CHAPTER 32

Labor Markets, Unemployment, and Inflation

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The Nature of UnemploymentFrictional unemployment = unemployment due to the time workers spend in job search.

Structural unemployment = more people seeking jobs in a labor market than there are jobs available at the current wage. (Unemployed don’t have the right skills)

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The Natural Rate of Unemployment

The natural rate of unemployment is the normal unemployment rate around which the actual unemployment rate fluctuates.

Cyclical unemployment is a deviation in the actual rate of unemployment from the natural rate. (Unemployment based on a downturn in the business cycle.)

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Unemployment and the Business Cycle

(The Natural rate of unemployment corresponds to LRAS) (potential output)

When the output gap is positive (an inflationary gap), the unemployment rate is below the natural rate.

When the output gap is negative (a recessionary gap), the unemployment rate is above the natural rate.

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The Actual Unemployment Rate FluctuatesAround the Natural Rate

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Okun’s Law

According to Okun’s law, each additional percentage point of output gap reduces the unemployment rate by less than 1 percentage point.

Example: RGDP increases 1%, therefore,

Unemployment decreases less than 1%

Employers are hesitant to hire additional workers – instead they have the existing labor force work overtime.

In a recession, some laid-off workers will exit the labor force.

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Unemployment and Inflation: The Phillips CurveThe short-run Phillips curve is the negative short-run relationship between the unemployment rate and the inflation rate.

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Expected Inflation and the Short-Run Phillips CurveThe expected rate of inflation is the rate of

inflation that employers and workers expect in the near future. (based on recent inflation trends)

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The NAIRU and the Long-Run Phillips Curve

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The NAIRU and the Long-Run Phillips Curve

The nonaccelerating inflation rate of unemployment, or NAIRU, is the unemployment rate at which inflation does not change over time.

It is equal to the natural rate of unemployment.

NAIRU is simply what the unemployment rate would be in a zero-inflation economy.

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The NAIRU and the Long-Run Phillips CurveThe long-run Phillips curve shows the relationship between unemployment and inflation after expectations of inflation have had time to adjust to experience.

The long-run Phillips curve is vertical because there is no trade-off between the unemployment rate and the inflation rate in the long run.

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The End of Chapter 32