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CHAPTER 12. “Now joblessness isn’t just for philosophy majors.” -Kent Brockman. Recent History of Unemployment In the United States.
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CHAPTER 12 “Now joblessness isn’t just for philosophy majors.” -Kent Brockman
Recent History of Unemployment Inthe United States Although the average unemployment rate in the United States drifted upward between 1960 and 1990, the economic expansion of the 1990s through 2007 reduced the unemployment rate substantially. The unemployment rate rose to 9.6% by 2010 following the Great Recession of 2008-09 and has slowly fallen since then, to 7.6% in March 2013. The unemployment rate in the U.S. has exceeded unemployment rates in much of Europe since 2007.
Frictional Unemployment Frictional unemployment arises when workers and firms need time to locate each other and to process information about the potential quality of the job match. Even a well-functioning competitive labor market experiences frictional unemployment, because some workers will unavoidably be “between” jobs and some firms will have unfilled vacancies. The “solution” to frictional unemployment involves providing less costly information about the characteristics of available workers and jobs.
Structural Unemployment Structural unemployment arises when there is an mismatch between the supply of workers and the demand for workers, specifically because of a difference between the workplace skills possessed by workers and the skills demanded by firms or because the workers with skills demanded by firms are located in a different area. Structural unemployment is inefficient because human capital is no longer being put to its most productive use. The “solution” to structural unemployment involves worker retraining and/or re-location.
The Steady-State Unemployment Rate The steady-state unemployment rate depends on the transition probabilities among employment, unemployment, and out of the labor force. = the fraction of employed workers who lose their jobs and become unemployed h = the fraction of unemployed workers who find work and are hired In the steady state E = hU. Since the labor force is LF = E + U, then = U/LF = /(+ h)
Unemployment Duration Although most spells of unemployment do not last very long, most weeks of unemployment can be attributed to workers who are in very long spells of unemployment.
Trends in Alternative Measures of the Unemployment Rate, 1994-2010
Flows Between Employment and Unemployment Job Losers (E) Employed (E workers) Unemployed (U Workers) Job Finders (h U) Suppose a person is either working or unemployed. At any point in time, some workers lose their jobs and unemployed workers find jobs. If the probability of losing a job equals , there are E job losers. If the probability of finding a job equals h, there are hU job finders.
Flows in the U.S. Labor Market: March 2013 2.2 million Unemployed: 11.7 million Employed: 143.3 million 1.9 million 3.7 million 2.7 million 2.7 million 4.2 million Out of Labor Force: 90.0 million
Job Search and the Reservation Wage At the reservation wage, the worker is indifferent between continuing to search for additional job offers and accepting the job offer at hand. An increase in the benefits from search raises the reservation wage and lengthens the duration of a spell of unemployment. An increase in search costs reduces the reservation wage and shortens the duration of a spell of unemployment.
The Wage-Offer Distribution Frequency $5 $8 $22 Wage $25 The wage-offer distribution gives the probability distribution of possible wage offers. This worker faces a range of possible wage offers from $5 to $25 per hour.
Determination of the Asking Wage Dollars MC MR Wage Offer at Hand 0 w $25 $20 $10 $5 The marginal revenue curve gives the expected gain from additional search. It is downward sloping because the better the wage offer at hand, the less there is to gain from additional search. The marginal cost curve gives the cost of additional search. It is upward sloping because the better the wage offer at hand, the higher is the opportunity cost of additional search. The reservation wage w equates the marginal revenue and the marginal cost of additional search.
Discount Rates, Unemployment Insurance, and the Reservation Wage Dollars MC0 MC MC1 MR0 MR1 MR Wage Wage w1 w1 w0 w0 (a) Increase in the discount rate (b) Increase in unemployment benefits
Unemployment Insurance Unemployment benefits are typically paid a maximum of 26 weeks of unemployment, but this length is frequently extended by Congress during recessions. The level of unemployment benefits depends on previous earnings. The replacement ratio averages about 60 percent for low-wage workers and about 25 percent for high-wage workers. Unemployment insurance lengthens the duration of unemployment spells and increases the probability that workers are laid off temporarily.
Funding the UI System: Imperfect Experience Rating Tax rate tMAX tMIN Layoff Rate in the Past 0 l1 l0 If the firm has very few layoffs (below threshold l0), the firm is assessed a very low tax rate to fund the UI system. If the firm has had many layoffs in the past (above some threshold l1), the firm is assessed a tax rate, but this tax rate is capped at tMAX.
The Intertemporal Substitution Hypothesis The intertemporal substitution hypothesis argues that the large shifts in labor supply observed over the business cycle is the result of workers reallocating their time so as to consume more leisure when it is relatively cheap (that is, during recessions). Thus, it is a theory of voluntary cyclical unemployment.
The Sectoral-Shifts Hypothesis The sectoral shifts hypothesis argues that structural unemployment has risen because the skills of newly unemployed workers from declining industries, occupations, or regions cannot be easily transferred to other, expanding industries, occupations, or regions. The skills of workers laid off in declining industries or occupations have to be retooled, or they have to relocate, before they can find jobs in expanding sectors of the economy..
Efficiency Wages and Unemployment (Revisited) Efficiency wages arise when it is difficult to monitor worker output. The above-market efficiency wage generates involuntary unemployment.
The Determination ofthe Efficiency Wage If shirking is not a problem, the market clears at wage w* (where supply S equals demand D). If monitoring is expensive, the threat of unemployment can keep workers in line. If unemployment is high (point F), firms can attract workers who will not shirk at a very low wage. If unemployment is low (point G), firms must pay a very high wage to ensure that workers do not shirk. The efficiency wage wNS is given by the intersection of the no-shirking supply curve (NS) and the demand curve. Dollars S NS G Q wNS F P w* D Employment E ENS
The Impact of an Economic Contraction on the Efficiency Wage Dollars NS wNS 0 w* 0 D0 wNS w* D1 Employment E E0 E1 S A fall in output demand shifts the labor demand curve from D0 to D1. The competitive wage falls from w*0 to w*. If firms pay an efficiency wage, the contraction in demand also reduces the efficiency wage but by a smaller amount.
The Relation Between Wage Levels and Unemployment Across Regions Wage B A Unemployment Rate Geographic regions (such as B) that offer higher wage rates also tend to have lower unemployment rates. Efficiency wage models help explain this pattern: firms located in regions with high unemployment rates do not need to offer a very high wage to discourage shirking.
Implicit Contracts Implicit contract theory argues that workers prefer employment contracts where incomes are relatively stable over the business cycle, even if such contracts imply reductions in hours of work during recessions.
The Phillips Curve A downward-sloping Phillips curve can only exist in the short run. In the long run, there is no trade-off between inflation and unemployment.
Rate of Inflation B 4 A 3 Unemployment Rate The Phillips Curve The Phillips curve depicts a negative relationship between the inflation rate and the unemployment rate. The Phillips Curve implies that an economy faces a trade-off between inflation and unemployment.
The Short-Run and Long-Run Phillips Curves Rate of Inflation Long Run B 7 A 0 Short Run Unemployment Rate 3 5
The Short-Run and Long-Run Phillips Curves The economy is initially at point A (on the previous graph); there is no inflation and a 5 percent unemployment rate. If monetary policy increases the inflation rate to 7 percent, job searchers will suddenly find many jobs that meet their reservation wage and the unemployment rate falls in the short run, moving the economy to point B.
Over time, workers realize that the inflation rate is higher and will adjust their reservation wage upward, returning the economy to point C. In the long run, the unemployment rate is still 5 percent, but there is now a higher rate of inflation. In the long run, therefore, there is no trade-off between inflation and unemployment. The Short-Run and Long-Run Phillips Curves
Percent of Unemployed Persons in Spells of Unemployment Lasting at Least 12 Months
Unemployment in Europe A combination of… high unemployment-insurance benefits employment-protection restrictions wage rigidity accounts for much of the relatively high levels of unemployment and the relatively stable wage distribution observed in Europe in the 1980s and 1990s.
