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1 MACROECONOMICS ACROECONOMICS C H A P T E R © 2007 Worth Publishers, all rights reserved SIXTH EDITION SIXTH EDITION PowerPoint PowerPoint ® Slides by Ron Cronovich Slides by Ron Cronovich N. . GREGORY REGORY MANKIW ANKIW Unemployment 6 CHAPTER 6 Unemployment slide 1 In this chapter, you will learn… …about the natural rate of unemployment: what it means what causes it understanding its behavior in the real world CHAPTER 6 Unemployment slide 2 Natural rate of unemployment Natural rate of unemployment: The average rate of unemployment around which the economy fluctuates. In a recession, the actual unemployment rate rises above the natural rate. In a boom, the actual unemployment rate falls below the natural rate. CHAPTER 6 Unemployment slide 3 Actual and natural rates of unemployment in the U.S., 1960-2006 Percent of labor force 0 2 4 6 8 10 12 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Unemployment rate Natural rate of unemployment CHAPTER 6 Unemployment slide 4 A first model of the natural rate Notation: L = # of workers in labor force E = # of employed workers U = # of unemployed U/L = unemployment rate CHAPTER 6 Unemployment slide 5 Assumptions: 1. L is exogenously fixed. 2. During any given month, s = fraction of employed workers that become separated from their jobs s is called the rate of job separations f = fraction of unemployed workers that find jobs f is called the rate of job finding s and f are exogenous

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Page 1: ACROECONOMICS SIXTH EDITION N G M - Business School

1

MMACROECONOMICSACROECONOMICS

C H A P T E R

© 2007 Worth Publishers, all rights reserved

SIXTH EDITIONSIXTH EDITION

PowerPointPowerPoint®® Slides by Ron Cronovich Slides by Ron Cronovich

NN. . GGREGORY REGORY MMANKIWANKIW

Unemployment

6

CHAPTER 6 Unemployment slide 1

In this chapter, you will learn…

…about the natural rate of unemployment:

what it means

what causes it

understanding its behavior in the real world

CHAPTER 6 Unemployment slide 2

Natural rate of unemployment

Natural rate of unemployment:The average rate of unemployment around whichthe economy fluctuates.

In a recession, the actual unemployment rate risesabove the natural rate.

In a boom, the actual unemployment rate falls belowthe natural rate.

CHAPTER 6 Unemployment slide 3

Actual and natural rates ofunemployment in the U.S., 1960-2006

Per

cent

of l

abor

forc

e

0

2

4

6

8

10

12

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Unemployment rate

Natural rate ofunemployment

CHAPTER 6 Unemployment slide 4

A first model of the natural rate

Notation:

L = # of workers in labor force

E = # of employed workers

U = # of unemployed

U/L = unemployment rate

CHAPTER 6 Unemployment slide 5

Assumptions:

1. L is exogenously fixed.

2. During any given month,s = fraction of employed workersthat become separated from their jobs

s is called the rate of job separationsf = fraction of unemployed workersthat find jobs

f is called the rate of job findings and f are exogenous

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CHAPTER 6 Unemployment slide 6

The transitions betweenemployment and unemployment

Employed Unemployed

s ×E

f ×U

CHAPTER 6 Unemployment slide 7

The steady state condition

Definition: the labor market is insteady state, or long-run equilibrium,if the unemployment rate is constant.

The steady-state condition is:

s ×E = f ×U

# of employedpeople wholose or leavetheir jobs

# of unemployedpeople who findjobs

CHAPTER 6 Unemployment slide 8

Finding the “equilibrium” U rate

f ×U = s × E

= s × (L – U )

= s × L – s × U

Solve for U/L:

(f + s) × U = s × L

so,=

+

U s

L s f

CHAPTER 6 Unemployment slide 9

Example:

Each month, 1% of employed workers lose their jobs

(s = 0.01) 19% of unemployed workers find jobs

(f = 0.19)

Find the natural rate of unemployment:

0 010 05, or 5%

0 01 0 19

U s

L s f= = =

+ +

..

. .

CHAPTER 6 Unemployment slide 10

Policy implication

A policy will reduce the natural rate ofunemployment only if it lowers s or increases f.

CHAPTER 6 Unemployment slide 11

Why is there unemployment?

If job finding were instantaneous (f = 1),then all spells of unemployment would be brief,and the natural rate would be near zero.

There are two reasons why f < 1:1. job search2. wage rigidity

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CHAPTER 6 Unemployment slide 12

Job search & frictional unemployment

frictional unemployment: caused by the timeit takes workers to search for a job

occurs even when wages are flexible and thereare enough jobs to go around

occurs because workers have different abilities, preferences jobs have different skill requirements geographic mobility of workers not instantaneous flow of information about vacancies and job

candidates is imperfectCHAPTER 6 Unemployment slide 13

Sectoral shifts

def: Changes in the composition of demandamong industries or regions.

example: Technological changemore jobs repairing computers,fewer jobs repairing typewriters

example: A new international trade agreementlabor demand increases in export sectors,decreases in import-competing sectors

Result: frictional unemployment

CHAPTER 6 Unemployment slide 14

CASE STUDY:Structural change over the long run

4.2%

28.0%

9.9%

57.9%

Agriculture

Manufacturing

Other industry

Services

1960

1.6%

17.2%7.7%

73.5%

2000

CHAPTER 6 Unemployment slide 15

More examples of sectoral shifts

Late 1800s: decline of agriculture,increase in manufacturing

Late 1900s: relative decline of manufacturing,increase in service sector

1970s: energy crisis caused a shift in demandaway from gas guzzlers toward smaller cars.

In our dynamic economy,smaller sectoral shifts occur frequently,contributing to frictional unemployment.

CHAPTER 6 Unemployment slide 17

Unemployment insurance (UI)

UI pays part of a worker’s former wages for alimited time after losing his/her job.

UI increases search unemployment,because it reduces the opportunity cost of being unemployed the urgency of finding work f

Studies: The longer a worker is eligible for UI,the longer the duration of the average spell ofunemployment.

CHAPTER 6 Unemployment slide 18

By allowing workers more time to search,UI may lead to better matches betweenjobs and workers,which would lead to greater productivity andhigher incomes.

Benefits of UI

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CHAPTER 6 Unemployment slide 19

Why is there unemployment?

Two reasons why f < 1:1. job search2. wage rigidity

U s

L s f=

+

DONE Next

The natural rate of unemployment:

CHAPTER 6 Unemployment slide 20

Unemployment from real wagerigidity

Labor

Realwage

Supply

Demand

Unemployment

Rigidrealwage

Amount of laborwilling to work

Amount oflabor hired

If real wageis stuckabove itsequilibriumlevel, thenthere aren’tenough jobsto go around.

CHAPTER 6 Unemployment slide 21

Unemployment from real wagerigidity

Then, firms must ration thescarce jobs among workers.

Structural unemployment:The unemployment resultingfrom real wage rigidity andjob rationing.

If real wageis stuckabove itsequilibriumlevel, thenthere aren’tenough jobsto go around.

CHAPTER 6 Unemployment slide 22

Reasons for wage rigidity

1. Minimum wage laws

2. Labor unions

3. Efficiency wages

CHAPTER 6 Unemployment slide 23

1. The minimum wage

The min. wage may exceed the equilibriumwage of unskilled workers, especially teenagers.

But, the min. wage cannot explain themajority of the natural rate of unemployment,as most workers’ wages are well abovethe min. wage.

CHAPTER 6 Unemployment slide 24

2. Labor unions

Unions exercise monopoly power to secure higherwages for their members.

When the union wage exceeds the equilibriumwage, unemployment results.

Insiders: Employed union workers whose interestis to keep wages high.

Outsiders: Unemployed non-union workers whoprefer equilibrium wages, so there would beenough jobs for them.

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105,508Private sector (total)20,381Government (total)

14,045Health care3,312Education

10,951Professional services6,304Finance, insurance4,379Transportation

14,973Retail trade15,518Manufacturing

600Mining

122.3121.7

115.1112.7

90.690.7

129.2114.0107.8113.7156.9

8.5%40.5

815.4

3.12.1

24.45.8

13.79.5

13.88,053Construction

wageratio

U % oftotal

# employed(1000s)industry

wage ratio = 100×(union wage)/(nonunion wage) slide 25

Union membership and wage ratios by industry, 2005

CHAPTER 6 Unemployment slide 26

3. Efficiency wage theory

Theories in which higher wages increase workerproductivity by: attracting higher quality job applicants increasing worker effort, reducing “shirking” reducing turnover, which is costly to firms improving health of workers

(in developing countries)

Firms willingly pay above-equilibrium wages toraise productivity.

Result: structural unemployment.

CHAPTER 6 Unemployment slide 27

The duration of U.S. unemployment,average over 1/1990-5/2006

70.5%31%15 or more

22.3%31%5-14

7.2%38%1-4

amount of timethese workers spent

unemployedas % of total time all

workers spentunemployed

# of unemployedpersons

as % of total# of unemployed

# of weeksunemployed

CHAPTER 6 Unemployment slide 28

The duration of unemployment

The data: More spells of unemployment are short-term

than medium-term or long-term. Yet, most of the total time spent unemployed

is attributable to the long-term unemployed.

This long-term unemployment is probablystructural and/or due to sectoral shifts amongvastly different industries.

Knowing this is important because it can helpus craft policies that are more likely to work.

CHAPTER 6 Unemployment slide 29

TREND: The natural rate rises during1960-1984, then falls during 1985-2006

3

4

5

6

7

8

9

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

CHAPTER 6 Unemployment slide 30

EXPLAINING THE TREND:

The minimum wage

0

1

2

3

4

5

6

7

8

9

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Dol

lars

per

hou

r

minimum wage incurrent dollars

minimum wagein 2006 dollars

The trend in thereal minimum wageis similar to that ofthe natural rate ofunemployment.

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CHAPTER 6 Unemployment slide 31

EXPLAINING THE TREND:Union membership

Since the early1980s, the naturalrate of unemploy-ment and unionmembership haveboth fallen.

But, from 1950sto about 1980,the natural raterose while unionmembership fell.

27%1970

percent of labor forceyear

12%1930

35%1945

35%1954

20.1%1983

12.5%2005

Union membershipselected years

CHAPTER 6 Unemployment slide 32

EXPLAINING THE TREND:

Sectoral shifts

$0

$20

$40

$60

$80

$100

1970 1975 1980 1985 1990 1995 2000 2005

Price perbarrel of oil,

in 2006dollars

From mid 1980s to early 2000s,oil prices less volatile,so fewer sectoral shifts.

CHAPTER 6 Unemployment slide 33

EXPLAINING THE TREND:Demographics

1970s:The Baby Boomers were young.Young workers change jobs more frequently(high value of s).

Late 1980s through today:Baby Boomers aged. Middle-aged workerschange jobs less often (low s).

Chapter SummaryChapter Summary

1. The natural rate of unemployment the long-run average or “steady state” rate of

unemployment depends on the rates of job separation and job

finding

2. Frictional unemployment due to the time it takes to match workers with jobs may be increased by unemployment insurance

CHAPTER 6 Unemployment slide 37

Chapter SummaryChapter Summary

3. Structural unemployment results from wage rigidity: the real wage remains

above the equilibrium level caused by: minimum wage, unions, efficiency

wages

4. Duration of unemployment most spells are short term but most weeks of unemployment are attributable

to a small number of long-term unemployedpersons

CHAPTER 6 Unemployment slide 38

Chapter SummaryChapter Summary

5. Behavior of the natural rate in the U.S. rose from 1960 to early 1980s, then fell possible explanations:

trends in real minimum wage,union membership, prevalence of sectoral shifts,and aging of the Baby Boomers

CHAPTER 6 Unemployment slide 39

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CHAPTER 6 Unemployment slide 41

Question for discussion:

• Use the material we’ve just covered tocome up with a policy or policiesto try to reduce the natural rate ofunemployment.

• Note whether your policy targetsfrictional or structural unemployment.