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Lecture 15: Unemployment and the Business Cycle

Lecture 15: Unemployment and the Business Cycle. L11200 Introduction to Macroeconomics 2009/10. Reading: Barro Ch.9 25 February 2010. Introduction. Last time: Expanded model to incorporate supply of capital over the business cycle to match data Today

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Lecture 15: Unemployment and the Business Cycle

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  1. Lecture 15: Unemployment and the Business Cycle L11200 Introduction to Macroeconomics 2009/10 Reading: Barro Ch.9 25 February 2010

  2. Introduction • Last time: • Expanded model to incorporate supply of capital over the business cycle to match data • Today • Try to explain unemployment within the model • Develop a model of job separation and job search

  3. Why is this a Problem? • Equilibrium Business Cycle model has no unemployment • If labour market clears than labour supply = labour demand • No-one who wants to work is without a job • All unemployment is voluntary – if people wanted to work at the going wage they could

  4. Explanations for Unemployment • To explain unemployment, some appeal to excess supply of labour • i.e. labour demand falls in recessions but wages are somehow held above equilibrium • Minimum wages, Union bargaining, Wage Contracts • More modern theories appeal to ‘search and matching’, which we develop today

  5. Basics of the Model • Workers looking for jobs don’t immediately find a job which pays their MPL=w/P • Search around looking for the best offer possible • Searching is much more easily done while unemployed • Income while unemployed is some minimum paid by the government, ω • Job offers taken from some distribution of possible wages above ω

  6. Distribution of w/P • Small chance of getting a high-paid job, more likely get a job close to worker’s MPL • So when job offer comes along, have to make a decision • Do you take the offer and forego the chance of a better offer? • Certainly will not take any offer below ω (unemployment benefit) paid by government

  7. Reservation Wage • Will take a job at some reservation wage (w/P)’ depending on preferences • Certainly won’t take any job paying below ω • Have to make a judgement about what offer would be taken • This decision results in the individual deciding on their reservation wage

  8. Dynamics and the Labour Force • Data shows that the labour force is very steady over the cycle • So patterns in employment and unemployment not caused by changes in labour force • Instead, caused by job-separations:workers leave current job to find another / firms find workers have MPL less than anticipated • And by job-findings: workers find an acceptable wage offer above reservation wage and take job

  9. Model Setup • So growth of employment depends on : • Critical issue is determinants of σ and • Do these vary over the business cycle? growth in employment = (job finding rate x no. people unemployed) - (job separation rate x no. people employed)

  10. ‘Equilibrium’ Unemployment • Employment is unchanged when • Denote overall labour force F • U/F is ‘natural unemployment rate’, denoted by un

  11. Factors affecting un • Variation in explained by factors which shift either job-separation of job-finding rate • Unemployment insurance: which lowers job-finding rate • Search technology (e.g. internet) which raises job-finding rate • Generally, job-finding rate more likely to change compared with job-separation rate

  12. Fluctuations and Employment • Positive technology shock raises prospective MPL of workers • Increases recruitment by firms • For a given ω, increases likelihood of worker taking an advertised position • So job-finding rate increases and un falls. • Converse is true when negative shocks lower MPL, job-finding rate falls and un rises.

  13. Advertising and Unemployment • If this is true, should find greater job-advertising when unemployment is low • Firms demand for workers reflected in more job-adverts • More jobs ease ability of workers to find a good matching job • Unemployment rate falls • Known as the Beveridge Curve

  14. Recap • Why does unemployment rise in recessions • Because lower MPL reduces wage offers and advertising by firms • Lower wage offer reduces likelihood that workers will take jobs (for a given ω) • Job-finding rate falls, so natural unemployment rate increases • So unemployment is counter-cyclical: high when output is falling, and vice-versa

  15. Summary • Unemployment is possible, and counter-cyclical in the modified model • Arises because of friction in the labour market between rate at which individuals separate from jobs and find new jobs • Data suggests this is a plausible model • Next time: introduce a new topic, money, and consider role of money in our economy

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