Chapter 27 Unemployment

1. Chapter 27Unemployment David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 8th Edition, McGraw-Hill, 2005 PowerPoint presentation by Alex Tackie and Damian Ward

2. Some key terms • Unemployment rate: • the percentage of the labour force without a job but registered as being willing and available for work. • Labour force • those people holding a job or registered as being willing and available for work. • Participation rate • the percentage of the population of working age declaring themselves to be in the labour force.

3. Unemployment in the UK1950-2003 Source: Economic Trends Annual Supplement, Labour Market Trends

4. Unemployment in Turkey1988-2007 Source: TURKSTAT, SPO

5. Unemployment (%) in selected countries

7. LABOUR FORCE Labour market flowsIt is tempting to see the labour market in static terms Working Unemployed Non-participants but...

8. New hires Recalls Job-losers Lay-offs Quits Retiring Temporarily leaving Discouraged workers Re-entrants New entrants Taking a job Labour market flows LABOUR FORCE Working Unemployed Non-participants

9. More on labour market flows • The size of these flows is surprisingly high. • In 1999 unemployment in the UK began at 1.29 million. • During the year: • 3.14 million became unemployed • but 3.3 million left the ranks of the unemployed.

11. Types of unemployment • Frictional • the irreducible minimum level of unemployment in a dynamic society • people between jobs • the ‘almost unemployable’ • Structural • unemployment arising from a mismatch of skills and job opportunities when the pattern of demand and production changes • it takes time for ex-coal miners to retrain as international bankers

13. Types of unemployment (2) • Demand-deficient unemployment • occurs when output is below full capacity • ‘Keynesian’ unemployment occurs in the transitional period before wages and prices have fully adjusted • Classical unemployment • created when the wage is deliberately maintained above the level at which labour supply and labour demand schedules intersect

14. Beginning at E, suppose labour demand falls to LD’. A w2 H G If labour demand remains at LD’, the new equilibrium when wages and prices have fully adjusted will be at G. LD’ Keynesian unemployment AJ With sticky wages and prices in the short-run, the economy will move to equilibrium at A LF and there will be unemployment of AF. Of which EF will be voluntary and AE will be involuntary (ie Keynesian). Real wage E F w* LD Number of workers

15. Suppose that union power succeeds in maintaining a real wage of w2. Equilibrium is at A A B C w2 and unemployment is AC, of which BC is voluntary and AB is involuntary. N2 Classical unemployment AJ LF Real wage w* To the extent that this unemployment reflects a conscious decision by unions to restrict employment, it is voluntary unemployment. LD N1 N* Number of workers

16. A ‘modern’ view of unemployment • A similar categorisation is retained, but an important distinction is to be noted between: • Voluntary unemployment • when a worker chooses not to accept a job at the going wage rate. • Involuntary unemployment • when a worker would be willing to accept a job at the going wage but cannot get an offer.

17. The natural rate of unemployment • The natural rate of unemployment is the rate of unemployment when the labour market is in equilibrium. • This is entirely voluntary. • It includes: • frictional unemployment • structural unemployment

18. LF: size of labour force AJ LF AJ: the number of workers prepared to accept jobs F w* E LD Equilibrium is at w*/ N*. The distance EF is the natural rate of unemployment. N1 N* The natural rate of unemployment LD: labour demand Real wage AJ is to the left of LF because some members of the labour force are between jobs, others are waiting for better offers. Number of workers

20. The natural rate of unemployment in the UK, 1956-95

21. Supply-side economics • entails the use of microeconomic incentives to alter • the level of full employment • the level of potential output • the natural rate of unemployment. • In the long run the performance of the economy can only be changed by affecting the level of full employment and the corresponding level of potential output.

22. Firms pay a gross wage of w1 w1 > w3 (the take-home net pay of workers). A w1 Equilibrium is at N1 E w2 F AB is the amount of tax B w3 Unemployment is BC C Without tax, equilibrium is at E. Unemployment is now EF. N1 N2 Tax cuts and unemployment AJ Real wage LF LD EF < BC i.e. unemployment is reduced. Number of workers

23. Other supply-side policies • Trade union reform • reducing the power of trade unions may limit distortions in the labour market • Other labour supply policies • training and retraining measures • improving the efficiency of the labour market • such measures may affect frictional and structural unemployment • Investment • higher investment may increase the demand for labour • may be achieved via tax incentives or low interest rates

24. Hysteresis • The idea that a (short-run) fall in aggregate demand can lead to a persistence of unemployment even when the fall in aggregate demand has been reversed. • This could help to explain high and persistent unemployment in Europe in the 1980s.

25. Hysteresis (continued) • Four channels: • Insider-outsider distinction • only those in work take part in wage bargaining & they protect their own positions • Discouraged workers • people stop looking for jobs • Search and mismatch • firms and workers get used to low search • capital stock • low levels of investment in recession lead to permanently low capital stock levels

26. Summary • Unemployment is a dynamic phenomenon. • It impacts upon different groups differently. • Modern view emphasises difference between voluntary and involuntary unemployment. • Supply-side policies are a favoured way of dealing with the problem. • Hysteresis may help to explain unemployment persistence.