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Unemployment and Its Natural Rate
1
Types of Unemployment
• In United States, people are considered unemployed
if they are not working and actively seeking a job
– Unemployment can arise for a variety of reasons, each
with its own policy implications
– This is why economists have found it useful to classify
unemployment into four different categories
–
–
–
–
Frictional unemployment
Seasonal unemployment
Structural unemployment
Cyclical unemployment
» Each arises from a different cause and has different
consequences
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Frictional Unemployment
• Short-term joblessness experienced by people who
are between jobs or who are entering the labor
market for first time or after an absence
• Because frictional unemployment is, by definition,
short-term, it causes little hardship to those affected
by it
• By spending time searching rather than jumping at
the first opening that comes their way
– People find jobs for which they are better suited and in
which they will ultimately be more productive
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Seasonal Unemployment
• Joblessness related to changes in weather, tourist
patterns, or other seasonal factors
• Is rather benign
– Short-term
– Workers are often compensated in advance for
unemployment they experience in off-season
• To prevent any misunderstandings, government
usually reports the seasonally-adjusted rate of
unemployment
– Rate that reflects only those changes beyond normal for
the month
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IDENTIFYING UNEMPLOYMENT
• Long-run versus Short-run Unemployment:
– Long-run: The natural rate of unemployment
– Short-run: The cyclical rate of unemployment
• Natural Rate of Unemployment
– The amount of unemployment that the economy normally
experiences and does not go away on its own even in the
long run.
• Cyclical Unemployment
– Associated with with short-term ups and downs of the
business cycle and refers to the year-to-year fluctuations in
unemployment around its natural rate.
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• Describing Unemployment
– Three Basic Questions:
• How does government measure the economy’s rate of
unemployment?
• What problems arise in interpreting the unemployment
data?
• How long are the unemployed typically without work?
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How Is Unemployment Measured?
• Unemployment is measured by the Bureau of Labor Statistics
(BLS).
– It surveys 60,000 randomly selected households every month.
– The survey is called the Current Population Survey.
• Based on the answers to the survey questions, the BLS places
each adult (over 16) years old into one of three categories:
– Employed
– Unemployed
– Not in the labor force
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Employed, Unemployed, Not in the Labor
Force, Labor Force
• Employed: A person is considered employed if he or she has
spent most of the previous week working at a paid job.
• Unemployed: A person is unemployed if he or she is on
temporary layoff, is looking for a job, or is waiting for the start
date of a new job.
• Not in the Labor Force: A person who fits neither of these
categories, such as a full-time student, homemaker, or retiree,
is not in the labor force.
• Labor Force
– The labor force is the total number of workers and the BLS
defines the it as the sum of the employed and the
unemployed.
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Figure 1 The Breakdown of the Population
Employed
(135.1 million)
Labor Force
(141.8 million)
Adult
Population
(211.9 million)
Unemployed (6.7 million)
Not in labor force
(70.1 million)
Copyright©2003 Southwestern/Thomson Learning
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
How to Find
Labor
Market
Indicators
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Figure 20.3
Employment-to-Population Ratio for
Men, Women, and Everyone
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Table 1 The Labor-Market Experiences of Various
Demographic Groups
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
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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Advantages of Household Survey
• The unemployment rate and employmentpopulation ratios come from a monthly
household survey which has the following
advantages:
– Time-consistent and large survey
– Time lag in obtaining data is short.
– Data is available on a disaggregated basis.
– The unemployment rate provides information
about the business cycle.
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Disadvantages of Household Survey
• The monthly household survey has the following
disadvantages:
– Part-time workers are counted as fully employed even if
they wanted to work as a full-time worker.
– Unemployed persons must be actively seeking work.
– It does not measure persons who are subemployed.
– Persons may provide false information.
– All unemployed persons are counted equally.
– The data contain no information about minimum
acceptable wages.
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Issues in Measuring Unemployment
• It is difficult to distinguish between a person who is
unemployed and a person who is not in the labor
force.
– Discouraged workers, people who would like to work but
have given up looking for jobs after an unsuccessful
search, don’t show up in unemployment statistics.
– Other people may claim to be unemployed in order to
receive financial assistance, even though they aren’t
looking for work.
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Stock-Flow Model
• At any point in time,
there is a measurable
stock of people in
each of the three
boxes that represent
categories of labor
force status.
• But these stocks are
simultaneously being
depleted by flows in
and out of each
category.
Population Not in the Labor Force
Unemployed
Employed
• Changes in the
rates of these flows
can significantly affect
the unemployment
rate.
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Labor Market Flows
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Determining Full Employment
• Some unemployment is voluntary and some
unemployment is involuntary.
• The natural rate of unemployment is:
– The unemployment rate at which there is neither
excess demand nor excess supply in the labor
market, or
– The unemployment rate that will occur in the long
run if the expected and actual rates of inflation are
equal.
• The natural rate of unemployment changes over
time.
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Question for Thought
1. Do you expect the natural rate of unemployment
to (a) increase, (b) decrease, or (c) remain at the
present level over the next decade? Explain your
reasoning.
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Macroeconomic Output and
Employment
Determination
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Aggregate Demand
• Aggregate demand for goods and services
indicates the total quantity of goods and
services that domestic consumers,
businesses, government, and foreign buyers
will collectively desire to purchase at each
price level.
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Aggregate Demand
• The aggregate demand curve slopes downward
because of the
– Interest rate effect
• A lower price level will reduce money demand and thus interest rates.
• The lower interest rate will increase spending on goods such as
housing.
– Wealth or real balances effect
• A lower price level will increase the real value of assets whose value is
fixed in nominal terms and thus raise spending.
– Foreign purchases effect
• A lower price level will reduce the price of U.S. goods relative to
foreign goods and so foreigners will increase their spending on U.S.
goods.
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Aggregate Supply
• Aggregate supply of goods and services is the
relationship between the price level and total
quantity of real output that firms are willing to
produce and offer for sale.
– The aggregate supply curve is upward sloping below the
natural rate of output.
• Since wages are inflexible downward, a decrease in demand will result
in layoffs and reduce output.
– The aggregate supply curve is vertical at the natural rate
of output.
• Greater demand increases can’t increase output since the economy is
at full-employment.
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Real Output Determination
• The intersection of the
aggregate demand and supply
curves D and SkASc produces
equilibrium price and real
output levels P0 and Qn.
Price
Level
Sc
P0
A
D
Sk
Qn
Real Output
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Employment Determination
• In the aggregate labor market, Wage rate
the equilibrium wage rate and
level of total employment are
determined by the intersection
of the aggregate labor demand
supply curves.
W0
SL
• Employment level En is the
natural rate of employment; it
is the amount of labor needed
to produce the natural level of
real output.
DL
En
Employment
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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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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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Why does unemployment occur?
• In an ideal labor market, wages would adjust to balance the
supply and demand for labor, ensuring that all workers would
be fully employed.
• Frictional unemployment refers to the unemployment that
results from the time that it takes to match workers with jobs.
In other words, it takes time for workers to search for the jobs
that are best suit their tastes and skills.
• Structural unemployment is the unemployment that results
because the number of jobs available in some labor markets is
insufficient to provide a job for everyone who wants one.
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Frictional Unemployment and Job
Search
• Job search
– the process by which workers find appropriate
jobs given their tastes and skills.
– results from the fact that it takes time for qualified
individuals to be matched with appropriate jobs.
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Job Search
• This unemployment is different from the other types
of unemployment.
– It is not caused by a wage rate higher than equilibrium.
– It is caused by the time spent searching for the “right” job.
• Search unemployment is inevitable because the
economy is always changing.
• Changes in the composition of demand among
industries or regions are called sectoral shifts.
• It takes time for workers to search for and find jobs in
new sectors.
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Public Policy and Job Search
• Government programs can affect the time it takes unemployed
workers to find new jobs.
– Government-run employment agencies
• Government-run employment agencies give out information about job
vacancies in order to match workers and jobs more quickly.
– Public training programs
• Public training programs aim to ease the transition of workers from
declining to growing industries and to help disadvantaged groups escape
poverty.
– Unemployment insurance
• Unemployment insurance is a government program that partially
protects workers’ incomes when they become unemployed.
– Offers workers partial protection against job losses.
– Offers partial payment of former wages for a limited time to those
who are laid off.
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Effects of Unemployment Insurance
• Unemployment insurance increases the
amount of search unemployment.
• It reduces the search efforts of the
unemployed.
• It may improve the chances of workers being
matched with the right jobs.
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Structural Unemployment
• Structural unemployment occurs when the
quantity of labor supplied exceeds the
quantity demanded.
• Structural unemployment is often thought to
explain longer spells of unemployment.
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Public Policy and Job Search
• Why is there Structural Unemployment?
– Minimum-wage laws
• When the minimum wage is set above the level that
balances supply and demand, it creates
unemployment.
– Unions
– Efficiency wages
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Figure 4 Unemployment from a Wage Above the
Equilibrium Level
Wage
Labor
supply
Surplus of labor =
Unemployment
Minimum
wage
WE
Labor
demand
0
LD
LE
LS
Quantity of
Labor
Copyright©2003 Southwestern/Thomson Learning
UNIONS AND COLLECTIVE
BARGAINING
• A union is a worker association that bargains with employers
over wages and working conditions.
• In the 1940s and 1950s, when unions were at their peak,
about a third of the U.S. labor force was unionized.
• A union is a type of cartel attempting to exert its market
power.
• The process by which unions and firms agree on the terms of
employment is called collective bargaining.
• A strike will be organized if the union and the firm cannot
reach an agreement.
• A strike refers to when the union organizes a withdrawal of
labor from the firm.
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• A strike makes some workers better off and other
workers worse off.
• Workers in unions (insiders) reap the benefits of
collective bargaining, while workers not in the union
(outsiders) bear some of the costs.
• By acting as a cartel with ability to strike or otherwise
impose high costs on employers, unions usually
achieve above-equilibrium wages for their members.
• Union workers earn 10 to 20 percent more than
nonunion workers.
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Are Unions Good or Bad for the Economy?
• Critics argue that unions cause the allocation of labor
to be inefficient and inequitable.
– Wages above the competitive level reduce the quantity of
labor demanded and cause unemployment.
– Some workers benefit at the expense of other workers.
• Advocates of unions contend that unions are a
necessary antidote to the market power of firms that
hire workers.
• They claim that unions are important for helping
firms respond efficiently to workers’ concerns.
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THE THEORY OF EFFICIENCY WAGES
• Efficiency wages are above-equilibrium wages paid by firms in
order to increase worker productivity.
• The theory of efficiency wages states that firms operate more
efficiently if wages are above the equilibrium level.
• A firm may prefer higher than equilibrium wages for the
following reasons:
– Worker Health: Better paid workers eat a better diet and thus are
more productive.
– Worker Turnover: A higher paid worker is less likely to look for
another job.
• A firm may prefer higher than equilibrium wages for the
following reasons:
– Worker Effort: Higher wages motivate workers to put forward their
best effort.
– Worker Quality: Higher wages attract a better pool of workers to
apply for jobs.
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Summary
• The unemployment rate is the percentage of those who
would like to work but don’t have jobs.
• The Bureau of Labor Statistics calculates this statistic monthly.
• The unemployment rate is an imperfect measure of
joblessness.
• In the U.S. economy, most people who become unemployed
find work within a short period of time.
• Most unemployment observed at any given time is
attributable to a few people who are unemployed for long
periods of time.
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Summary
• One reason for unemployment is the time it takes for workers
to search for jobs that best suit their tastes and skills.
• A second reason why our economy always has some
unemployment is minimum-wage laws.
• Minimum-wage laws raise the quantity of labor supplied and
reduce the quantity demanded.
• A third reason for unemployment is the market power of
unions.
• A fourth reason for unemployment is suggested by the theory
of efficiency wages.
• High wages can improve worker health, lower worker turnover,
increase worker effort, and raise worker quality.
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