Macroeconomy in the Long Run Topic: Unemployment Macroeconomy in the Long Run Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Introduction Study unemployment: Identify its causes Improve public policies that affect the unemployed Rate of unemployment = percentage of the labour force unemployed There is always some unemployment What determines its level? Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Natural Rate of Unemployment The average rate of unemployment around which the economy fluctuates The steady-state rate of unemployment Rate towards which the economy gravitates in the long run Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Job loss, Job finding and the Natural rate of unemployment What determines the natural rate of unemployment? Notation: L = labour force E = number of employed workers U = number of unemployed workers L = E + U Rate of unemployment = U/L Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Job loss, Job finding and the Natural rate of unemployment Assume labour force is fixed Focus on the transition of individuals between employment and unemployment s = rate of job separation: fraction of employed people who lose this job each month f = rate of job finding: fraction of unemployed people who can find a job each month S and f determine the rate of unemployment Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Job loss, Job finding and the Natural rate of unemployment Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Job loss, Job finding and the natural rate of unemployment If unemployment rate is staying the same i.e. not rising or falling = labour market is in steady state = Number of people finding jobs = number of people losing jobs fU = number of people finding jobs sE = number of people losing jobs Steady-state condition: fU = sE Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Job loss, Job Finding and the Natural Rate of Unemployment Finding the steady-state unemployment rate: We know: E = L – U i.e. number employed = Labour force minus number unemployed We know: fU = sE Substitute (L – U) for E: fU = s(L – U) Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Natural rate of unemployment To solve for the unemployment rate (U/L) in the steady state divide both sides of the equation by L: fU/L = s(1 – U/L) Solve for U/L: U/L = s/s+f Steady-state rate of unemployment (U/L) depends on the rates of job separation (s) and job finding (f) Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Natural Rate of Unemployment Higher the rate of job separation = higher the unemployment rate Higher the rate of job finding = lower the unemployment rate To lower the natural rate of unemployment either: Reduce rate of job separation or Increase rate of job finding Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Natural Rate of Unemployment Why is there unemployment? Model above assumes job finding is not instantaneous but why is it not? Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Job Search and Frictional Unemployment One reason for unemployment: takes time to match workers and jobs Frictional unemployment: the time it takes workers to search for a job It’s inevitable in a changing economy As long as supply and demand of labour among firms is changing, frictional unemployment will be present Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Public policy and frictional unemployment Public policy: seeks to decrease the natural rate of unemployment by reducing frictional unemployment: Examples: Disseminating info on job vacancies Retraining programs Unemployment Assistance/Benefit Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Real-Wage Rigidity and Wait Unemployment Second reason for unemployment: wage rigidity Wage rigidity = The failure of wages to adjust until labour supply equals labour demand Wages are not always flexible Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Source: Mankiw (2000) Macroeconomics, Chapter 6, p Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Real-Wage Rigidity and Wait Unemployment reduces the rate of job finding and Increases the level of unemployment Wait unemployment: Unemployed not because they are searching for jobs that suits their skills best but because at the going wage rate, supply of labour > demand for labour Waiting for jobs to become available Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Causes of wage rigidity Wait unemployment arises because firms fail to reduce wages Why? Three causes of wage rigidity: Minimum-wage laws Monopoly power of unions Efficiency wages Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

1. Minimum-wage Laws Government prevents wages from falling to equilibrium levels In Ireland: National Minimum Wage Act, 2000: From 1st May 2005, minimum wage = €7.65 per hour Before May: €7.00 per hour Applies to an experienced adult employee = an employee who has any employment whatsoever in any two years over the age of 18 Wage rate reviewed at regular intervals Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Minimum-Wage Laws For most employees it doesn’t apply because employer pays above the minimum wage But for some workers, e.g. unskilled or inexperienced workers the minimum wage raises their wage above its equilibrium level and reduces quantity demanded by firms Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Minimum-wage Laws Advocates of higher minimum-wage: A means of raising the income of the working poor The cost of having more unemployment is worth it to raise others out of poverty Opponents of higher minimum-wage: Raises unemployment Other ways of increasing incomes of the working poor e.g. tax credits Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

2. Unions and Collective Bargaining Monopoly power of unions : Wages of unionised workers determined not by the equilibrium of supply and demand but by collective bargaining Agreement often raises the wage rate above the equilibrium level Insiders: workers employed by a firm try to keep wages high Outsiders: the unemployed pay the cost of that because at a lower wage they may be hired Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Unions and Collective Bargaining In US wage bargaining takes place at the firm level – ‘outsiders’ have no influence In Ireland wage bargaining takes place at the national level Social Partnership – unions, employers, community and voluntary groups, farmers and government Includes ‘outsiders’ and ‘insiders’ Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Unions and Collective Bargaining Social Partnership in Ireland (cont’d) - Six national agreements to date: 1988 Programme for National Recovery 1991 Programme for Economic and Social Progress 1994 Programme for Competitiveness and Work 1997 Partnership 2000 2000 Programme for Prosperity and Fairness 2003 Sustaining Progress Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

3. Efficiency Wages Efficiency wage theories: High wages make workers more productive Influence of wages on worker efficiency may explain failure of firms to cut wages despite an excess supply of labour Lower wages may reduce costs for firms but it would also lower worker productivity and thus a firm’s profits Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Efficiency Wages Theories: Firms pay wages above equilibrium to maintain a healthy workforce Higher wages reduce labour turnover Average quality of a firm’s workforce depends on the wage it pays to its employees Adverse selection Higher wages improves worker effort Moral hazard Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Efficiency wages If a firm pays its workers a high wage, the firm operates more efficiently and the firm may find it more profitable to keep wages above the level that balances supply and demand Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Summary An economy’s steady-state unemployment rate depends on: Rate of job separation and rate of job finding Two reasons for unemployment i.e. that job finding is not instantaneous: Process of job search leading to frictional unemployment Wage rigidity leading to wait unemployment Wage rigidity arises from Minimum-wage laws, unionisation and efficiency wages Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition

Patterns of unemployment Duration of unemployment Short-term unemployment more likely to be frictional unemployment Long-term unemployment more likely to be wait unemployment Variations in unemployment rates across demographic groups e.g. younger vs. older people Source: Mankiw (2000) Macroeconomics, Chapter 6, p. 132-153, Fourth Edition