Ch7 Unemployment

Natural rate of unemployment

the average rate of unemployment around which the economy fluctuates

In a recession

the actual unemployment is

above the natural rate

In a boom

the actual unemployment is below the natural rate

Equilibrium Unemployment

In the data, we always observe positive unemployment

Job Search & Frictional Unemployment

Caused by the time it takes workers to search for a job, occurs since jobs and workers are heterogeneous, workers have different abilities, preferences, jobs have different skill requirements, flow of information about vacancies and job candidates is imperfect

Reducing frictional unemployment

Government employment agencies distribute information about job vacancies to match jobs and workers more efficiently

Retraining programs ease the transition of workers from declining to growing industries

Unemployment Insurance

• UI pays part of a worker’s former wages for a limited time after the worker loses his/her job

• N: UI increases frictional unemployment and raises the unemployment rate since it reduces

• P: Reduces worker’s uncertainty about incomes, induces workers to reject bad job offers, UI may lead to better matches between jobs and workers —> higher future productivity

Structural Unemployment

Workers are unemployed because there is a

fundamental mismatch between # of people

who want to work and # of available jobs

• Excess supply of labor at the going wage

The Minimum Wage

The min. wage may exceed the eq’m wage

of unskilled workers, especially teenagers.

• Studies: a 10% increase in min. wage

reduces teen employment by 1–3%

Proponents claim that cost of unemployment is

worth bearing to raise others out of poverty

• Opponents claim that minimum wage not the

best way to help the working poor

• Poorly targeted: many minimum-wage earners

are teenagers from middle-class homes

working for discretionary spending money

Monopoly Power of Labor Unions

Wages of unionized workers are determined not by

the equilibrium of supply and demand but by

bargaining between union leaders and firms

• Unions exercise monopoly power to secure higher

wages for their members

• When union wage exceeds the eq’m wage,

unemployment results

Q: Explain the Henry Ford $5 workday example .

A: Ford paid above-market wages, which increased worker morale, productivity, and reduced turnover — an example of efficiency wages in practice.

The natural rate of unemployment refers to:

A. The unemployment rate when cyclical unemployment is zero.

2. In the steady-state model of the labor market, unemployment is constant when:

A. The number of people losing jobs equals the number finding jobs.

3. Frictional unemployment arises because:

B. There is imperfect information about job vacancies and worker skills.

4. Which policy would likely reduce frictional unemployment?

B. Creating better job-matching platforms.

5. Structural unemployment results primarily from:

B. Wage rigidity that prevents market clearing.

8. Briefly explain how unemployment insurance (UI) can increase the natural rate of unemployment, but also improve long-term productivity.

UI increases the natural rate because it lowers the opportunity cost of unemployment, reducing the job finding rate f. 

However, it can also improve productivity by allowing workers more time to find a good job match

Frictional unemployment and one policy example

Cause: Job search & imperfect info

Policy: Job-matching platforms, retraining programs

Structural unemployment and one policy example

Cause: Wage rigidity (min wage, unions, efficiency wages)

Policy: Reducing binding wage floors, improving labor flexibilityq

11. Suppose the government raises the minimum wage. Discuss how this might affect the natural rate of unemployment, and which group of workers is most affected.

Raising the minimum wage can increase the natural rate by creating structural unemployment among low-skill workers whose equilibrium wage is below the new minimum. Teenagers and unskilled workers are most affected.

12. Explain the concept of efficiency wages and how it can lead to persistent unemployment.

Firms may voluntarily pay wages above equilibrium to increase productivity, reduce turnover, and attract higher-quality workers. However, this creates excess labor supply-some workers want jobs at that wage but cannot get them - causing structural unemployment.

13. Using the Henry Ford $5 workday example, explain how high wages can reduce costs for firms.

Higher wages can increase worker morale, effort, and retention, reducing turnover and training costs. These productivity gains can outweigh higher wage expenses - this is the essence of the efficiency wage theory.