Module The Meaning and Calculation of Unemployment 13 KRUGMAN'S MACROECONOMICS for AP* Margaret Ray and David Anderson

What you will learn in this Module: The three different types of unemployment and their causes The factors that determine the natural rate of unemployment

Job Creation and Job Destruction 4.5 million jobs destroyed in a ‘good’ month Structural changes in the economy The job market is constantly fluctuating.   Example: point out to the students a handful of local businesses that might have opened in recent months (a new restaurant) or maybe closed. This is happening all over the country. There are different types of unemployment that explains how this happens.

Frictional Unemployment Job Search Frictional Unemployment Duration periods of low unemployment periods of high unemployment Consists of those searching for jobs or waiting to take jobs soon; Ex. A college student graduates but doesn’t start a job for a month. Ex. A truck driver is quits her job for one company because she thinks there is a better driving route with a competitor. it is regarded as somewhat desirable, because it indicates that there is mobility as people change or seek jobs. If workers are seeking new jobs that better fit their skills or lifestyle, this increases productivity and efficiency in the labor markets.

Structural Unemployment Persistent Surplus Structural Unemployment Minimum Wages Labor Unions Efficiency Wages Side Effects of Public Policy This occurs when there are more people seeking jobs in a labor market than there are jobs available at the current wage rate. This may be due to changes in the structural demand for labor; e.g., when certain skills become obsolete or geographic distribution of jobs changes.   Examples of structural unemployment: Bottle-making machines replaced glass blowers. Airline mergers displaced many airline workers in 1980s. Foreign competition has led to downsizing in U.S. industry and loss of jobs. Military cutbacks led to displacement of workers in military-related industries. Note: You can use the example below or describe a labor market for a good example of a job that has experienced local structural unemployment. Example: Loggers and sawmill workers have lost jobs when environmental restrictions are placed on old-growth forests. Once the labor market adjusts to a new lower wage and lower employment, the structural unemployment has been eliminated, but it may be difficult for these former timber workers to find a similar source of earnings. What if the wage does not adjust downward? What could cause this to happen? 1. Minimum wages The minimum wage is a price floor, so in some industries (ie, fast food) there may always be structural unemployment because there may always be a surplus of labor. 2. Labor unions A labor union will negotiate with employers on behalf of the workers. The goal is usually to raise the wages above market equilibrium. As a result, there may be some structural unemployment. The members and leadership of the unions usually are willing to make this tradeoff of higher wages for lower employment. 3. Efficiency Wages Firms may choose to pay efficiency wages—wages that employers set above the equilibrium wage rate as an incentive for their workers to deliver better performance. If the efficiency wage creates a surplus of workers, it has created structural unemployment. 4. Side Effects of Public Policy Most economically advanced countries provide benefits to laid­ -­ off workers as a way to tide them over until they find a new job. The drawback to this generosity is that it reduces the incentive to quickly find a new job, and by keeping more people searching for longer, the benefits increase structural and frictional unemployment. The alternative to unemployment benefits is to provide nothing and let workers, and their families, fend for themselves. Most nations are willing to have support these families so that they are not financially ruined in the event of a recession.

Structural Unemployment To reiterate: This occurs when there are more people seeking jobs in a labor market than there are jobs available at the current wage rate. This may be due to changes in the structural demand for labor; e.g., when certain skills become obsolete or geographic distribution of jobs changes. Unlike We, where the number of workers willing to work equals the number of jobs available, at Wf, more workers are willing to supply their labor than there are employers willing to hire them. This surplus (Qd < Qs) represents structural unemployment.

The Natural Rate of Unemployment Natural unemployment = Frictional unemployment + Structural unemployment Cyclical Unemployment Actual unemployment = Natural unemployment + Cyclical unemployment Frictional unemployment is inevitable and many factors create some structural unemployment.   So a certain amount of unemployment is normal, or “natural” and actual unemployment fluctuates around this normal level. Natural rate of unemployment: the normal unemployment rate around which the actual unemployment rate fluctuates. Natural unemployment = Frictional unemployment ++ Structural unemployment When the economy goes through the business cycle, jobs are created and destroyed, and this can add to, or subtract from, the natural rate. Cyclical unemployment : the deviation of the actual rate of unemployment from the natural rate, or it is the share of unemployment that arises from the business cycle. Actual unemployment = Natural unemployment ++ Cyclical unemployment But the natural rate can also rise and fall.

Changes in the Natural Rate of Unemployment Natural rate of unemployment changes Changes in Labor Force Characteristics Changes in Labor Market Institutions Changes in Government Policies Congressional Budget Office, the independent agency that conducts budget and economic analyses for Congress, believes that the U.S. natural rate of unemployment was 5.3% in 1950, rose to 6.3% by the end of the 1970s, but has fallen to 4.8% today.   1. Changes in Labor Force Characteristics Older, more experienced, workers are more likely to be employed. As the US workforce has gradually aged, this has contributed to a declining natural rate of unemployment. 2. Changes in Labor Market Institutions The declining role of unions in the US labor market has weakened their ability to raise wages and some of that structural unemployment has been reduced. Better technology in job search (on-line services) has lessened the time a worker is in between jobs, lessening the frictional unemployment. 3. Changes in Government Policies The government can offer subsidies to employers to employ workers who are currently unemployed. Programs to retrain workers with obsolete skills can also lessen the natural rate of unemployment.