6' Unemployment

1
6. Unemployment

• Agenda
• The classical theory assumes that the labor is
  fully utilized, thus there is no unemployment.
  However, even in the long run,
• Why do we always face some unemployment?
• What determines the level?

2
Natural Rate of Unemployment
The average rate of unemployment around which the
economy fluctuates the unemployment rate toward
which the economy gravitates in the long run.
3
Job Separation, Job Finding and Unemployment Rate

• L E
  U
• labor force the employed the
  unemployed
• Let assume that L is fixed and the following
• Job finding a fraction f (constant) of the
  unemployed finds jobs
• Job separation a fraction s (constant) of the
  employed loses jobs
• In the steady sate,
• fU
  sE
• the number of people finding jobs the number of
  people losing jobs
• Using LEU and fUsE, we get the natural rate of
  unemployment (U/L)
• U/L s/(sf)
• ? Any policy aimed at lowering the natural rate
  of unemployment must either reduce the rate of
  job separation or increases the rate of job
  finding

4
The Reasons for Unemployment (1)

• Job search
• Frictional unemployment the unemployment
  caused by the time it takes workers to search for
  a job.
• Frictional unemployment is often caused by
  sectoral shift a change in the composition of
  demand among industries and regions.
• Unemployment insurance raises the frictional
  unemployment.

The European (EC15) unemployment rate has risen
since 1980
because of generous benefits for unemployed
workers and less demand for unskilled workers
caused by technological change
5
The Reasons for Unemployment (2)

• Wage rigidity
• Structural unemployment the unemployment
  resulting from real-wage rigidity --- the failure
  of wages to adjust labor market.

If the real wage is stuck above the equilibrium
level, then the supply of labor exceeds the
demand. The result is unemployment
6
The Reasons for Real Wage Rigidity

• Minimum-wage law
• Raising the income of the working poor at the
  cost of increase in the unemployment.
• Unions and collective bargaining
• Conflicts between insiders and outsiders
• Efficiency wage
• High wages make workers more productive. So,
  firms may find it profitable to keep wages above
  the level that equilibrates labor supply and
  demand.
• Improving nutrition and health of workers
• Reducing labor turnover
• Improving the average quality of workers by
  keeping good workers (avoiding adverse selection)
  
• Improving workers efforts (avoiding moral hazard)

7
Summary

• The theory of natural unemployment rate says
• The natural rate of unemployment depends on the
  rate of job separation and the rate of job
  finding.
• Frictional unemployment inevitably occurs because
  it takes time for workers to search for their
  jobs
• Structural unemployment results when the
  real-wage remains above the equilibrium level of
  labor market.
• The reasons for the real-wage rigidity are
  minimum-wage laws, unions, and efficiency-wages.