Macroeconomics

Topic 02

Unemployment
in the Long Run

Unemployment
 For society, unemployment represents wasted
resources: a loss of output potential.

 The unemployment rate fluctuates from year to

year with the business cycle.
 Unemployment rate usually goes up during a
recession. It goes down when there is an
economic boom.
 This cyclical unemployment should be of
short-lived.(Topic 05-07)

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U.S. unemployment rate,
1950-2023

Unemployment in the long run

 To study the unemployment in the long run,
we are not concerned with the
unemployment created by the business cycle.
 This is short-lived but not sustained.

 When macroeconomic performance is

normal, one shop closes, another opens.

The overall unemployment is roughly the
same.

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Unemployment in the long run
 According to the Classical Theories, wages
are flexible in the long run.
 Under a competitive market, wages would
adjust to balance the supply and demand for
labor. Hence, theoretically, all workers would
be fully employed.
 However, unemployment rate never drops to
zero.
 What makes unemployment persist even in
the long run?

Natural rate of unemployment

 Natural rate of unemployment (UN) refers to
the unemployment rate associated with the
long run full-employment output level.

 Since actual output evolves around the

potential output level year to year, the actual
unemployment rate also fluctuates around
the natural rate.

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Natural rate of unemployment
 Natural rate of unemployment (UN) refers to
the unemployment rate around which the
actual unemployment rate fluctuates.
 It “discards” the _______ unemployment
created by the ups and downs of the
economy.
 For instance, in the US, since 1960, the
unemployment rate fluctuated around and
average of 6%.

Natural rate of unemployment

 Empirically, the natural rate of
unemployment is estimated by the
average rate of unemployment of an
economy in a long period of time (say,
20 years), which has already accounted
for the effects of the ups and downs of
the economic activity in the short-run,
namely, business cycle.
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Fig 7.1 - Unemployment rate
in U.S., 1950–2021

Why are there always some

people unemployed?
 In the long run, the free market should be
able to balance the supply and demand for
labor by adjusting wages.
 There must be some persistent imperfection
in the labor market that impede workers
from instantly finding jobs.

 Natural rate of unemployment

1. Frictional unemployment
2. Structural unemployment
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Frictional unemployment
 Frictional unemployment is caused by
the time it takes to search for a job. It
takes time for labor market to _____the
job seekers and the available jobs.
 A laid-off worker could not immediately
find a new job in the market.
 It occurs even in equilibrium wages and
there are enough jobs to go around.
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Job separation and job search

 Why do people need to search for jobs
from time to time?
 Even under normal economic environment,
some firms fail.
 workers are not satisfied with their work
condition/salary.
 employers are not satisfied with the
performance of a worker.
 Graduates/housewives/retirees join/rejoin
the labour market.
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Frictional unemployment and
job search
 Job search takes time because:
 Workers have different abilities,
preferences
 Jobs have different skill requirements,
attributes
 geographic mobility of workers not
instantaneous
 flow of information about vacancies and
job candidates is imperfect.

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Frictional unemployment and

sectoral shifts
 Job search also occurs when there are
sectoral shifts - changes in the composition
of demand among industries or regions.
 A technological advancement increases demand
for computer repair persons, decreases demand
for typewriter repair persons.
 It takes time for workers to change sectors,
so sectoral shifts cause frictional
unemployment.

Mankiw p.187 14
Frictional Unemployment
 Frictional unemployment exists in all
economies, but there are large variation
in the levels of frictional unemployment.
 It depends on the characteristics of the
labour force and the speed of the
sectoral shifts.
 lot of teenagers?
 many low-education level workers?

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Public Policy and Job Search

 The level of frictional unemployment
can also be affected by government
policies.
 How can a government speed up the
job searching process?
 Public Policy and Job Search
1. Government employment agencies:
 Disseminate information about job openings
to better match workers and jobs

2. Public job training programs

 Help workers displaced from declining industries get
skills needed for jobs in growing industries

Public Policy and Job Search

3. Unemployment insurance:
The unemployed are less pressed to search
for new jobs.
They are willing to turn down unattractive offers.
It may improve the chances of workers
being matched with the right jobs.
Overall effect on unemployment?
Example
 In the past, Germany is a massive
welfare state. An unemployed can
receive generous social welfare
indefinitely. Her unemployment rate
remained high in 2000s.
 How can the government reduce the
unemployment rate by reforming the social
welfare system?

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Structural Unemployment
& Real Wage Rigidity
 Structural unemployment arises when the
quantity of labor supplied is ______than the
quantity demanded.
 This happens when the real wage fails to
adjust and is stuck above the equilibrium
wage
 There are not enough jobs in the market.
 Structural unemployment is often thought to
explain longer periods of unemployment.

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 Unemployment from real wage rigidity

Real Supply
If the real wage
Unemployment
wage is
stuck ____
the Rigid
equilibrium real
level, then wage w
there aren’t Demand
enough jobs
to go around Labor
Amount of Amount of labor
labor hired willing to work
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A note on “Structural
unemployment”
 In Hong Kong the frictional
unemployment caused by sectoral shift
is also called the “structural
unemployment”
 But our textbook reserves this term for
the unemployment caused by wage
rigidity.

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Reasons for wage rigidity
1. Minimum wage laws
2. Labour union
3. Efficiency wages

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1. Minimum wage laws

 These laws set a legal minimum on the
wages firms pay their employees.

 For instance, in 2017, the federal minimum

wage is $7.25 per hour; California sets her
level at $10, Seattle at $15.

 This prevents wages from falling to

equilibrium levels
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 1. Minimum wage laws
 Theoretically, a rise in the minimum wage
level would reduce employment level
according to labor demand.
 However, many researches find out that
unemployment rate does not rise after a
minimum wage hike.
 So, why not?
 Who actually lose their jobs?

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Who earns minimum wage?

 For most workers, the minimum wage is not
binding.
 However, the minimum wage may exceed the
equilibrium wage of _________ workers,
especially teenagers.
 If so, then we would expect that increases in
the minimum wage would __________
unemployment among these groups.

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Minimum wage in the real world
 In Sept 1996, the minimum wage was raised
from $4.25 to $4.75. Here’s what happened:
Unemployment rates, before & after
3rd Q 1996 1st Q 1997
Teenagers 16.6% 17.0%

Single mothers 8.5% 9.1%

All workers 5.3% 5.3%

 Other studies: A 10% increase in the minimum
wage increases teenage unemployment by 1-3%.
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Example
 Following the above production function, find the
Yf when K = 64 and L = 100.
a. Find the quantity of labour demanded if the
government sets a minimum wage at w = 5.
b. Find the corresponding output of the economy.
c. Compare against the output without the
minimum wage.

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 29

2. Labor Unions
 In many European countries, unions
play an important role.
 Labour unions exercise power of
collective bargaining on wages. This
secures higher wages for their
members.
 When the union wage exceeds the
equilibrium wage, structural
unemployment results. 30
 3. Theory of Efficiency Wages

 Efficiency wages are above-equilibrium wages

paid by Firms in order to increase worker
productivity:
 attract higher quality job applicants (adverse
selection)
 increase worker effort and reduce “shirking”
(moral hazard)
 reduce costly turnover
 The increased productivity justifies the
cost of paying above-equilibrium wages.

Discussion
 Read “Jobs are not enough”(Economist, 19 July,2014)

1. Why aren’t ”falling unemployment rate” and “rising

job vacancies” good news?
What do they imply on labour productivity?
2. How does the labour force change? In what ways
are the changes ”structural”?

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Key concepts of this topic
 Natural Rate of Unemployment
 Frictional Unemployment
 Job search and Sectoral shift
 Structural unemployment
 Minimum wage law
 Labour Union
 Efficiency wage theory

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Reading
 Mankiw
 p.165, pp168-176

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