Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 1 Economics THIRD EDITION By John B. Taylor Stanford University

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 2 Chapter 20 (Macro 7) Unemployment and Employment

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 3 Overview Unemployment arises in both the growth and the cyclical parts of macroeconomics. Any contemporary account of unemployment must therefore attempt to define and explain each of these sources. So the natural rate or, alternatively, frictional and structural unemployment are due to the enduring features of an economy in normal times, while cyclical unemployment is a consequence of economic fluctuations. Due to the close connection between cyclical unemployment and economic fluctuations, detailed discussion of the underlying connections is deferred until the model of economic fluctuations is introduced and developed in later chapters.

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 4 Teaching Objectives Develop a clear set of definitions of unemployment and employment that is consistent with government reports of these data. Use the demand and supply model as it applies to the labor market in the determination of real wages, employment, and unemployment. Discuss the policy implications of the demand and supply for labor model.

Copyright © 2001 by Houghton Mifflin Company. All rights reserved Employment and Unemployment Trends The labor force consists of all people who are 16 or over, employed or unemployed. The current population survey is the source of this number. The distinction between employed and unemployed depends on whether the person is paid or not. The labor force consists of the employed plus the unemployed, the latter consisting of those in the labor force but not employed. Discouraged workers are not in the labor force and so are not counted as unemployed. Part-time workers (1 to 34 hours per week) are counted as employed. See Figure 21.2.

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 6 Three indicators of labor market conditions The unemployment rate, or unemployed/labor force. Figure 20.1 makes clear the relation between unemployment and real GDP. The labor force participation rate, or labor force/working-age population. It fluctuates with real GDP as does unemployment. The employment-to-population ratio, or employed/working-age population. These ratios are given in Figure 20.3.

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 7 Figure 20.1 (Macro 7) The Unemployment Rate

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 8 Figure 20.2 (Macro 7) How to Find Labor Market Indicators

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 9 Figure 20.3 (Macro 7) Employment-to-Population Ratio for Men, Women, and Everyone

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 10 Adjustments Because the labor force is composed of both full- time workers and a significant number of part- time workers, the number employed needs to be supplemented by other measures that reflect this fact. Aggregate hours = (average hours per worker) x (labor force participation) x (working- age population).

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 11 Unemployment and GDP Increases in unemployment reduce real GDP as the labor input to production falls because fewer workers are employed. So an increase in the natural rate reduces potential real GDP, provided there are no accompanying changes in productivity to be accounted for.

Copyright © 2001 by Houghton Mifflin Company. All rights reserved The Nature of Unemployment People become unemployed because they are job losers, job leavers, or new entrants. See Figure Job losers are unemployed because of the dynamism of the economy: As jobs are created and destroyed, workers are often left unemployed in the process. As a consequence, job vacancies and unemployment exist at the same time, a reflection of this dynamism. However, job losers increase during recessions and decline during booms, as seen in Figure 20.4.

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 13 Figure 20.4 (Macro 7) Job Losers, Job Leavers, New Entrants and Re-entrants (January 2000)

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 14 Unemployment Job leavers, or quits, are relatively constant over the cycle due to the opposing forces of reduced quits and fewer job vacancies in a recession. New entrants are a large fraction of the unemployed, especially on a seasonal basis. Most of the unemployed (85 percent) are unemployed for less than 6 months. See Figure However, the long-term unemployed (the other 15 percent) increase during recessions and decrease during booms. The rate of unemployment varies dramatically across groups in society, with very high unemployment rates among minority teenagers.

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 15 Figure (Macro 7) Unemployment Rates for Young Adults (ages 20-24)

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 16 Figure (Macro 7) Percentage of year-olds Still Living with Parents

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 17 Figure 20.5 (Macro 7) Unemployment by Duration (January 2000)

Copyright © 2001 by Houghton Mifflin Company. All rights reserved Determination of Employment and Unemployment The relationship between labor demand and supply is given in Figure 20.6, determining the equilibrium quantity of full-employment labor and the real wage. Two broad trends in labor are the general increase in real wages and employment. This is associated with a shift in the demand for labor, as seen in Figure 20.7, due in part to the growth of service industries, which hire more women. Women are quite sensitive to changes in real wages, so the increased demand in service industries probably explains the higher participation rate by women.

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 19 Figure 20.6 (Macro 7) Labor Supply, Labor Demand, and Equilibrium Employment

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 20 Figure 20.7 (Macro 7) Explaining the Increase in the Employment-to-Population Ratio

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 21 Other Explanations for Unemployment In order to account for unemployment in a model such as Figure 20.6, it is necessary to introduce some explanation outside of equilibrium. Two complementary explanations are job rationing and job search. Job rationing is depicted in Figure 21.8 in terms of excess supply that is always present, not allowing for the normal downward price (real wage) adjustment due to: (1) the minimum wage law and its effect on teenage unemployment; (2) insiders sometimes preventing outsiders from being employed; (3) employers paying efficiency wages.

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 22 Figure 20.8 (Macro 7) Excess Supply of Labor and Unemployment

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 23 Figure 20.9 (Macro 7) Labor Market Flows

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 24 Policy implications of the demand and supply model of the labor market The policy implications of the demand and supply model of the labor market are discussed in terms of the effect on employment and the natural rate of unemployment. Taxes such as a payroll tax affect the demand for labor, as seen in Figure For example, an increase in the social security tax will reduce the demand for labor by the amount of the tax, reducing the real wage and employment.

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 25 Figure (Macro 7) Effects of a Tax on Wages

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 26 Figure (Macro 7) Tax Rates on Wages

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 27 Figure (Macro 7) Minimum Wage as a Percentage of Average Wage

Copyright © 2001 by Houghton Mifflin Company. All rights reserved. 28 Policy implications The job-rationing and job-search models have policy implications for the natural rate of unemployment. To the extent that job rationing is present due to the minimum wage, any reduction in the minimum wage will reduce unemployment. Similarly, a reduction in unemployment can be realized by reduced unemployment compensation benefits.