Unemployment Notes

Unemployment

Introduction

Unemployment is a macroeconomic problem that directly and severely affects individuals. Economists study unemployment to understand its causes and to improve public policies like:

  • Job-training programs

  • Unemployment insurance

Some unemployment exists in all free market economies.

Historical Unemployment in the US

The graph shows the unemployment rate and natural rate of unemployment in the US from 1950 to 2020.

The Natural Rate of Unemployment

The natural rate of unemployment is the normal level around which the unemployment rate fluctuates. It is the rate to which the economy gravitates in the long run, considering labor-market imperfections that prevent workers from instantly finding jobs.

The "Bathtub Model" of Unemployment

The labor force LL is the sum of the employed EE and the unemployed UU.
L=E+UL = E + U

The job separation rate ss is the fraction of employed workers who lose their jobs each month.

The job finding rate ff is the fraction of unemployed workers who find a job each month.

The labor market is in a steady state, meaning the unemployment rate remains constant if fU=sEfU = sE.

The "Bathtub Model" - Diagram

The diagram illustrates the flow between employment and unemployment, with job separation leading from employed to unemployed and job finding leading from unemployed to employed.

The "Bathtub Model" - Equations

fU=sEfU = sE
fU=s(L−U)fU = s(L - U)
fUL=s(1−UL)f \frac{U}{L} = s(1 - \frac{U}{L})
UL=ss+f\frac{U}{L} = \frac{s}{s + f}

If s=1%s = 1\% and f=19%f = 19\%, then:
UL=11+19=120=5%\frac{U}{L} = \frac{1}{1 + 19} = \frac{1}{20} = 5\%
This results in a 5% unemployment rate.

Why is there unemployment?

There are different types of unemployment:

  • Frictional

  • Structural

  • Cyclical

Frictional Unemployment

Frictional unemployment is caused by the time it takes workers to search for a job because:

  • Workers have different preferences and abilities.

  • Jobs have different attributes, skill requirements, and wages.

  • Unemployed workers may not accept the first job they are offered.

  • Information flow about job candidates and vacancies is imperfect.

  • Geographic mobility of workers is not instantaneous.

Causes for Frictional Unemployment

The types of goods demanded by firms and households vary over time, causing sectoral shifts. Examples:

  • Invention of the PC reduced demand for typewriters and labor in typewriter manufacturing.

  • An increase in oil prices increases demand for labor in oil-producing areas.

  • An increase in gasoline prices reduces demand for labor at automotive manufacturers.

Sectoral shifts can make certain skills redundant, forcing workers to retrain. Frictional unemployment is unavoidable as long as the supply and demand for labor are changing.

Unemployment Policy

Policies that reduce frictional unemployment:

  • Government employment agencies disseminate information about vacancies.

  • Publicly funded retraining programs.

Policies that increase frictional unemployment:

  • Generous unemployment insurance.

Structural Unemployment

Structural unemployment is caused by wage rigidity and job rationing. The graph illustrates the rigid real wage above the equilibrium, leading to unemployment.

Causes for Wage Rigidity

  • Minimum wage laws: Wages are legally set above the market-clearing wage.

  • Unions and collective bargaining: Wages are determined through bargaining, often resulting in wages above the market-clearing level. The threat of unionization can also keep wages high.

  • Efficiency wages: Higher wages make workers more productive due to:

    • Better nutrition (especially in developing countries)

    • Lower labor turnover because employees are more satisfied.

    • Adverse selection: Lower wages cause the best employees to leave.

    • Moral hazard: Less shirking because losing a high-wage job is a greater deterrent.

Cyclical Unemployment

Cyclical unemployment is caused by booms and recessions and captures deviations of unemployment from the natural level. Fluctuations in output are closely associated with fluctuations in unemployment.

  • Okun’s Law: negative relationship between unemployment and output.

  • Employed workers produce, while unemployed workers do not.

US Historical Unemployment Rate Graph

The graph shows the unemployment rate in the US from 1970 to 2015.

  1. Introduction to Unemployment

    • Definition and significance of unemployment

    • Importance of studying unemployment for public policy, such as job-training programs and unemployment insurance.

  2. Historical Unemployment in the US

    • Examination of unemployment rates from 1950 to 2020.

  3. The Natural Rate of Unemployment

    • Definition and significance of the natural rate of unemployment.

  4. The "Bathtub Model" of Unemployment

    • Introduction to labor force components and job separation/job finding rates.

    • Steady state of the labor market.

  5. The "Bathtub Model" - Diagram and Equations

    • Visual representation of employment flows.

    • Relevant equations detailing relationships between employed and unemployed.

  6. Types and Causes of Unemployment

    • Frictional, structural, and cyclical unemployment.

  7. Frictional Unemployment

    • Exploration of the reasons behind frictional unemployment

    • Impact of sectoral shifts on job availability.

  8. Unemployment Policy

    • Policies to reduce or increase frictional unemployment.

  9. Structural Unemployment

    • Factors leading to structural unemployment, including wage rigidity.

  10. Cyclical Unemployment

    • Description of cyclical unemployment and its relationship to economic fluctuations.

    • Relationship between unemployment and output (Okun’s Law).

  11. US Historical Unemployment Rate Graph

    • Overview of the unemployment rate trends in the US from 1970 to 2015.