices are "sticky." What policy
should government pursue in the face of unemployment caused by a drop in aggregate
demand?
It has been shown that unemployment can exist at equilibrium levels of output. The
persistence of unemployment depends upon the flexibility of wages and other input prices.
In order to understand this statement and its policy implications, observe the following
graph.
GDP Deflator
P1
P2
P3
.B
AS 1
.A
.C
AD2
AS 2
Q2
Q1
AD1
Real GDP
Given the aggregate demand and supply curves, equilibrium is initially given by point A with
the price level equal to P1 and output equal to Q1. Note that at Q1 full employment exists. Now
suppose there is a decrease in aggregate demand to AD2. This will result in a new equilibrium
at point B. The price level will fall to P2 and output will fall to Q2. As output falls, employers
lay off workers and unemployment occurs. If wages and other input prices are flexible, they
adjust so that the unemployment is temporary.
The existence of unemployment means that there is now an excess supply of labor. Wages fall
in response to this excess supply. As wages fall, the aggregate supply curve will shift to AS2.
With AS2, a new equilibrium at point C is reached. At C, output increases to the original level,
Q1, and full employment is restored. Thus, if wages and other input prices are flexible, there is
no need for government to undertake stabilization policies.
If wages and other input prices are "sticky," the above analysis is changed. There is now room
for government intervention. Observe the following graph.
GDP Deflator
AS
P1
P2
.
B
.A
AD2
Q2 Q1
AD1
Real GDP
Suppose equilibrium is initially at point A. The price level is P1 and the full employment level
of output is Q1. As aggregate demand falls to AD2, the economy will reach a new equilibrium
at point B. Output and employment will fall. With wages "sticky," there will be no decrease in
the wage, and thus no increase in aggregate supply to restore full employment. In this case,
government can use stabilization policy to return the economy to full employment.
Generally, government will pursue some type of monetary or fiscal policy. The use of either
policy will shift the aggregate demand curve. For example, suppose the government uses
expansionary fiscal policy and increases government spending or decreases taxes. Either
action will increase aggregate demand to, say, AD1. Equilibrium will return to point A, output
will return to Q1, and full employment will be restored. The government could also use
expansionary monetary policy. As the money supply increases, both investment and
consumption will rise. As a result, aggregate demand will increase to, say, AD1, and full
employment will be restored. Thus, if wages and other input prices are sticky, stabilization
policy can be used to achieve full employment.
It should be noted that while the policies increased output and employment, they also increased
in the price level. Although price increases are generally thought to be undesirable, most
economists believe that the benefits associated with reducing unemployment are worth the
costs associated with a higher price level.
9. "If pursued vigorously, expansionary fiscal or monetary policies can be used to reduce
unemployment caused by inadequate aggregate demand." If this statement is true, why
do we still experience periods of cyclical unemployment?
There are at least two factors that account for the continued existence of cyclical
unemployment. First, to use policy to eliminate this type of unemployment, policy- makers
must know exactly how much to shift the aggregate demand curve. To obtain the desired shift,
they must change government spending, taxes, or the money supply by precisely the amount
that will restore full employment. Even if policymakers know this amount, political and other
considerations might prevent the adoption of the appropriate policy. For example, members of
Congress might be reluctant to reduce government spending in an election year. Such a
reduction might eliminate certain programs that voters desire, and thereby jeopardize
politicians' chances of winning the election.
The timing of policy is a second factor accounting for the continued existence of cyclical
unemployment. If policymakers act in a timely manner, policy may reduce unemployment;
however, if they are slow to act, by the time a policy is put into place and has an effect, the
economy may have returned to full employment. In this case, the policy, instead of reducing
unemployment, will lead to a higher price level. Thus, problems of obtaining information in
order to enact the correct policy, political considerations, and the timeliness of policy will
contribute to continuing cyclical unemployment.
10. Can stabilization policy be used to deal with structural unemployment? Why or why
not? If we cannot use stabilization policy what - if anything - can policy-makers do to
reduce structural unemployment?
Stabilization policy cannot be used to deal with structural unemployment. With structural
unemployment, the problem is not a lack of jobs. Instead, as technological change occurs, old
jobs are destroyed and new jobs are created. The destruction of jobs causes workers to be
displaced. The displaced workers do not have the skills necessary to fill the new jobs that are
created. Increasing aggregate demand through the use of stabilization policies will simply
create jobs similar to the ones created by technical change. Unemployed workers will be
unable to fill the jobs created by stabilization policy; therefore, firms will bid qualified workers
away from other firms and wages and prices will rise. Unemployment will be unaffected.
Thus, stabilization policy cannot be used to deal with structural unemployment.
There are several solutions that could be used to reduce structural unemployment. Government
could initiate programs to retrain workers. Once equipped with the proper skills, workers
should have little difficulty finding employment. Government could also help workers relocate
to areas where jobs exist. Without such help, prospective workers may be unwilling or unable
to relocate. Firms could be given tax breaks if they either expanded or built new plants in areas
where surplus labor existed. Finally, prospective workers could be given incentives to
continue their education. This education may be necessary to survival in a technologically
advanced society. Thus, although stabilization policy cannot deal with structural
unemployment, there are several actions that can be pursued to deal with the problem.
11. Suppose the economy is experiencing full employment. In response to political pressure,
Congress reduces taxes. What are the effects of this tax cut on GDP, the GDP deflator,
and employment? Defend your answer.
If the economy is currently operating at full employment and a tax cut occurs, there will be an
increase in the GDP deflator; however, GDP and employment will be unchanged. In order to
understand this, consider the following graph.
GDP Deflator
AS
P2
P1
.B
.A
AD2
AD1
0
Q1
Real GDP
Initially, the economy is in equilibrium at point A where AD1 and AS intersect. The GDP
deflator is P1 and full employment GDP, Q1, prevails. The tax cut will work to increase
consumption, a component of aggregate demand. This will shift the demand curve to AD2.
The new equilibrium will be at point B. At B, the GDP deflator has risen to P2 while GDP
remains constant at Q1. Because there is no change in output there will be no change in
employment. The only effect of the tax cut is to raise prices.
12. Discuss the impact of an increase in the minimum wage on the market for low-skill
workers. Use graphical analysis to assist you.
The wage is simply the price that employers pay for the use of labor resources. As is generally
true, whenever the price of a good increases, there will be an increase in quantity supplied and
a decrease in quantity demanded. Thus, the minimum wage raises the price of labor and
creates a surplus in the market for low-skill workers. This effect is demonstrated in the
following graph.
Wage
S
W2
A
.
W1
D
0
N2
N
1
N
3
Employment
The demand for labor is given by the demand curve, D, while the supply of labor is given by
the supply curve, S. Initially the market is in equilibrium at point A where the wage rate is W1
and the quantity of workers is N1. Now suppose that government imposes a minimum wage
equal to W2. At this wage, the quantity of workers demanded is equal to N2 while the quantity
of workers supplied is equal to N3. A surplus equal to N2N3 exists. In a labor market, this
surplus translates into unemployment.
It should be noted that the minimum wage may have an especially adverse effect upon teenage
workers and those who are structurally unemployed. When the minimum wage is enacted, the
firm will discharge the least experienced, lowest skilled workers. Many teenagers fall into this
class. This creates a dilemma for teenagers. They are discharged because they lack
experience; however, the only way for them to get experience is to work.
Those who are structurally unemployed may also suffer. With the imposition of the minimum
wage, employers are less likely to offer on-the-job training. This makes it more difficult for
those who are structurally unemployed to find jobs.
Finally, the minimum wage puts employers in a position to practice discriminatory hiring
practices. Because there is a surplus of labor, employers are in a position to choose their
employees on some basis other than their willingness to work. This is not the case when the
quantity of labor demanded is equal to the quantity of labor supplied.
13. "Even though some low-skill workers are laid off as the minimum wage increases, the
economic situation of the working poor is improved because those low-skill workers who
retain their jobs are receiving a higher wage." Is this statement true or false? Defend
your answer.
It is true that workers who remain on the job receive a higher income; however, it is doubtful
that the economic situation of the working poor is improved due to the imposition of a
minimum wage. In order to understand why observe the following graph.
Wage
S
W2
A
.
W1
D
0
N2
N
1
N3
Employment
Originally the market is in equilibrium at point A with employment equal to N1 and the wage
rate equal to W1. With the imposition of a minimum wage of W2, employment falls to N2.
Notice that the N2 workers who remain on the job do receive a higher wage and are better off.
However, N2N3 are now unemployed. Of these, N2N1 have been laid off and suffer a decrease
in income. N1N3 enter the market because of the higher wage. Those laid off are most likely
the lowest skilled, least experienced workers. Thus, those most in need of employment in
order to gain skills and experience are harmed.
Further, the decrease in labor from N1 to N2 means that firms are producing fewer goods and
services. As output falls, society as a whole will have fewer goods and services. Low-skilled
workers, as members of this society, are harmed.
Finally, a little over half of those working in minimum wage jobs live in households whose
income is above average. Thus, only part of the benefit of higher income for those retaining
jobs goes to the working poor. Because of these factors, it is unlikely that the minimum wage
will improve the economic situation of the poor.
14. Compare and contrast unemployment in the United States and Europe. If unemployment
in Europe is caused by structural factors, what will be the effect of an increase in
aggregate demand?
Unemployment is a greater problem in most European countries than in the United States.
Long-term unemployment is also a greater problem. In many of these countries, over half of
the persons classified as unemployed have been unemployed for at least one year.
If unemployment in Europe is caused by structural factors, increasing aggregate demand will
have little impact. Recall that those who are structurally unemployed do not have the requisite
skills to fill available job vacancies. Thus, policies designed to increase aggregate demand will
result in increases in the price level with little impact on employment. (Note: there may be an
increase in the willingness of employers to train workers if consumers are demanding more
goods and services from firms.)
15. Based on the European experience, list and briefly discuss the factors that discourage: (a)
firms from hiring, and (b) unemployed persons from accepting jobs. How might these
factors be altered to reduce unemployment?
There are several impediments to hiring. First, minimum wages in most European countries
are higher than in the United States. Labor unions in most European countries are more
powerful than in the United States. Their efforts have resulted in higher wages for their
members. These higher wages have come at the expense of less employment. European firms
also higher social security and payroll taxes than do the counterparts in the United States. This
increases the cost of employing workers. Government regulations in many European countries
also make it costly to discharge workers. As a result, firms are reluctant to replace workers.
Finally, regulations in many European countries make it difficult for entrepreneurs to start or
expand firms. Small firms that have made an important contribution to the increase in
employment in the United States.
In addition to impediments in hiring, there are also impediments to accepting employment.
Those who are unemployed in Europe receive relatively more generous benefits over a longer
time period than those who are unemployed in the United States. In addition, relatively high
tax rates in Europe, combined with loss of unemployment and other benefits reduce the
incentive for the unemployment to accept employment.
As the above discussion indicates, many of the factors leading to high, long-term
unemployment rates in Europe are the result of government regulation. In order to alter these
factors, governments in the various European countries will have to enact policies to reduce or
eliminate these regulations.