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Economics
THIRD EDITION
By John B. Taylor
Stanford University
Copyright © 2001 by Houghton
Mifflin Company. All rights reserved.
1
Chapter 20 (Macro 7)
Unemployment and
Employment
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Overview
• Unemployment arises in both the growth and the
cyclical parts of macroeconomics. Any contemporary
account of unemployment must therefore attempt to
define and explain each of these sources. So the
natural rate or, alternatively, frictional and structural
unemployment are due to the enduring features of an
economy in normal times, while cyclical
unemployment is a consequence of economic
fluctuations. Due to the close connection between
cyclical unemployment and economic fluctuations,
detailed discussion of the underlying connections is
deferred until the model of economic fluctuations is
introduced and developed in later chapters.
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Teaching Objectives
• Develop a clear set of definitions of
unemployment and employment that is consistent
with government reports of these data.
• Use the demand and supply model as it applies to
the labor market in the determination of real
wages, employment, and unemployment.
• Discuss the policy implications of the demand and
supply for labor model.
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1. Employment and Unemployment Trends
• The labor force consists of all people who are 16
or over, employed or unemployed. The current
population survey is the source of this number.
• The distinction between employed and
unemployed depends on whether the person is
paid or not. The labor force consists of the
employed plus the unemployed, the latter
consisting of those in the labor force but not
employed. Discouraged workers are not in the
labor force and so are not counted as unemployed.
• Part-time workers (1 to 34 hours per week) are
counted as employed. See Figure 21.2.
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Three indicators of labor market conditions
• The unemployment rate, or
unemployed/labor force. Figure 20.1 makes
clear the relation between unemployment
and real GDP.
• The labor force participation rate, or labor
force/working-age population. It fluctuates
with real GDP as does unemployment.
• The employment-to-population ratio, or
employed/working-age population. These
ratios are given in Figure 20.3.
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Figure 20.1 (Macro 7)
The Unemployment Rate
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Figure 20.2
(Macro 7)
How to Find Labor
Market Indicators
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Figure 20.3
(Macro 7)
Employment-to-Population Ratio for Men, Women, and Everyone
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Adjustments
• Because the labor force is composed of both fulltime workers and a significant number of parttime workers, the number employed needs to be
supplemented by other measures that reflect this
fact. Aggregate hours = (average hours per
worker) x (labor force participation) x (workingage population).
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Unemployment and GDP
• Increases in unemployment reduce real
GDP as the labor input to production falls
because fewer workers are employed. So an
increase in the natural rate reduces potential
real GDP, provided there are no
accompanying changes in productivity to be
accounted for.
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2. The Nature of Unemployment
• People become unemployed because they are job
losers, job leavers, or new entrants. See Figure
20.4.
• Job losers are unemployed because of the
dynamism of the economy: As jobs are created
and destroyed, workers are often left unemployed
in the process. As a consequence, job vacancies
and unemployment exist at the same time, a
reflection of this dynamism. However, job losers
increase during recessions and decline during
booms, as seen in Figure 20.4.
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Figure 20.4
(Macro 7)
Job Losers, Job
Leavers, New
Entrants and
Re-entrants
(January 2000)
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Unemployment
• Job leavers, or quits, are relatively constant over
the cycle due to the opposing forces of reduced
quits and fewer job vacancies in a recession.
• New entrants are a large fraction of the
unemployed, especially on a seasonal basis.
• Most of the unemployed (85 percent) are
unemployed for less than 6 months. See Figure
20.5. However, the long-term unemployed (the
other 15 percent) increase during recessions and
decrease during booms.
• The rate of unemployment varies dramatically
across groups in society, with very high
unemployment rates among minority teenagers.
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Figure 20.10
(Macro 7)
Unemployment Rates for Young Adults
(ages 20-24)
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Figure 20.11
(Macro 7)
Percentage of 20-24-year-olds Still
Living with Parents
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Figure 20.5
(Macro 7)
Unemployment by
Duration (January
2000)
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3. Determination of Employment and Unemployment
• The relationship between labor demand and
supply is given in Figure 20.6, determining the
equilibrium quantity of full-employment labor and
the real wage.
• Two broad trends in labor are the general increase
in real wages and employment. This is associated
with a shift in the demand for labor, as seen in
Figure 20.7, due in part to the growth of service
industries, which hire more women. Women are
quite sensitive to changes in real wages, so the
increased demand in service industries probably
explains the higher participation rate by women.
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Figure 20.6 (Macro 7)
Labor Supply, Labor Demand, and Equilibrium Employment
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Figure 20.7 (Macro 7)
Explaining the Increase in the Employment-to-Population Ratio
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Other Explanations for Unemployment
• In order to account for unemployment in a model
such as Figure 20.6, it is necessary to introduce
some explanation outside of equilibrium. Two
complementary explanations are job rationing and
job search.
• Job rationing is depicted in Figure 21.8 in terms of
excess supply that is always present, not allowing
for the normal downward price (real wage)
adjustment due to: (1) the minimum wage law and
its effect on teenage unemployment; (2) insiders
sometimes preventing outsiders from being
employed; (3) employers paying efficiency wages.
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Figure 20.8 (Macro 7)
Excess Supply of Labor and Unemployment
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Figure 20.9
(Macro 7)
Labor Market Flows
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Policy implications of the demand and supply
model of the labor market
• The policy implications of the demand and supply
model of the labor market are discussed in terms
of the effect on employment and the natural rate of
unemployment.
• Taxes such as a payroll tax affect the demand for
labor, as seen in Figure 20.13. For example, an
increase in the social security tax will reduce the
demand for labor by the amount of the tax,
reducing the real wage and employment.
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Figure 20.13 (Macro 7)
Effects of a Tax on Wages
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Figure 20.14
(Macro 7)
Tax Rates on Wages
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Figure 20.12
(Macro 7)
Minimum Wage as a Percentage of
Average Wage
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Policy implications
• The job-rationing and job-search models
have policy implications for the natural rate
of unemployment. To the extent that job
rationing is present due to the minimum
wage, any reduction in the minimum wage
will reduce unemployment. Similarly, a
reduction in unemployment can be realized
by reduced unemployment compensation
benefits.
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