Lecture 6

Unemployment
(Ch:15; P.O.M.E)

ECO 104
Faculty: Asif Chowdhury

 Unemployment is a concern for both

the unemployed individuals & the
government. Unemployment causes
problems both at personal level &
also has social cost implications.
Unemployment in turn can be
classified into two categories; Natural
Rate of Unemployment & Cyclical
Unemployment. Here we shall focus
on Natural Rate of Unemployment.

Natural Rate of
Unemployment
Natural Rate of Unemployment is long run in
nature while Cyclical Unemployment is short
run
in
nature.
NRU
refers
to
the
unemployment level that exist in an economy
even if the economy approaches full
employment level. Cyclical unemployment is
the short run fluctuations around this long run
natural rate of unemployment. Incidentally
CU is linked to Business Cycle ( fluctuation in
level of economic activities.)

Measuring Unemployment:
Government
statistical
division
conducts survey of adult population
(16+ age) & identifies three categories
among those surveyed:
Employed
Unemployed
Not in the labor force.
Using the above three categories some
unemployment
statistics
are
calculated:

 Labor Force = Number of Employed +

Number of Unemployed.
Unemployment Rate = (Number of
Unemployed/ Labor Force) X 100
Labor Force Participation Rate: (Labor
Force/ Adult population) X 100
o Adult population consist of employed,
unemployed as well as people who are
not in the labor force.

Some Definitions:
Labor Force: the total number of
workers who are both employed &
unemployed.
Unemployment Rate: the percentage
of population that is unemployed.
Labor Force Participation Rate: the
percentage of adult population thats
in the labor force.

Difficulty in Measuring
Unemployment level:
Since people can intentionally stay in the
unemployment
group
for
receiving
government unemployment benefits, or are
working but to avoid tax burden are calling
themselves unemployed, they should be
categorized into different groups other than
the unemployment group. Another group of
people are called discouraged workers; who
have looked for jobs but have stopped looking,
out of frustration. This group should be
included in the unemployed group, but they
are included in the out of labor force group. So
these type of complications makes it difficult

Classifying NRU:
Natural Rate of Unemployment can be
classified into two categories:
Frictional
Unemployment:
Unemployment
resulting from time taken by a worker to search
for an appropriate job suiting the workers skills
& preferences.
Structural Unemployment : Unemployment that
arise because the number of jobs available is
insufficient compared to the available workers
wanting a position, in some labor markets.

Frictional Unemployment:
Frictional Unemployment is related to
the concept of job search: the
process of matching workers with
appropriate jobs. Since a laid off
worker needs some time to find the
appropriate job that suits his/her
skills & preferences, that worker is
frictionally unemployed during that
time duration.

Reasons for Frictional

Unemployment:
Changes in Demand in a market
Sectorial Shifts
Government can mitigate the impact of
Frictional Unemployment through public
provision of job information & provisions of
training for developing workers skills.
Critics argue that government doesnt need
to intervene since the private sector can do
both the task of information dissemination
& training provision efficiently.

 Another way government can reduce

the
impact
of
Frictional
Unemployment
is
through
Unemployment Insurance. However
critics argue that this can instead
discourage unemployed workers to
look for jobs sincerely.
Unemployment
Insurance:
a
government program that partially
protects workers income when they

Explaining Structural
Unemployment:
Structural Unemployment occurs when
wage level fails to clear the demand &
supply of labor in a labor market. This
occurs when wage level is artificially
pegged at some given level. This in
turn leads to a situation of labor supply
exceeding labor demand & hence
unemployment occurs, since there are
surplus workers who arent hired.

Reasons for Wage Rigidity:

Minimum Wage Law: affects low skilled/ semi
skilled workers more.
Unions & Collective Bargaining:
Unions: A worker association that bargains with
employers over wage, benefits & working
conditions.
Collective Bargaining: the process by which
unions & firms agree on the terms of
unemployment.
Strike: the organized withdrawal of labor from a
firm by an union.

 From the concept of unions, two additional

concepts arises:
o Insiders
o Outsiders
Arguments against unions hold that allocation of
labor becomes inefficient & inequitable.
Arguments for unions hold that unions provides
workers with necessary bargaining power when
dealing with a monopoly employer. Also,
presence of union can make a firm more
responsive to workers welfare.

 Efficiency Wages: above equilibrium

wages paid by firms to increase workers
productivity. To support the concept of
efficiency wages, a number of efficiency
wage theories have been put forward:
Worker Health
Worker Turnover
Worker Quality
Worker Effort