Transcript Macroeconomics Term III Ace Institute of Management

Macroeconomics & The global
economy
Ace Institute of Management
Chapter 6: Unemployment
Instructor
Sandeep Basnyat
[email protected]
9841 892281
Unemployment- Major
Macroeconomic Issue
• Major concern for all government
• Develop policies to curb unemployment
or increase employment rate.
• However…
U.S. Unemployment, 1958-2002
11
Percent of labor force
10
9
8
7
6
5
4
3
2
1955
1960
1965
1970
1975
Unemployment rate
1980
1985
1990
1995
2000
Natural rate of unemployment
What determines the natural rate of unemployment?
Natural Rate of Unemployment
• Natural rate of unemployment:
the average rate of unemployment around which
the economy fluctuates.
• In a recession, the actual unemployment rate rises
above the natural rate.
• In a boom, the actual unemployment rate falls
below the natural rate.
A first model of the natural rate
Notation:
L = # of workers in labor force
E = # of employed workers
U = # of unemployed
U/L = unemployment rate
L = E+U or E = L – U or U = L - E
Assumptions:
1. L is exogenously fixed.
2. During any given month,
s = fraction of employed workers
that become separated from their jobs,
f = fraction of unemployed workers
that find jobs.
s = rate of job separations
f = rate of job finding
(both exogenous)
The steady state condition
• Definition: the labor market is in
steady state, or long-run equilibrium,
if the unemployment rate is constant.
• The steady-state condition is:
s E = f U
# of employed
people who lose or
leave their jobs
# of unemployed
people who find jobs
The transitions between employment and
unemployment
f U
Employed
Unemployed
s E
Solving for the “equilibrium” U rate
f U
= s E
= s (L –U )
= s L – s U
f xU + sU = s L
or,
(f + s)U = s L
so,
U
s

L s f
Or,
Example:
• Each month, 1% of employed workers
lose their jobs (s = 0.01)
• Each month, 19% of unemployed workers
find jobs (f = 0.19)
• Find the natural rate of unemployment:
U
s
0.01


 0.05, or 5%
L s f
0.01  0.19
Policy implication
• A policy that aims to reduce the natural
rate of unemployment will succeed only if
it lowers s or increases f.
Why is there unemployment?
• There are two reasons:
1. Job search
2. Wage rigidity
Job Search & Frictional Unemployment
• frictional unemployment: caused by the time it
takes workers to search for a job
• occurs even when wages are flexible and there are
enough jobs to go around
• occurs because
 workers have different abilities, preferences
 jobs have different skill requirements
 geographic mobility of workers not
instantaneous
 flow of information about vacancies and job
candidates is imperfect
Sectoral shifts
• def: changes in the composition of demand among
industries or regions
• example: Technological change
increases demand for computer repair persons,
decreases demand for typewriter repair persons
• example: A new international trade agreement
causes greater demand for workers in the export
sectors and less demand for workers in importcompeting sectors.
• It takes time for workers to change sectors,
so sectoral shifts cause frictional unemployment.
Industry shares in U.S. GDP, 1960
57.9%
Agriculture
Manufacturing
Other industry
Services
9.9%
4.2%
28.0%
Source: World Development Indicators, World
Bank
Industry shares in U.S. GDP, 1997
72.0%
Agriculture
Manufacturing
Other industry
Services
8.5%
17.8%
1.7%
Even the “tiny” category of
agriculture drops by more
than half : from 4.2% to 1.7%
of GDP.
Source: World Development Indicators, World Bank
Sectoral shifts abound
• more examples:
 Late 1800s: decline of agriculture, increase in
manufacturing
 Late 1900s: relative decline of manufacturing,
increase in service sector
 1970s energy crisis caused a shift in demand away
from huge gas guzzlers toward smaller cars.
• Sectoral shifts occur frequently, contributing to
frictional unemployment.
For your information
Assess the trend in sectoral shift in the industrial
sectors in:
1. Nepal
2. India
3. China
4. Japan
5. South Korea
6. Taiwan
7. Malaysia, and
8. Vietnam
Public Policy and Job Search
Govt programs affecting unemployment
 Govt employment agencies:
disseminate info about job openings to better match
workers & jobs
 Public job training programs:
help workers displaced from declining industries get
skills needed for jobs in growing industries
Unemployment insurance (UI)
• UI pays part of a worker’s former wages for a limited
time after losing his/her job.
• UI increases search unemployment, because it:
– reduces the opportunity cost of being
unemployed
– reduces the urgency of finding work
– hence, reduces f
• Studies: The longer a worker is eligible for UI,
the longer the duration of the average spell of
unemployment.
Benefits of UI
• By allowing workers more time to
search,
UI may lead to better matches between
jobs and workers,
which would lead to greater productivity
and higher incomes.
Why is there unemployment?
U
s
The natural rate of unemployment:

L s f
• There are two reasons:
DONE  1. job search
Next 
2. wage rigidity
Unemployment from real wage rigidity
If the real
wage is
stuck above
the eq’m
level, then
there aren’t
enough jobs
to go
around.
Real
wage
Supply
Unemployment
Rigid
real
wage
Demand
Labor
Amount of
labor hired
Amount of labor
willing to work
Unemployment from real wage rigidity
If the real
wage is
stuck above
the eq’m
level, then
there aren’t
enough jobs
to go
around.
Then, firms must ration the
scarce jobs among workers.
Structural unemployment:
the unemployment resulting
from real wage rigidity and
job rationing.
Reasons for wage rigidity
1.
Minimum wage laws
2.
Labor unions
3.
Efficiency wages (employers offer high wage as
incentive for worker productivity and loyalty)
The minimum wage : US Case Study
• In Sept 1996, the minimum wage was raised
from $4.25 to $4.75. Here’s what happened:
Unemployment rates, before & after
3rd Q 1996
1st Q 1997
Teenagers
16.6%
17.0%
Single
mothers
8.5%
9.1%
All workers
5.3%
5.3%
 Other studies: A 10% increase in the minimum
wage increases teenage unemployment by 1-3%.
Labor unions
• Unions exercise monopoly power to
secure higher wages for their members.
• When the union wage exceeds the eq’m
wage, unemployment results.
• Employed union workers are insiders
whose interest is to keep wages high.
• Unemployed non-union workers are
outsiders and would prefer wages to be
lower (so that labor demand would be
high enough for them to get jobs).
Efficiency Wage Theory
• Theories in which high wages increase worker
productivity:
– attract higher quality job applicants
– increase worker effort and reduce “shirking”
– reduce turnover, which is costly
– improve health of workers
(in developing countries)
• The increased productivity justifies the cost of
paying above-equilibrium wages.
• The result: unemployment
Wage Inflation and Unemployment
• In 1958, economist A W Philips, through empirical study of
Britain’s economy, concluded that there exists inverse
relationship between wage Inflation and Unemployment
• It shows the trade-off between wage inflation and
unemployment.
Logic:
1. When Labour demand is high, most of the labour get
employed and labour market is in shortage of labour or
tight.
2. Labour unions find opportunities to bargain with
employers or they have high bargaining power for
increasing wage rates faster.
3. So, Lower the unemployment rate, higher the wage rate.
Relationship Between Inflation and
Unemployment
1. Faster increase in wage rates will result in
faster increase in disposable income of the
labour causing higher increase in price level
or inflation.
2. Conclusion: Higher the employment rate or
Lower the Unemployment rate, higher the
inflation rate.
The Phillips Curve
The Phillips curve shows the relationship between the
inflation rate and the unemployment rate.
• This macroeconomic
relationship has been
widely studied.
• It shows that there is a
trade-off between inflation
and unemployment. To
lower the inflation rate, we
must accept a higher
unemployment rate.
Unemployment and Growth
• In 1960s, Arthur Okun, through empirical study,
concluded that there exists inverse relationship
between unemployment and economic growth
• He concluded that one percent decrease in
unemployment will increase the output by 2.5
percent in the short run.
• This law is known as Okun’s Law
• This relation can be used to deduce inflationary
pressure curve, which along with Phillips curve
gives the short run rate of inflation and
unemployment
Criticism of Phillip Curve-Non Trade off
Milton Friedman:
• Downward sloping curve is a short run and in
the long run Phillips curve become vertical line
– In the long run, Phillips curve shifts constantly due
to improvement in economic situations (such as
labour market reform, labours wanting stability,
increased competition in labour market etc. )
– Regardless of the rate of inflation, there is only
one rate of unemployment in the long run, that is
natural rate: NAIRU (Non Accelerating Rate of
Unemployment).
Criticism of Phillip Curve-Non Trade off
Inflation Rate
B
C
A
New SR Phillips Curve
Initial SR Phillips Curve
Unemployment Rate
For further info:
Macroeconomic Analysis, Edward Shapiro
Macroeconomics, Theory and Policy, D.N. Dwivedi
Thank You