Chapter 13 labor economics

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Chapter 13

Unemployment

Copyright © 2008 The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

Labor Economics, 4 th edition



13 - 3

History of Unemployment inthe United States

• Although the unemployment rate in the United States driftedupward between 1960 and 1990, the economic expansion of the1990s reduced the unemployment rates substantially.



13 - 4

Unemployment in the U.S. from1900 to 2005

0

5

10

15

20

25

30

1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

Ye ar

U n e m p

l o y m e n t

R a

t e



13 - 5

Unemployment Rates by EducationAttainment, 1970-2005

0

2

4

6

8

10

12

14

16

1970 1980 1990 2000 2010

Year

U n e m p l o y m e n t R a t e

High school dropouts

College graduates

High school graduates



13 - 6

Frictional Unemployment

• Even a well-functioning competitive economy experiencesfrictional unemployment because some workers willunavoidably be “in between” jobs.



13 - 7

Structural Unemployment

• Structural unemployment arises when there is an imbalance between the supply of workers and the demand for workers.



13 - 8

The Rate of Unemployment

• The steady-state rate of unemployment depends on thetransition probabilities among employment, unemployment, andthe nonmarket sector.



13 - 9

Unemployed Persons by Reason forUnemployment, 1967-2005

0

10

20

30

40

50

60

1960 1970 1980 1990 2000 2010

Year

P e r c e n t

Job losers

Job leavers

Reentrants

New entrants



13 - 10

Unemployment Duration

• Although most spells of unemployment do not last very long,most weeks of unemployment can be attributed to workers whoare in very long spells.





13 - 12

Trends in Alternative Measures of theUnemployment Rate

0

2

4

6

8

10

12

1994 1996 1998 2000 2002 2004 2006

Year

U n e m p l o y m e n t R a t e

Official unemployment rate

Official + marginally attached workers

Official + marginally attached workers + part-time workers available for full-time work



13 - 13

Flows Between Employment andUnemployment

Employed( E workers) Unemployed

( U Workers)

Job Losers ( E )

Job Finders ( h U )

Suppose a person is either working or unemployed. At any point intime, some workers lose their jobs and unemployed workers find

jobs. If the probability of losing a job equals , there are E joblosers. If the probability of finding a job equals h, there are h U

job finders.

13 14



13 - 14

Dynamic Flows in the U.S. LaborMarket, May 1993

Employed:119.2 million

Unemployed:8.9 million

Out of Labor Force:65.2 million

1.8 million

2.0 million

1.5 million

1.7 million

3.2 million

3.0 million

13 15



13 - 15

Job Search

• The asking wage makes the worker indifferent betweencontinuing his search activities and accepting the job offer athand.

• An increase in the benefits from search raises the asking wageand lengthens the duration of the unemployment spell• An increase in search costs reduces the asking wage and

shortens the duration of the unemployment spell.

13 16



13 - 16

The Wage Offer Distribution

$5

45

$8 $22 $25

Frequency

Wage

The wage offer distribution gives the frequency distribution of potential job offers. A given worker can get a job paying anywherefrom $5 to $25 per hour.

13 17



13 - 17

The Determination of the Asking Wage

$5 $25Wage Offer

at Hand

Dollars

w

MC

MR

$10 $200

The marginal revenue curve givesthe gain from an additionalsearch. It is downward sloping

because the better the offer at

hand, the less there is to gain froman additional search. The marginalcost curve gives the cost of anadditional search. It is upwardsloping because the better the joboffer at hand, the greater the

opportunity cost of an additionalsearch. The asking wage equatesthe marginal revenue and themarginal cost of search.

13 18



13 - 18

Discount Rates, UnemploymentInsurance, and the Asking Wage

Wage

Dollars

w 0 w 0 w 1 w 1

MC

MR 0

MR 1

Wage

MC 0

MC 1

MR

( a ) Increase in discount rates ( b ) Increase in unemployment benefits

13 19



13 - 19

Unemployment Insurance

• Unemployment insurance lengthens the duration ofunemployment spells and increases the probability that workers

are laid off temporarily.

13 20



13 - 20

The Relationship Between the Probability ofFinding a New Job and UI Benefits

.00

.02

.04

.06

.08

25 20 15 10 5 0 -5 -10 -15

Weeks Until Exhaustion of Benefits

P r o

b a

b i l i t y

13 21



13 - 21

Funding the UI System: ImperfectExperience Rating

Layoff Ratein the Past

Tax rate

l0

0

t MIN

t MAX

l1

If the firm has very fewlayoffs (below thresholdl0), the firm is assessed a

very low tax rate to fundthe UI system. If thefirm has had manylayoffs in the past (abovesome threshold l 1), thefirm is assessed a taxrate, but this tax rate iscapped at t MAX .

13 - 22



13 - 22

The Intertemporal SubstitutionHypothesis

• The intertemporal substitution hypothesis argues that the hugeshifts in labor supply observed over the business cycle may be

the result of workers reallocating their time so as to purchaseleisure when it is cheap (that is, during recessions).

13 - 23



13 23

The Sectoral Shifts Hypothesis

• The sectoral shifts hypothesis argues that structuralunemployment arises because the skills of workers cannot beeasily transferred across sectors.

• The skills of workers laid off from declining industries have to be retooled before they can find jobs in growing industries.

13 - 24



13 24

Efficiency Wages and Unemployment

• Efficiency wages arise when it is difficult to monitor workers’output.

• The above-market efficiency wage generates involuntaryunemployment

13 - 25



13 25

The Determination ofthe Efficiency Wage

Dollars

Employment

S

NS

G

Q

F P

D

E E NS

w*

w NS

If shirking is not a problem, themarket clears at wage w* (wheresupply S equals demand D). Ifmonitoring is expensive, the threat

of unemployment can keep workersin line. If unemployment is high(point F ), firms can attract workerswho will not shirk at a very lowwage. If unemployment is low(point G), firms must pay a veryhigh wage to ensure that workers donot shirk. The efficiency wage w NS is given by the intersection of theno-shirking supply curve ( NS ) andthe demand curve .

13 - 26



13 26

The Impact of an Economic Contractionon the Efficiency Wage

w *

w NS

Dollars

Employment

NS

D0

D1

E E 1

w *

E 0

0

0

w NS

S A fall in output demandshifts the labor demandcurve from D0 to D1. Thecompetitive wage fallsfrom to . If firms pay anefficiency wage, thecontraction in demand alsoreduces the efficiencywage but by a smalleramount.



13 - 28



Implied Contracts

• Implicit contract theory argues that workers prefer employmentcontracts where incomes are relatively stable over the businesscycle, even if such contracts imply reductions in hours of workduring recessions.

13 - 29



The Phillips Curve

• A downward-sloping Phillips curve can only exist in the shortrun.

• In the long run, there is no trade-off between inflation andunemployment.

13 - 30



The Phillips Curve

UnemploymentRate

Rate ofInflation

3

4 B

A

The Phillips curve describes thenegative correlation between the

inflation rate and the unemploymentrate. The curve implies that aneconomy faces a trade-off betweeninflation and unemployment.

13 - 31



Inflation and Unemployment in theUnited States, 1961-2005

0

2

4

6

8

10

12

14

3 4 5 6 7 8 9 10

Unemployment Rate

R a t e o f I n f l a t i o n

6162

6365

64

66

67

68

69

70

71

72

73

74

75

7677

78

79

80

81

82

83

84

86

858887

89 91

90

929394

9596979899

00 01

03

02

05

13 - 32



The Short-Run and Long-Run PhillipsCurves

3 5

0 A

B 7

Short Run

Long Run

Rate ofInflation

UnemploymentRate



13 - 34



Unemployment in Europe

• The combination of… - high unemployment insurance benefits

- employment protection restrictions- wage rigidity… • …probably accounts for the high levels of unemployment

observed in Europe in the 1980s and 1990s.

13 - 35



Unemployment in Western Europe,1960-2005

0

3

6

9

12

15

1960 1970 1980 1990 2000 2010

Year

U n e m p

l o y m e n

t R a t e

USFranceGermanyItalyUK



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Chapter 13 labor economics

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