CHAPTER SIX

macro Unemployment

macroeconomics
fifth edition

N. Gregory Mankiw
PowerPoint® Slides
by Ron Cronovich

© 2003 Worth Publishers, all rights reserved

 Chapter objectives
The natural rate of unemployment:
 what it means
 what causes it
 understanding its behavior in the
real world

CHAPTER 6 Unemployment slide 2

Natural Rate of Unemployment
 Natural rate of unemployment:
the average rate of unemployment around
which the economy fluctuates.
 In a recession, the actual unemployment rate
rises above the natural rate.
 In a boom, the actual unemployment rate falls
below the natural rate.

CHAPTER 6 Unemployment
 U.S. Unemployment, 1960-2003
11
11
10
10
99
force)
laborforce)

88
77
(%ofoflabor

66
55
(%

44
33
22
1960
1960 1965
1965 1970
1970 1975
1975 1980
1980 1985
1985 1990
1990 1995
1995 2000
2000

Unemployment
Unemploymentrate
rate Natural
Naturalrate
rateofofunemployment
unemployment

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A first model of the natural rate

Notation:
L = # of workers in labor force
E = # of employed workers
U = # of unemployed
U/L = unemployment rate

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 Assumptions:
1. L is exogenously fixed.
2. During any given month,
s = fraction of employed workers
that become separated from their jobs,
f = fraction of unemployed workers
that find jobs.
s = rate of job separations
f = rate of job finding
(both exogenous)
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 The transitions between
employment and unemployment
s E

Employed Unemployed

f U

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 The steady state condition
 Definition: the labor market is in
steady state, or long-run equilibrium,
if the unemployment rate is constant.
 The steady-state condition is:
s E = f  U

# of employed
people who # of unemployed
lose or leave people who find
their jobs jobs

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Job Search & Frictional Unemployment
 frictional unemployment: caused by the
time it takes workers to search for a job
 occurs even when wages are flexible and
there are enough jobs to go around
 occurs because
 workers have different abilities, preferences
 jobs have different skill requirements
 geographic mobility of workers not
instantaneous
 flow of information about vacancies and job
candidates is imperfect
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 Sectoral shifts
 def: changes in the composition of demand
among industries or regions
 example: Technological change
increases demand for computer repair persons,
decreases demand for typewriter repair persons
 example: A new international trade agreement
causes greater demand for workers in the export
sectors and less demand for workers in import-
competing sectors.
 It takes time for workers to change sectors,
so sectoral shifts cause frictional unemployment.
CHAPTER 6 Unemployment slide 10
Public Policy and Job Search
Govt programs affecting unemployment
 Govt employment agencies:
disseminate info about job openings to better
match workers & jobs
 Public job training programs:
help workers displaced from declining
industries get skills needed for jobs in
growing industries

CHAPTER 6 Unemployment
Unemployment from real wage rigidity

If the real
wage is
stuck above Then, firms must ration the
the eq’m scarce jobs among workers.
level, then
there aren’t
enough jobs
to go Structural unemployment:
around. the unemployment resulting
from real wage rigidity and
job rationing.

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 Reasons for wage rigidity
1. Minimum wage laws

2. Labor unions

3. Efficiency wages

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 1. The minimum wage
 The minimum wage is well below the eq’m
wage for most workers, so it cannot explain
the majority of natural rate unemployment.
 However, the minimum wage may exceed
the eq’m wage of unskilled workers,
especially teenagers.
 If so, then we would expect that increases in
the minimum wage would increase
unemployment among these groups.

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The minimum wage in the real world:
 In Sept 1996, the minimum wage was raised
from $4.25 to $4.75. Here’s what happened:

Unemployment rates, before & after

3rd Q 1996 1st Q 1997
Teenagers 16.6% 17.0%
Single
8.5% 9.1%
mothers
All workers 5.3% 5.3%
 Other studies: A 10% increase in the minimum
wage increases teenage unemployment by 1-3%.
CHAPTER 6 Unemployment slide 15
 2. Labor unions
 Unions exercise monopoly power to secure
higher wages for their members.
 When the union wage exceeds the eq’m
wage, unemployment results.
 Employed union workers are insiders whose
interest is to keep wages high.
 Unemployed non-union workers are
outsiders and would prefer wages to be
lower (so that labor demand would be high
enough for them to get jobs).

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 3. Efficiency Wage Theory
 Theories in which high wages increase worker
productivity:
– attract higher quality job applicants
– increase worker effort and reduce “shirking”
– reduce turnover, which is costly
– improve health of workers
(in developing countries)
 The increased productivity justifies the cost of
paying above-equilibrium wages.
 The result: unemployment

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COSTS OF UNEMPLOYMENT

 A. Economic Costs
 1. For the individual, the greatest economic
cost of unemployment is lost income.
 2. For society, the greatest economic cost of
unemployment is the decrease in goods and
services that occurs as a result of the
unemployment.

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 Noneconomic Costs
 B. Noneconomic Costs
 1. For the individual, noneconomic costs
include adverse effects on mental and
physical health, adverse effects on the
family, higher rates of alcoholism and drug
abuse, and higher crime and suicide rates.

CHAPTER 6 Unemployment slide 19

 Question for Discussion:

• Use the material we’ve just covered

to come up with a policy or policies
to try to reduce the natural rate of
unemployment.
• Note whether your policy targets
frictional or structural unemployment.

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 The duration of U.S. unemployment,
average over 1993-2002

amount of time
# of unemployed these workers spent
# of weeks persons as % of unemployed
unemployed total # of as % of total time
unemployed all workers spent
unemployed

1-4 39% 6.5%

5-14 31% 20.5%

15 or more 30% 73.0%

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EXPLAINING THE TREND:
Demographics
 1970s:
The Baby Boomers were young.
Young workers change jobs more frequently
(high value of s).
 Late 1980s through today:
Baby Boomers aged. Middle-aged workers
change jobs less often (low s).

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 The rise in European Unemployment
Percent
unemployed
12

10

2
0
1960 1965 1970 1975 1980 1985 1990 1995 2000
Year
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The rise in European Unemployment
Two explanations:
1. Most countries in Europe have generous
social insurance programs.
2. Shift in demand from unskilled to skilled
workers, due to technological change.

This
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CHAPTER 6 Unemployment slide 24
 OKUN’S LAW
 When it comes to studying the economy,
growth and jobs are two primary factors
economists must consider. There is a clear
relationship between the two and many
economists have framed the discussion by
trying to study the relationship
between and unemployment levels.

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 Economist Arthur Okun first started tackling the
discussion in the 1960s and his research on the
subject has since become known as Okun's law.
Louis explains that Okun's law "is intended to tell us
how much of a country's gross domestic product
 (GDP) may be lost when the unemployment rate is
above its natural rate." It goes on to explain that
"the logic behind Okun's law is simple. Output
depends on the amount of labor used in the
production process, so there is a positive
relationship between output and employment.

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 Total employment equals the labor force minus
the unemployed, so there is a negative
relationship between output and unemployment
(conditional on the labor force)." Okun's law says
that GDP must grow at about a 4% rate for one
year to achieve a one percentage point reduction
in the rate of unemployment."
 

CHAPTER 6 Unemployment slide 27

 Chapter summary
1. The natural rate of unemployment
 the long-run average or “steady state” rate
of unemployment
 depends on the rates of job separation and
job finding
2. Frictional unemployment
 due to the time it takes to match workers
with jobs
 may be increased by unemployment
insurance

CHAPTER 6 Unemployment slide 28

 Chapter summary
3. Structural unemployment
 results from wage rigidity: the real wage
remains above the equilibrium level
 caused by: minimum wage, unions,
efficiency wages
4. Duration of unemployment
 most spells are short term
 but most weeks of unemployment are
attributable to a small number of
long-term unemployed persons

CHAPTER 6 Unemployment slide 29

 Chapter summary
5. Behavior of the natural rate in the U.S.
 rose from 1960 to early 1980s, then fell
 possible explanations:
trends in real minimum wage,
union membership, prevalence of sectoral
shifts, and aging of the Baby Boomers
6. European unemployment
 has risen sharply since 1980
 probably due to generous unemployment
insurance there and a technology-driven shift
in demand away from unskilled workers
CHAPTER 6 Unemployment slide 30
CHAPTER 6 Unemployment slide 31