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Unemployment and the Labor Market

Dosen pembimbing Rinny Apriliany Zakaria, SE., M.E.

DISUSUN OLEH:
NURAFNI HANAPI
941423058
 Unemployment is the macroeconomic problem that affects people most directly and severely. For
most people, the loss of a job means a reduced living standard and psychological distress. It is no surprise
that unemployment is often a topic of political debate, with politicians claiming their proposed policies
would help create jobs.

Figure 7-1 shows the rate of unemployment—the percentage of the labor force unemployed—in the
United States from 1950 to 2017. Although the rate of unemployment fluctuates from year to year, it
never gets close to zero. The average is between 5 and 6 percent, meaning that out of every eighteen
people wanting a job, one person does not have one.
Here we examine the determinants of the natural rate of unemployment—the average rate of
unemployment around which the economy fluctuates. The natural rate is the rate of unemployment
toward which the economy gravitates in the long run, given all the labor-market imperfections that
impede workers from instantly finding jobs.
 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.
 A first model of the natural rate
Notation: L=E+U.
L = # of workers in labor force
E = # of employed workers
U = # of unemployed
U/L = unemployment rate
  Assumptions

1. L is exogenously fixed.
2. During any given month,
S = rate of job separation, fraction of employed workers who lose or leave his/her jobs
F = rate of job finding, fraction of unemployed workers who find jobs
s and f are exogenous

To see what determine the unemployment rate, we assume that the labor force L is fixed and focus on
the transition of individuals in the labor force between employment E and unemployment U. This is
illustrated in Figure 7-2. Let s denote the rate of job separation, the fraction of employed individuals who
lose or leave their jobs each month. Let f denote the rate of job finding, the fraction of unemployed
individuals who find a job each month. Together, the rate of job separation s and the rate of job finding f
determine the rate of unemployment.

The steady-state condition

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

 The steady-state condition is:

Finding the “equilibrium” unemployment rate

f ×U = s ×E
= s ×(L – U)
 = s ×L – s ×U

Solve for U/L:

(f + s) × U = s × L
so,

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:

Policy implication:
A policy will reduce the natural rate of unemployment only if it lowers s or increases f.

Why is there unemployment? (1 of 2):

1. If job finding were instantaneous (f = 1), then all spells of unemployment would be brief, and the
natural rate would be near zero.
2. There are two reasons why f < 1:
a. job search
b. wage rigidity

Job search and frictional unemployment:

 Frictional unemployment: caused by the time it takes workers to search for a job
 occurs even when wages are flexible and there are enough jobs to go around
 occurs because
a. workers have different abilities, preferences
b. jobs have different skill requirements
c. geographic mobility of workers not instantaneous
d. flow of information about vacancies and job candidates is imperfect

Sectoral shifts:
 a) sectoral shifts: changes in the composition of demand among industries or regions
b) example: technological change
more jobs repairing computers, fewer jobs repairing typewriters
c) example: a new international trade agreement
labor demand increases in export sectors, decreases in import-competing sectors
d) These scenarios result in frictional unemployment.

More examples of sectoral shifts, part 1:

 Industrial revolution (1800s): agriculture declines, manufacturing soars
 Energy crisis (1970s): demand shifts from larger cars to smaller ones
 Health care spending as % of GDP:
1960: 5.2 2000: 13.8
1980: 9.1 2010: 17.9

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

More examples of sectoral shifts, part 2:

Government programs affecting unemployment include:
 Government employment agencies
disseminate info about job openings to better match workers and jobs.
 Public job training programs
help workers displaced from declining industries get skills needed for jobs in growing industries.

Unemployment insurance (UI):

o UI pays part of a worker’s former wages for a limited time after the worker loses his/her job.
o UI increases frictional unemployment because it reduces
 the opportunity cost of being unemployed
 the urgency of finding work
 f
o Studies: The longer a worker is eligible for UI, the longer the average spell of unemployment.

Benefits of UI:
By allowing workers more time to search:
1. UI may lead to better matches between jobs and workers
2. which would lead to greater productivity and higher incomes

Why is there unemployment? (2 of 2):

The natural rate of unemployment:

Two reasons why f < 1:

DONE 1. job search
Next 2. wage rigidity

Unemployment from real wage rigidity, part 1:

If the real wage is stuck above its equilibrium level, there aren’t enough jobs to go around.
Figure 7-3 shows why wage rigidity leads to unemployment. When the real wage is above the level that
equilibrates supply and demand, the quantity of labor supplied exceeds the quantity demanded. Firms
must in some way ration the scarce jobs among workers. Real-wage rigidity reduces the rate of job
finding and raises the level of unemployment.

The unemployment resulting from wage rigidity and job rationing is sometimes called structural
unemployment. Workers are unemployed not because they are actively searching for the jobs that best
suit their skills but because there is a mismatch between the number of people who want to work and the
number of jobs that are available. At the going wage, the quantity of labor supplied exceeds the quantity
of labor demanded; many workers are simply waiting for jobs to open up.

Unemployment from real wage rigidity, part 2:

If the real wage is stuck above its equilibrium level, there aren’t enough jobs to go around.
” Then, firms must ration the scarce jobs among workers.”
“Structural unemployment: The unemployment resulting from real wage rigidity and job
rationing.”

Reasons for wage rigidity:

a) Minimum-Wage Laws
The government causes wage rigidity when it prevents wages from falling to equilibrium levels.
Minimumwage laws set a legal minimum on the wages that firms pay their employees. Since the passage
of the Fair Labor Standards Act of 1938, the U.S. federal government has enforced a minimum wage that
has usually been between 30 and 50 percent of the average wage in manufacturing. In addition, many
states and cities enact minimum wages that are higher than the federal one: for example, in 2017, when
the federal minimum wage was $7.25 per hour, California had a minimum wage of $10 per hour, and
Seattle had a minimum wage of $15 per hour for large employers. For most workers, the minimum wage
is not binding because they earn well above the legislated minimum. Yet for some workers, especially the
unskilled and inexperienced, the minimum wage raises their wage above its equilibrium level and,
therefore, reduces the quantity of their labor that firms demand.

Economists believe that the minimum wage has its greatest impact on teenage unemployment. The
equilibrium wages of teenagers tend to be low for two reasons. First, because teenagers are among the
least skilled and least experienced members of the labor force, they tend to have low marginal
productivity. Second, teenagers often take some “compensation” in the form of on-the-job training rather
than direct pay. An internship is a classic example of training offered in place of wages. For both reasons,
the wage at which the supply of teenage workers equals the demand is low. The minimum wage is
therefore more often binding for teenagers than for others in the labor force. Empirical studies typically
find that a 10 percent increase in the minimum wage reduces teenage employment by 1 to 3 percent.

The minimum wage is a perennial source of political debate. Advocates of a higher minimum wage view
it as a way to raise the income of the working poor. Certainly, the minimum wage provides only a meager
standard of living: in the United States, a single parent with one child working full time at a minimum-
wage job would fall below the official poverty level for a family of that size. Although minimum-wage
advocates often admit that the policy causes unemployment for some workers, they argue that this cost is
worth bearing to raise others out of poverty.

The minimum wage may exceed the equilibrium wage of unskilled workers, especially teenagers.
Studies: a 10% increase in minimum wage reduces teen employment by 1–3%
But, the minimum wage cannot explain the majority of the natural rate of unemployment, as most
workers’ wages are well above the minimum wage.

b) Unions and Collective Bargaining

A second cause of wage rigidity is the market power of unions. The wages of unionized workers
are determined not by the equilibrium of supply and demand but bybargaining between union
leaders and firm management. Often, the final agreement raises the wage above the equilibrium
level and allows the firm to decide how many workers to employ. The result is a reduction in the
number of workers hired, a lower rate of job finding, and an increase in structural
unemployment. Unions can also influence the wages paid by firms whose workforces are not
unionized because the threat

of unionization can keep wages above the equilibrium level. Most firms dislike unions. Unions
not only raisewages but also increase the bargaining power of labor on many other issues, such
as hours of employment andworking conditions. A firm may choose to pay its workers high
wages to keep them happy and discouragethem from forming a union.The unemployment caused
by unions and by the threat of unionization is an instance of conflict betweendifferent groups of
workers—insiders and outsiders. Workers already employed by a firm, the insiders,typically try
to keep their firm’s wages high. The unemployed, the outsiders, bear part of the cost of
higherwages because at a lower wage, they might be hired. These two groups have conflicting
interests. The effect ofany bargaining process on wages and employment depends on the relative
influence of each group.
Unions exercise monopoly power to secure higher wages for their members.
When the union wage exceeds the equilibrium wage, unemployment results.
Insiders: employed union workers whose interest is to keep wages high
Outsiders: unemployed non-union workers who prefer equilibrium wages, so there would be
enough jobs for them

c) Efficiency Wages

Efficiency-wage theories propose a third cause of wage rigidity in addition to minimum-wage laws and
unionization. These theories hold that high wages make workers more productive. The influence of wages
on worker efficiency may explain the failure of firms to cut wages despite an excess supply of labor. Even
though a wage reduction would lower a firm’s wage bill, it would also—if these theories are correct—
lower worker productivity and the firm’s profits.

A second efficiency-wage theory, more relevant for developed countries, holds that high wages
reduce labor turnover. Workers quit jobs for many reasons—to accept better positions at other firms, to
change careers, or to move to other parts of the country. The more a firm pays its workers, the greater is
their incentive to stay with the firm. By paying a high wage, a firm reduces the frequency at which its
workers quit, thereby decreasing the time and money spent hiring and training new workers.

A third efficiency-wage theory holds that the quality of a firm’s workforce depends on the wage it pays
its employees. If a firm reduces its wage, the best employees may take jobs elsewhere, leaving the firm
with inferior employees who have fewer alternative opportunities. And A fourth efficiency-wage theory
holds that a high wage improves worker effort. This theory posits that firms cannot perfectly monitor their
employees’ work effort and that employees must themselves decide how hard to work. Workers can work
hard, or they can shirk and risk getting caught and fired.

Theories in which higher wages increase worker productivity 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 to raise productivity.
Result: structural unemployment.