Unemployment1
7Unemployment
focus of the chapter
•In this chapter we examine the costs of unemployment.
•We also look very carefully at the “anatomy” of unemploymentthe different types of and reasons for unemployment; the difference between unemployment with high frequency and with high duration; and the effect of age distribution, and of other demographic and policy considerations on the natural rate.
section summaries
1.The Beveridge Curve
Even in the best of times there is some unemployment. The matching process between job openings and workers seeking employment is not perfect. The relation between job vacancies and the unemployment rate is called the Beveridge curve.
2.The Anatomy of Unemployment
Unemployment in the U.S. can be characterized by 5 “stylized facts”:
a) Different groups of people (“groups” in this case are defined by age, race, and experience) have very different unemployment rates.
b) There are substantial flows into and out of the unemployment poolthe number of people who are unemployed at any given point in time. The number of people entering and leaving this pool is large relative to the number of people in and out of it; for this reason, we say there is high labor market turnover.
c) The causes of the flows into this pool are somewhat cyclical in nature: layoffs tend to be high during recessions, while voluntary quits are high during booms.
d) Most people who become unemployed remain so for only a short time.
e) The unemployment pool is made up largely of people who are unemployed for long periods of time.
It is important to remember that people can only be in the unemployment pool if they are also in the labor forceeither working or actively seeking work. Individuals can thus enter and leave the unemployment pool by entering and leaving the labor force, as well as by losing and finding jobs. Discouraged workerspeople who would like jobs but have given up looking for themare not considered a part of the labor force, and thus, technically, are not unemployed.
It is also important to understand how the aggregate, or overall, rate of unemployment is formed. Because the labor force is made up of a number of different groups, many of which have radically different rates of unemployment, we must take a weighted average of them to find the overall rate:
u = w1 u1 + w2 u2 + … + wnun
The wi, here, are “weights,” equal to the fraction of the labor force represented by each group. The ui are the unemployment rates for each group. The aggregate rate can change either because the unemployment rate of one or more groups changes, or because the fraction of the labor force they represent changes.
Finally, it is useful to distinguish between cyclical and frictional unemployment. Frictional unemployment, as we have already learned, is the unemployment that exists when the economy is at full employment, and results from job search. Cyclical unemployment is unemployment in excess of this amount. Because of the connection between output and unemployment, it tends to move with the business cycle.
3.Full Employment
The natural rate of unemployment is determined by a number of factors, some which affect the duration of unemploymentthe average length of time person remains out of workand others which affect the frequency of unemploymentthe average number of times in a given period that workers become unemployed.
The duration of unemployment depends on the state of the economy (i.e., recession/boom). It is also affected by the organization of the labor market (e.g., the presence or absence of employment agencies), the demographic makeup of the labor force (i.e., the fraction of the labor force represented by different groups), and the amount of time people are willing or able to spend seeking new jobs. This last depends in part on the availability of unemployment benefits, which reduce the cost of joblessness as measured by the replacement ratiothe ratio of after-tax income while unemployed to after-tax income while employed.
The frequency of unemployment is determined by both the rate at which new workers enter the labor force, and the variability of labor demand across different firms in the economy (some firms will be shrinking, some growing; people will need move to those firms which are creating jobs for them).
The natural rate of unemployment varies over time, both because of changes in the composition of the labor force and because the natural rates of unemployment for the different groups that make up the labor force vary. The natural rate of unemployment is currently estimated to be between 5 percent and 6 percent.
Economists have tended to think of the natural rate of unemployment as a policy variable, affected by demographic factors, unemployment benefits and jobs programs, but unaffected by business cycle fluctuations. It is also possible, however, that extended periods of unemployment can raise the natural rate: workers may lose marketability or job skills while unemployed, or may learn to use the unemployment system more effectively. This is known as unemployment hysteresis.
4.The Costs of Unemployment
The largest single cost of unemployment is the output lost - remember from Chapter 6 that Okun’s law states that one percentage point increase in the unemployment rate will reduce output by 2 percent. There are also distributional coststhe poor, for example, tend to be more strongly affected by changes in the rate of unemployment than the rich.
Key terms
Unemployment1
labor force
unemployed person
unemployment pool
frictional unemployment
cyclical unemployment
duration of unemployment
search unemployment
frequency of unemployment
unemployment hysteresis
replacement ratio
reservation wage
employment stability
experience rating
reporting effects
labor market turnover
Beveridge curve
Unemployment1
GRAPH IT 7
Although we generally use measures of output and output growth in order to determine whether the economy is doing well, we can also look at changes in the rate of unemployment. This graph asks you to chart the rate of unemployment in the U.S. between the years 1990and 2012 and to compare your graph to the one you created in Chapter 1.
Can you see a connection between the rate of unemployment and the growth rate of output?
Unemployment1
Table 71Year / Civilian
Rate of Unemployment
1990 / 5.6
1991 / 6.9
1992 / 7.5
1993 / 6.9
1994 / 6.1
1995 / 5.6
1996 / 5.4
1997 / 4.9
1998 / 4.5
1999 / 4.2
2000 / 4.0
2001 / 4.7
2002 / 5.8
2003 / 6.0
2004 / 5.5
2005 / 5.1
2006 / 4.6
2007 / 4.6
2008 / 5.8
2009 / 9.3
2010 / 9.6
2011 / 8.9
2012 / 8.1
Unemployment1
Chart 7-1
the language of economics 7
The Definition of Unemployment
To be considered unemployed, in the economic sense, one must be more than simply jobless. It is also necessary to be actively searching for employmenti.e. you must (1) have actively looked for work during the last 4 weeks, (2) be waiting to be recalled to a job after having been laid off, or (3) be waiting to report to a new job that will begin within the next 4 weeks.
Those who do not have jobs and are not actively seeking them are not considered to be a part of the labor force; they are neither considered employed nor considered unemployed. This is an important point to remember, as it highlights the fact that there are people without jobs, people who may have given up looking because they believe themselves unemployable, who, because of the way that we measure unemployment, are not captured by unemployment statistics. These discouraged workers represent a very real social problemone that is not measured at all by unemployment statistics.
review of technique 7
Weighting
In order to construct a statistic that provides information about a diverse population, it is necessary to account for differences across groups within that population. As these groups are likely to be different sizes, a statistic will best represent the population if the characteristics of smaller groups affect it less than those of larger ones. Weightingmultiplying the statistic for each individual group by the fraction of the population that group representsis an effective way to guarantee this.
Let’s suppose, for example, that there are two groups of people in our society with verydifferent sleeping habits. People in group A tend to sleep an average of 4 hours a night; people in group B tend to sleep an average of 10. If there are 10 people in group A and 40 in group B, the average number of hours that the 50 people in our society spend asleep will be equal to
((10/50) x 4) + ((40/50) x 10), or 8.8.
Multiplying each statistic by the fraction of the population it represents and then adding these statistics together is called taking a weighted average.
Unemployment1
fill-in questions
1.To be considered unemployed, it is not enough to be without a job. An unemployed person must also count him/herself in the ______(must be actively looking for work, or waiting to start a new job).
2.An increase in unemployment benefits will______the natural rate of unemployment.
3.The ______of unemployment describes, on average, the flow into the unemployment pool.
4.The ______of unemployment describes the amount of time the average person remains in that pool.
5.The ______of unemployment is the level at which the flows into and out of the labor pool exactly balance.
6.If periods of high unemployment tended to raise the natural rate, there would be ______.
true-false questions
TF 1. The rate of unemployment is a flow variable.
(See “The Language of Economics 3” for a review of stock and flow variables)
TF 2. A person is considered a part of the labor force as soon as they are old enough to work.
TF 3. People can move in and out of the labor force over their lifetimes.
TF 4. The effects of unemployment are mostly distributional.
TF 5. Optimally, the unemployment rate should be zero.
TF 6. An increase in unemployment benefits is likely to increase the duration of the average spell of unemployment.
TF 7. The natural rate of unemployment cannot be changed by government policies.
multiple-choice questions
1.Which of the following is present when the economy is at full-employment?
Unemployment1
a. cyclical unemployment
b. frictional unemployment
c. both
d. neither
Unemployment1
2. Unemployment benefits allow/create
Unemployment1
a. longer job search
b. greater employment stability
c. both
d. neither
Unemployment1
3. An unemployed person is likely to turn down a job offer if the wage they are offered is below their
Unemployment1
a. replacement ratio
b. reservation wage
c. experience rating
d. COLA
Unemployment1
4. The ______ratio is the ratio of one’s after-tax income while unemployed to one’s after-tax income while employed.
Unemployment1
a. replacement
b. sacrifice
c. benefit
d. indexation
Unemployment1
5. The natural rate of unemployment is currently estimated to be about
Unemployment1
a. 0%
b. 2% to 3%
c. 5% to 6%
d. 8% to 9%
Unemployment1
conceptual problems
1.Name four ways a person might enter the unemployment pool.
2.Name three ways a person might leave the unemployment pool.
3.What costs are associated with unemployment?
4.Unemployment insurance, because it allows people to spend more time searching for a job than they would otherwise be able to, can increase the natural rate of unemployment. Is this something that policymakers should be concerned with? Explain.
5.Should zero unemployment be a goal? Why or why not?
technical problems
1. Suppose that the natural rate of unemployment is 5% for adults and 10% for teenagers. If teenagers make up 40% of the labor force (and adults the other 60%), what is the natural rate for the labor force as a whole?
If the number of teenagers increased to 60% (and the number of adults fell to 40%), how would the overall natural rate change? Would the level of full-employment (potential) output be higher or lower than in the previous case?
2.Suppose that in a typical month, 4 people out of every 100 leave their jobs. If 2 of these people remain out of work for 1 month, 1 remains out of work for 3 months, and the last remains out of work (but in the labor force) for 1 year, what is the average duration of unemployment? What is the unemployment rate? (Hint for calculating the unemployment rate: You need to figure out how many people, out of each 100, will be unemployed in a typical month.)