Week10 - Unemployment

• what most likely accounts for the high levels of unemployment in Europe in the 1980's and 1990's

  i. high unemployment insurance benefits

  
  

  ii. employment protection restrictions

  
  

  iii. wage rigidity
• define frictional unemployment


  arises when workers and firms need time to locate each other and to digest information about the potential job match

  
  

  even a well functioning competitive economy experiences frictional unemployment
• define seasonal unemployment


  arises when workers are laid off regularly but most return to the same job when season starts
• define structural unemployment


  arises due to a mismatch between worker skills and skills needed by the firm

  
  

  structural unemployment may also arise when there is an imbalance between the supply and demand for workers

  
  

  most concerning type of unemployment - skills in the economy are not being put to productive uses
• define cyclical unemployment


  possibly caused by economic recessions - government needs to stimulate aggregate demand and re-establish equilibrium at the sticky wage
• explain the ready-state rate of unemployment

  depends on the transition probabilities among employment, unemployment and the non market sector

  
  

  in the steady state : the fraction of employed who lose their jobs and become unemployed is equal to the fraction of workers who were unemployed but have found a job
• what is the formula for steady state unemployment rate


  UR = U / LF = 1/(1+h)

  
  

  h: fraction of unemployed who have found a job
• what is ready state unemployment also known as and what are its determinants

  also known as the natural rate of unemployment

  
  

  determined by the incidence of unemployment ( l ) and the duration of the unemployment spell ( 1 / h )
• what are the three states that a person can be in

  i. employed

  ii. unemployed

  iii. non market
• explain how the wage offer distribution works


  gives the frequency distribution of potential job offers

  
  

  search is costly in the direct sense and also the opportunity cost sense
• explain non-sequential search


  workers randomly commit to a predetermined number of searches regardless of what happens while they are searching

  
  

  accepts the highest wage

  
  

  not optimal
• explain sequential search


  worker decides in advance the job offer they are willing to accept

  
  

  if the wage offer exceeds the desired wage, they stop searching

  
  

  otherwise rejects it and keeps on searching
• what is the asking wage and what are its effects

  what makes the worker indifferent between continuing the search and accepting the offer at hand

  
  

  an increase in the benefits from search raises the asking wage and lengthens the duration of the unemployment spell

  
  

  an increase in search costs reduces the asking wage and shortens the durations of the unemployment spell
• diagrammatically, how would you determine the asking wage

  marginal revenue curve gives the gain from an additional search

  
  

  its downward sloping because as the better offer at hand the less there is to gain from an additional search

  
  

  the marginal cost curve gives the cost of an additional search (direct and opportunity cost)

  
  

  it is upward sloping because the better the job offer at hand the greater the opportunity cost of an additional search

  
  

  the asking wage equates the marginal revenue and cost of the search
• what are the effects of an increase in discount rates

  the marginal revenue curve shifts downwards
• what are the effects of an increase in unemployment benefits

  the marginal cost curve shifts downwards
• what is the correlation between unemployment spells, costs and benefits


  unemployment spells last longer when the cost of searching falls and when the benefits from search rise
• what can be said about the asking wage and liquidity constraints


  asking wage is not constant over time

  
  

  unemployed workers have liquidity constraints which reduce the asking wage
• explain diagrammatically how temporary layoffs and imperfect experience ratings work

  unemployment insurance (UI) is funded by payroll tax on employers

  
  

  if the firm has layoffs below the first kink, it is assessed a very low tax rate to fund the UI

  
  

  if the firm has had layoffs in the past above the second kink, it is assessed a tax rate which is capped at the max and thus subsidised by other firms

  
  

  UI increases probability that workers are laid off temporarily

  
  

  the bond between firms and workers is mutually worthwhile - evidence of higher probability of recall the week the benefits end
• explain the inter temporal substitution hypothesis

  huge shifts in the labour supply observed over the business cycle may be the result of workers allocating their time so as to purchase leisure when its cheap i.e. during recessions

  
  

  two assumptions: real wage is pro cyclical and labour supply responds to shifts in real wage

  
  

  but movement in the real wage over the cycle is difficult to calculate - adverse effect on low skilled workers and the average wage computed during expansion is based on a different sample than when computed during recession
• what does evidence state about unemployment increase during economic downturn


  no evidence to suggest that increase in unemployment during downturn is due to rational time reallocation
• explain sectoral shifts hypothesis

  sectoral shifts argues that structural unemployment arises due to skills not being easily transferred across sectors

  
  

  there's a structural imbalance between the skills being sought after and the skills of unemployed workers

  
  

  skills of workers laid off from declining industries need to be retooled before they can find a new job in an emerging sector
• how do efficiency wages work

  firms pay a higher wage than equilibrium to motivate workers to be more productive

  
  

  causes a pool of workers who are involuntarily unemployed

  
  

  efficiency wages arise when its difficult to monitor worker output

  
  

  causes oversupply of labour generating involuntary unemployment

  
  

  if firm lowers wage then the payroll savings are outweighed by losses due to shirking
• why is there a link between wages and productivity

  a high wage makes it costly for a worker to shirk - lose wage if they get caught

  
  

  high wage is seen as a gift - well paid workers work harder even if there is no threat of dismissal

  
  

  efficiency wages reduce the quit rate and increase output and profits

  
  

  a firm that pays efficiency wages attract a more qualified pool increasing productivity and profits
• explain the no-shirking supply curve

  if there is no shirking the market clears at the competitive wage

  
  

  if monitoring is expensive, firms offer wage-employment packages to avoid shirking

  
  

  if unemployment is high, firms can attract workers who will not shirk at a low wage

  
  

  if unemployment is low firms must pay a high wage to ensure that workers do not shirk

  
  

  the no-shirking supply curve gives the number of workers at any wage who will not shirk
• what are the properties of the equilibrium regarding the no-shirking supply curve


  there's no pressure forcing the non-shirking wage (Wns) downward towards w*

  
  

  if wWns : more workers than demanded and w falls

  
  

  workers don't shirk

  
  

  there is involuntary and unproductive structural unemployment

  
  

  E-Ens : unemployed workers cannot find jobs and will not be hired because full employment incentivises shirking
• what is the impact of an economic contraction on the efficiency wage

  a fall in output demand shifts the labour demand curve inwards

  
  

  the competitive wage falls

  
  

  if firms pay an efficiency wage the contraction in demand also reduces the efficiency wage but by a smaller amount

  
  

  wages are relatively sticky

  
  

  unemployment rate rises
• what are the two main types of implicit contracts and what do they mean

  implicit contracts are unwritten and unspoken:

  
  

  i. fixed-employment: person works the same number of hours per day - over the business cycle firms vary the wage pro cyclically

  
  

  ii. fixed-wage: workers receive same hourly wage regardless of economic conditions - firms change hours pro cyclically and the wage losses offset by additional leisure and possible unemployment compensations
• what are the characteristics of implicit contracts

  i. workers prefer employment contracts where incomes are stable

  
  

  ii. workers are risk averse and exhibit diminishing marginal utility of income - high incomes during expansion do not offset low income during contraction

  
  

  iii. typical contract is fixed-wage and so wages are sticky and unemployment rises during recessions

  
  

  iv. voluntary unemployment is generated by these contracts - workers accept layoffs and a more stable consumption path