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

2. 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 , Fourth Edition

3. 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 , Fourth Edition

4. 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 , Fourth Edition

5. 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 , Fourth Edition

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

7. 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 , Fourth Edition

8. 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 , Fourth Edition

9. 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 , Fourth Edition

10. 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 , Fourth Edition

11. 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 , Fourth Edition

12. 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 , Fourth Edition

13. 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 , Fourth Edition

14. 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 , Fourth Edition

15. Source: Mankiw (2000) Macroeconomics, Chapter 6, p
Source: Mankiw (2000) Macroeconomics, Chapter 6, p , Fourth Edition

16. 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 , Fourth Edition

17. 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 , Fourth Edition

18. 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 , Fourth Edition

19. 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 , Fourth Edition

20. 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 , Fourth Edition

21. 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 , Fourth Edition

22. 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 , Fourth Edition

23. 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 , Fourth Edition

24. 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 , Fourth Edition

25. 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 , Fourth Edition

26. 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 , Fourth Edition

27. 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 , Fourth Edition

28. 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 , Fourth Edition