Unemployment

N. Gregory Mankiw & Mohamed H.
Rashwan
Economics
Principles of
Middle East Edition
Chapter 29
Unemployment
© 2012 Cengage Learning EMEA. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom
In this chapter,
look for the answers to these questions:
• How is unemployment measured?

• What is the “natural rate of unemployment”?
• Why are there always some people
unemployed?
• How is unemployment affected by unions and
minimum wage laws?
• What is the theory of efficiency wages, and how
does it help explain unemployment?
© 2012 Cengage Learning EMEA. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
1
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
Employment and Unemployment
Population
Yong &
Working age Population (adult population) institutionalized
Not in Labor
Labor Force Force
Employed Unemployed
Dr. Khaled Abdella Mohamed

2
Labor Force Statistics
For Labor force statistics, the population is usually divided
into 3 groups:
 Employed: paid employees, self-employed,
and unpaid workers in a family business
 Unemployed: people not working who have looked
for work during previous 4 weeks
 Not in the labor force: everyone else
The labor force is the total # of workers, including the

employed and unemployed.
3
Labor Force Statistics
Unemployment rate (“u-rate”):
% of the labor force that is unemployed
# of unemployed
u-rate = 100 x
labor force
Labor force participation rate:

% of the adult population that is in the labor force
labor force labor force

= 100 x
participation rate adult population
4
ACTIVE LEARNING 1
Calculate labor force statistics
Compute the labor force, u-rate, adult population,
and labor force participation rate using this data:
Adult population by group
# of employed 139.7 million
# of unemployed 13.7 million
not in labor force 85.7 million
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
ACTIVE LEARNING 1
Answers
Labor force = employed + unemployed
= 139.7 + 13.7
= 153.4 million
U-rate = 100 x (unemployed)/(labor force)

= 100 x 13.7/153.4
= 8.9%
ACTIVE LEARNING 1
Answers
Population = labor force + not in labor force
= 153.4 + 85.7
= 239.1
LF partic. rate = 100 x (labor force)/(population)

= 100 x 153.4/239.1
= 64.2%
Labor Force Statistics for Different Groups
 Many countries publish these statistics for
demographic groups within the population.
 These data can reveal widely different labor
market experiences for different groups.
8
ACTIVE LEARNING 2
Limitations of the u-rate
In each of the following, what happens to the u-rate?
Does the u-rate give an accurate impression of what’s
happening in the labor market?
A. Imad lost his job and begins looking for a new one.
B. Jabbar, who has been out of work since his factory
closed last year, becomes discouraged and gives
up looking for work.
C. Wajih, the sole earner in his family of 5, just lost his
$80,000 job as a research scientist. Immediately,
he takes a part-time job at McDonald’s until he can
find another job in his field.
ACTIVE LEARNING 2
Answers
A. Imad lost his job and begins looking for a new one.
unemployment-rate rises
A rising u-rate gives the impression that the labor
market is worsening, and it is.
ACTIVE LEARNING 2
Answers
B. Jabbar has been out of work since last year,
becomes discouraged, stops looking for work.
Discouraged workers
 would like to work but have given up looking for jobs
 classified as “not in the labor force” rather than
“unemployed”
Unemployment-rate falls because Jabbar is no longer
counted as unemployed.
A falling u-rate gives the impression that the labor
market is improving, but it is not.
ACTIVE LEARNING 2
Answers
C. Wajih lost his $80,000 job, and takes a part-time
job at McDonald’s until he finds a better one.
Unemployment-rate unchanged because a person is
“employed” whether they work full or part time.
Things are worse, but the u-rate fails to show it.
What Does the U-Rate Really Measure?
 The u-rate is not a perfect indicator of joblessness
or the health of the labor market:
 It excludes discouraged workers.
 It does not distinguish between full-time and
part-time work, or people working part time
because full-time jobs not available.
 Some people misreport their work status in
surveys.
 Despite these issues, the u-rate is still a very
useful barometer of the labor market & economy.
13
The Duration of Unemployment
Most spells of unemployment are short:
 Typically 1/3 of the unemployed
have been unemployed under 5 weeks,
2/3 have been unemployed under 14 weeks.
 Only 20% have been unemployed over 6 months.
Yet, most observed unemployment is long term.
 The small group of long-term unemployed persons
has fairly little turnover, so it accounts for most of
the unemployment observed over time.
Knowing these facts helps policymakers design
better policies to help the unemployed.
14
Cyclical Unemployment vs. the Natural Rate
There’s always some unemployment, though the
u-rate fluctuates from year to year.
Natural rate of unemployment
 the normal rate of unemployment around which
the actual unemployment rate fluctuates
Cyclical unemployment
 the deviation of unemployment from its
natural rate
 associated with business cycles,
which we’ll study in later chapters
15
Unemployment rates 1960–2011
12
Unemployment rate
10
percentage of labor force
4
Natural rate of
unemployment
2
0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Explaining the Natural Rate: An Overview
Even when the economy is doing well, there is

always some unemployment, including:
Frictional unemployment
 occurs when workers spend time searching for the
jobs that best suit their skills and tastes
 short-term for most workers
Structural unemployment
 occurs when there are fewer jobs than workers
 usually longer-term
17
Job Search
 Workers have different tastes & skills, and
jobs have different requirements.
 Job search is the process of matching workers
with appropriate jobs.
 Sectoral shifts are changes in the composition of
demand across industries or regions of the country.
 Such shifts displace some workers,
who must search for new jobs appropriate
for their skills & tastes.
 The economy is always changing,
so some frictional unemployment is inevitable.
18
Public Policy and Job Search
 Govt employment agencies
provide information about job vacancies to
speed up the matching of workers with jobs.
 Public training programs
aim to equip workers displaced from declining
industries with the skills needed in growing
industries.
19
Unemployment Insurance
 Unemployment insurance (UI):
a govt program that partially protects workers’
incomes when they become unemployed
 UI increases frictional unemployment.
To see why, recall one of the
Ten Principles of Economics:
People respond to incentives.
UI benefits end when a worker takes a job,
so workers have less incentive to search or
take jobs while eligible to receive benefits.
20
Unemployment Insurance
Benefits of UI:
 Reduces uncertainty over incomes
 Gives the unemployed more time to search,
resulting in better job matches and thus higher
productivity
21
Explaining Structural Unemployment
Structural unemp-
unemployment W loyment S
occurs when not actual
W1
wage
enough jobs to
go around. WE
Occurs when wage
is kept above eq’m.
There are three
reasons for this… D
L
22
1. Minimum-Wage Laws
 The min. wage may exceed the eq’m wage
for the least skilled or experienced workers,
causing structural unemployment.
 But this group is a small part of the labor force,
so the min. wage can’t explain most
unemployment.
23
2. Unions
 Union: a worker association that bargains with
employers over wages, benefits, and working
conditions
 Unions exert their market power to negotiate
higher wages for workers.
 The typical union worker earns 20% higher
wages and gets more benefits than a nonunion
worker for the same type of work.
24
2. Unions
 When unions raise the wage above eq’m,
quantity of labor demanded falls and
unemployment results.
 “Insiders” – workers who remain employed,
are better off
 “Outsiders” – workers who lose their jobs,
are worse off
 Some outsiders go to non-unionized labor
markets, which increases labor supply and
reduces wages in those markets.
25
2. Unions
Are unions good or bad? Economists disagree.
 Critics:
Unions are cartels. They raise wages above eq’m,
which causes unemployment and/or depresses
wages in non-union labor markets.
 Advocates:
Unions counter the market power of large firms,
make firms more responsive to workers’ concerns.
26
3. Efficiency Wages
 The theory of efficiency wages:
Firms voluntarily pay above-equilibrium wages
to boost worker productivity.
 Different versions of efficiency wage theory
suggest different reasons why firms pay high
wages.
27
3. Efficiency Wages
Four reasons why firms might pay efficiency wages:
1. Worker health
In less developed countries, poor nutrition is a
common problem. Paying higher wages allows
workers to eat better, makes them healthier,
more productive.
2. Worker turnover
Hiring & training new workers is costly.
Paying high wages gives workers more
incentive to stay, reduces turnover.
28
3. Efficiency Wages
Four reasons why firms might pay efficiency wages:
3. Worker quality
Offering higher wages attracts better job applicants,
increases quality of the firm’s workforce.
4. Worker effort
Workers can work hard or shirk. Shirkers are fired
if caught. Is being fired a good deterrent?
Depends on how hard it is to find another job.
If market wage is above eq’m wage, there aren’t
enough jobs to go around, so workers have more
incentive to work not shirk.
29
ACTIVE LEARNING 3
Applying the concepts
Which of the following would be most likely to reduce
frictional unemployment?
A. The govt eliminates the minimum wage.
B. The govt increases unemployment insurance
benefits.
C. A new law bans labor unions.
D. More workers post their resumes on a jobseekers
website and more employers use the same site to
find suitable workers to hire.
E. Sectoral shifts become more frequent.
ACTIVE LEARNING 3
Answers
A. The govt eliminates the minimum wage.
C. A new law bans labor unions.
These are likely to reduce

structural unemployment,
not frictional unemployment.
ACTIVE LEARNING 3
Answers
B. The govt increases unemployment insurance
benefits.
E. Sectoral shifts become more frequent.
These are likely to increase

frictional unemployment, not reduce it.
ACTIVE LEARNING 3
Answers
D. More workers post their resumes at an online
jobseekers site, and more employers use the site to
find suitable workers to hire.
Likely to speed up the process of
matching workers & jobs, which would
reduce frictional unemployment.
Explaining the Natural Rate of
Unemployment: A Summary
The natural rate of unemployment consists of
 frictional unemployment
 It takes time to search for the right jobs
 Occurs even if there are enough jobs to go around
 structural unemployment
 When wage is above eq’m, not enough jobs
 Due to min. wages, labor unions, efficiency wages
In later chapters, we will learn about cyclical
unemployment, the short-term fluctuations in
unemployment associated with business cycles.
34
SU MMA RY
• The unemployment rate is the percentage of

those who would like to work who do not have
jobs.
• Unemployment and labor force participation vary
widely across demographic groups.
• The natural rate of unemployment is the normal
rate of unemployment around which the actual
rate fluctuates. Cyclical unemployment is the
deviation of unemployment from its natural rate
and is connected to short-term economic
fluctuations.
SU MMA RY
• The natural rate includes frictional

unemployment and structural unemployment.
• Frictional unemployment occurs when workers
take time to search for the right jobs.
• Structural unemployment occurs when above-
equilibrium wages result in a surplus of labor.
• Three reasons for above-equilibrium wages
include minimum wage laws, unions, and
efficiency wages.

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N. Gregory Mankiw & Mohamed H.

Middle East Edition

• How is unemployment measured?

Dr. Khaled Abdella Mohamed

The labor force is the total # of workers, including the

Labor force participation rate:

labor force labor force

Adult population by group

# of employed 139.7 million

# of unemployed 13.7 million

not in labor force 85.7 million

U-rate = 100 x (unemployed)/(labor force)

LF partic. rate = 100 x (labor force)/(population)

Even when the economy is doing well, there is

These are likely to reduce

These are likely to increase

• The unemployment rate is the percentage of

• The natural rate includes frictional

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