Chapter 28 : Unemployment

Section A (MCQ)

1 b 2 c 3 a 4 b 5 d 6 d 7 c 8 c 9 d 10 b

Section B (Short answer question)

1. The labor force consists of the number of employed (138,547,000) plus the number of
unemployed (6,021,000), which equals 144,568,000.

To find the labor-force participation rate, we need to know the size of the adult
population. Adding the labor force (144,568,000) to the number of people not in the
labor force (67,723,000) gives the adult population of 212,291,000. The labor-force
participation rate is the labor force (144,568,000) divided by the adult population
(212,291,000) times 100%, which equals 68%.

The unemployment rate is the number of unemployed (6,021,000) divided by the

labor force (144,568,000) times 100%, which equals 4.2%.

2. a.) unemployment rate = (No. of unemployed / Labour force) x100

= [7.2/(135.1 + 7.2)] x 100 = 5.06%

b) Labour force participation rate = (Labour force/Adult population) x 100

= [(135.1 + 7.20] / [(135.1 + 7.2 + 7.2)] x 100 = 95.18%

c) Employment – to – population ratio = (No. of people employed)/(Adult population)

x 100

= 135.1 / [(135.1 + 7.2 + 7.2)] x 100 = 90.37%

3. The figure below shows a diagram of the labor market with a binding minimum
wage. The initial equilibrium with minimum wage m 1 has quantity of labor supply
L1S greater than the quantity of labor demanded L 1D, with unemployment equal to L1S
- L1D. An increase in the minimum wage to m 2 leads to an increase in the quantity of
labor supplied to L2S and a decrease in the quantity of labor demanded to L 2D. As a
result, unemployment increases as the minimum wage rises.
4. Frictional unemployment is inevitable because the economy is always changing.
Some firms are shrinking while others are expanding. Some regions are experiencing
faster growth than other regions. Transitions of workers between firms and between
regions are accompanied by temporary unemployment.
The government could help to reduce the amount of frictional unemployment by
public policies that provide information about job vacancies in order to match
workers and jobs more quickly, and through public training programs that help ease
the transition of workers from declining to expanding industries and help
disadvantaged groups escape poverty.

5. Advocates of unions claim that unions are good for the economy because they are an
antidote to the market power of the firms that hire workers and they are important for
helping firms respond efficiently to workers' concerns.

Section C (Essay Question)

Question 1
Wages may be set above their equilibrium level on purpose in order to increase worker
productivity. This theory is referred to as the efficiency-wage theory, and there are a
number of reasons that firms might find it profitable to behave in this way.
Reduced worker Turnover
In most cases, workers don't arrive at a new job knowing everything that they need to
know about the specific work involved, how to work effectively within the organization,
and so on. Therefore, firms spend quite a bit of time and money getting new employees
up to speed so that they can be fully productive at their jobs. In addition, firms spend a lot
of money on recruiting and hiring new workers.
Lower worker turnover leads to a reduction in the costs associated with recruiting, hiring,
and training, so it can be worth it for firms to offer incentives that reduce turnover.

Paying workers more than the equilibrium wage for their labor market means that it is
more difficult for workers to find equivalent pay if they choose to leave their current jobs.
This, coupled with the fact that it's also less attractive to leave the labor force or switch
industries when wages are higher, implies that higher than equilibrium (or alternative)
wages give employees an incentive to stay with the company that is treating them well
financially.
Increased Worker Quality
Higher than equilibrium wages can also result in increased quality of the workers that a
company chooses to hire. Increased worker quality comes via two pathways: first, higher
wages increase the overall quality and ability level of the pool of applicants for the job
and help to win the most talented workers away from competitors. (Higher wages
increase quality under the assumption that better quality workers have better outside
opportunities that they choose instead.) Second, better paid workers are able to take care
of themselves better in terms of nutrition, sleep, stress, and so on. The benefits of better
quality of life are often shared with employers since healthier employees are usually
more productive than unhealthy employees. (Luckily, worker health is becoming less off
a relevant issue for firms in developed countries.)
Worker Effort
The last piece of the efficiency-wage theory is that workers exert more effort (and are
hence more productive) when they are paid a higher wage. Again, this effect is realized in
two different ways: first, if a worker has an unusually good deal with her current
employer, then the downside of getting fired is larger than it would be if the worker could
just pack up and get a roughly equivalent job somewhere else. If the downside of getting
fired if more severe, a rational worker will work harder to ensure that she doesn't get
fired. Second, there are psychological reasons why a higher wage might induce effort,
since people tend to prefer working hard for people and organizations that acknowledge
their worth and respond in kind.

Question 2
a. The figure below illustrates the effect of a union being established in one labor
market. When one labor market is unionized, shown in the figure on the left, the wage
rises from w1U to w2U and the quantity of labor demanded declines from U1 to U2D.
Since the wage is higher, the supply of labor increases to U 2S, so there are U2S - U2D
unemployed workers in the unionized sector. The quantity of labor employed in this
market is inefficient, since more workers would like to have jobs at the existing wage.

b. When those workers who become unemployed in the union sector seek employment
in the nonunionized market, shown in the figure on the right, the supply of labor
shifts to the right from S1 to S2. The result is a decline in the wage in the
nonunionized sector from w1N to w2N and an increase in employment in the
nonunionized sector from N1 to N2.