Macroeconomics

N. Gregory Mankiw

Unemployment
and the Labor
Market

Presentation Slides
Modified for ECON 2204
by Bob Murphy
© 2025 Worth Publishers, all rights reserved
 IN THIS CHAPTER, YOU WILL LEARN:

. . . about the natural rate of

unemployment:
• What it means
• What causes it
• Understanding its
behavior in the real
world

3 The
CHAPTER 1 National
Science
Income
of Macroeconomics
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.
Actual and natural rates of unemployment,
United States, 1950–Jan 2023
Wage rigidity and structural unemployment (1 of 2)

• The model presented in Chapter 3 shows that real

wages adjust to bring the labor market into
equilibrium.

• In reality, real wages are not always flexible.

• Real wages may stay above the market-clearing level

because of wage-rigidity.
Wage rigidity and structural unemployment (2 of 2)

• Wage rigidity is one of the reasons why

unemployment may exist.

• Unemployment resulting from wage rigidity is known

as structural unemployment.
Job rationing

• Mismatch between workers who want to work and

the number of jobs available

• Model from Chapter 3 indicates that the real wage

should adjust to clear the market but not here.
 Unemployment from real wage rigidity, part 1

If the real wage

is stuck above
its equilibrium
level, there
aren’t enough
jobs to go
around.
Reasons for wage rigidity

1. Minimum-wage laws

2. Labor unions

3. Efficiency wages
1. Minimum-wage laws

• The minimum wage may exceed the equilibrium

wage of unskilled workers.
• Evidence shows that minimum wages above 60
percent to 66 percent of the median local wage
increase unemployment.
• However, evidence also shows if the minimum wage is
not set “too high,” then the unemployment effects are
minimal.
• But, the minimum wage cannot explain the majority
of the natural rate of unemployment, as most
workers’ wages are well above the minimum wage.
 elsewhere and the number of workers who are potentially covered by the legislation. The percentage of
workers covered by minimum wages rose during the 1960s and 1970s from less than 40 percent at the end
of the 1950s to more than 80 percent by the beginning of the 1980s. Minimum-wage legislation thus has
the potential to affect a large number of workers. The minimum wage has declined relative to average
earnings, however, lessening its impact on employment. Figure 1 shows the minimum wage and average

1. Minimum-wage laws
hourly earnings for private production and nonsupervisory workers; this clearly shows the marked decline
in the minimum wage relative to hourly earnings during the 1980s, 1990s, and 2000s.

Note: All figures are in dollars. Average hourly earnings is for production and nonsupervisory workers on private
nonfarm payrolls.
Source: Department of Labor, Bureau of Labor Statistics.

CHAPTER 7 Charles Brown, in a review of the evidence on minimum wages, concludes that both their harmful and
Unemployment and the1 Labor Market 25
beneficial effects tend to be exaggerated. For example, summarizing research on the effects of the
minimum wage on teenage unemployment, Brown notes that a 10 percent increase in the minimum wage
probably raises the teenage unemployment rate somewhere between 0 and 3 percentage points, with the
lower end more likely. He concludes, “my reading of the time series estimates is that they are not
2. Labor unions and collective bargaining

• Unions exercise monopoly power to secure higher wages

for their members.
• When the union wage exceeds the equilibrium wage,
unemployment results.
• Insiders: employed union workers whose interest is to
keep wages high.
• Outsiders: unemployed nonunion workers who prefer
equilibrium wages, so there would be enough jobs for
them.
Union membership and wage ratios by industry, 2013
# employed U % of wage
industry
(1000s) total ratio
Private sector (total) 104,737 6.9 122.6
Government (total) 20,450 37.0 121.1
Construction 6,244 14.0 151.7
Mining 780 7.2 96.4
Manufacturing 13,599 10.5 107.2
Retail trade 14,582 4.9 102.4
Transportation 4,355 20.4 123.5
Finance, insurance 6,111 1.1 90.2
Professional services 12,171 2.1 99.1
Education 4,020 13.0 112.6
Health care 15,835 7.5 114.9
wage ratio = 100 (union wage) / (nonunion wage)
EXPLAINING THE TREND:
Union membership
Since early 1980s,
Union membership the natural rate
selected years and union
membership
year percent of labor force have both fallen.
1930 12.0 But, from 1950s
1945 35.0 to about 1980,
the natural rate
1954 35.0 rose while union
1970 27.0 membership fell.
1983 20.1
2013 11.3
3. Efficiency wages

• Theories in which higher wages increase worker

productivity by:
• attracting higher-quality job applicants
• increasing worker effort and reducing “shirking”
• improving worker morale
• reducing turnover, which is costly to firms
• improving health of workers (in developing countries)
• Firms willingly pay above-equilibrium wages to raise
productivity.
• Result: structural unemployment
Job search and 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 and preferences
• jobs have different skill requirements
• geographic mobility of workers is not instantaneous
• flow of information about vacancies and job candidates is
imperfect
Sectoral shifts

• Sectoral shifts: changes in the composition of demand

among industries or regions
• Example: technological change
more jobs repairing computers, fewer jobs repairing
typewriters
• Example: a new international trade agreement
labor demand increases in export sectors, decreases in
import-competing sectors
• These scenarios result in frictional unemployment.
More examples of sectoral shifts, part 1

• Industrial revolution (1800s): agriculture declines,

manufacturing soars
• “China” Shock (2000–2010s): decline in manufacturing
(located in the Midwest), services (located along the
coasts) soar
• Healthcare spending as percentage of GDP:

1960 1980 2000 2020

5.2% 9.1% 13.8% 17.7%

In our dynamic economy,

smaller sectoral shifts occur frequently,
contributing to frictional unemployment.
More examples of sectoral shifts, part 2

Government programs affecting unemployment include:

• Government employment agencies
disseminate info about job openings to better match
workers and jobs.
• Public job training programs
help workers displaced from declining industries get
skills needed for jobs in growing industries.
Unemployment insurance (UI)

• UI pays part of a worker’s former wages for a limited time

after the worker loses their job.
• UI increases frictional unemployment because it reduces
• the opportunity cost of being unemployed
• the urgency of finding work
Unemployment insurance (UI) eligibility in the United
States
Eligibility:
• Unemployed through no fault of your own (fires and quits
are case-by-case basis)
• Able, ready, and willing to work immediately (and show
you are looking for work while receiving benefits)
• Have earned enough wages in the base period to qualify
(definitions vary by state)
Unemployment insurance (UI) claims in the United
States
Claims:
• Individual states run programs but receive money from
the federal government.
• Currently, most state systems use outdated computer
systems; it is difficult to make quick changes.
• Racial disparities in having claims approved and length of
time for approval.
• States vary in their documentation requirements.
Unemployment insurance (UI) benefits in the United
States
Benefits:
• Replacement Rate: Benefits are a percentage of your
previous wages (varies by state; about 50 percent).
• States set a cap on total weekly benefits.
• Standard benefits last 26 weeks.
• In normal times, benefits are considered taxable income.

Expanded Benefit (EB) Program: During bad economic

times, the length of benefits can be extended by 13 or 20
weeks (depending on the state of economic conditions).
Unemployment insurance (UI) during Covid in the
United States
• Additional 13-week extension starting March 2020, with
an extra 600 dollars a week (CARES Act)
• Additional 11-week extension starting December 2020,
with an extra 300 or 400 dollars a week depending on the
state and other eligibility requirements
• Additional 25-week extension starting March 2021, with
an extra 300 dollars a week (American Rescue Plan)
• Extra $ per week due to outdated computer systems and
adjusting the replacement rate
• Initial research finding that the extra 600 dollars a week
did not cause unemployment
Benefits of UI

By allowing workers more time to search:

• UI may lead to better matches between jobs and workers,
leading to greater productivity and higher incomes.
“Do Unemployment Insurance Benefits Improve Match
Quality? Evidence from Recent U.S. Recessions” reveals:
• “Longer UI benefit durations decrease the mismatch between
workers’ educational attainments and the educational
requirements of jobs.”
• “We find bigger effects of UI on match quality for those more
likely to be liquidity constrained—women, non-whites and less-
educated workers.”
• “UI extensions improve the functioning of the labor market.”
NOW YOU TRY
Questions for discussion
• Based on the previous slides, are unemployment
insurances expansions helpful or hurtful to the economy?
• Why?
• How would you judge the U.S. response to Covid, in
terms of unemployment benefits?
• What ways could the UI system be improved?
A model of the natural rate

Notation:
L = # of workers in labor force
E = # of employed workers
U = # of unemployed
U/L = unemployment rate
L=E+U
Elements of the model (1 of 6)

• Firms demand labor:

J = # of jobs firms want to fill

V = # job vacancies
F = # filled jobs
J=F+V
Elements of the model (2 of 6)

• We assume that each employed worker has one job.

E=F
J=F+V=E+V
Elements of the model (3 of 6)

• We assume that a fraction s of employed workers lose or

leave (they separate) their jobs every month.
• Therefore, total number of job separations every month is:
Separations = sE = sF.
Elements of the model (4 of 6)

• Job hiring is explained by a matching function:

New hires = μM(U, V).

• Function M() is the process of matching workers and jobs.
• ! measures how efficient job matching is.
• Various policies may affect !.
Elements of the model (5 of 6)

• Unemployment will change over time when the rate of

separations and new hires are different.

∆U = sE − μM (U, V)
Elements of the model (6 of 6)

∆U = sE − μM (U, V)

∆U = s (L − U) − μM (U, J + U − L)
The transitions between employment and
unemployment
Natural rate of unemployment
An increase in ! or J
An increase in "
The duration of unemployment, 1967–Oct 2023
The long-term (27 weeks or more) unemployed
Discouraged workers

• Discouraged workers: workers who have given up on

looking for a job and are considered out of the labor force
(U-4 unemployment rate)
• Marginally attached workers: persons not in the labor
force who want and are available for work and who have
looked for a job but have not recently looked for work
• Discouraged workers are included in marginally attached
workers. (U-5 unemployment rate)
• When combined with people who work part time for
economic reasons, it shows the U-6 unemployment rate.
 U-3 vs U-6 unemployment rates, 1994–2023

Source: U.S. Bureau of Labor Statistics

 Labor Force Participation Rate

68

67

66

65

64
Percent

63

62

61

60

59

58
1950 1960 1970 1980 1990 2000 2010 2020

Source: U.S. Bureau of Labor Statistics fred.stlouisfed.org

 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).

CHAPTER 7 Unemployment and the Labor Market 38

Unemployment rate by demographic group, 2021

Age White Men White Women Black Men Black Women

16–19 11.3% 9.6% 16.5% 16.7%
20–24 8.5 6.8 14.2 14.0
25–54 4.3 4.2 8.9 7.4
 Unemployment in Europe and United States, 2000–2019

Source: Organization for Economic Co-operation and Development

Why has unemployment in Europe been higher than in
the United States?
Shock
Technological progress shifting labor demand from
unskilled to skilled workers in recent decades
Effect in the United States
An increase in the “skill premium”—the wage gap between
skilled and unskilled workers
Effect in Europe
Higher unemployment, due to generous government
benefits for unemployed workers and strong union
presence
 CHAPTER SUMMARY, PART 1
• The natural rate of unemployment
§ Definition: the long-run average, or “steady-state,” rate of
unemployment
§ It depends on the rates of job separation and job finding.
• Frictional unemployment
§ It is due to the time it takes to match workers with jobs.
§ Longer unemployment benefits can increase match quality.
• Structural unemployment
§ It results from wage rigidity: The real wage remains above the
equilibrium level.

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 CHAPTER SUMMARY, PART 2
• Unemployment insurance in the United States
§ Issues caused by outdated and state-run computer systems
§ Massive expansion in benefits during Covid
• Duration of unemployment
§ Most spells are for short term.
§ Most weeks of unemployment are attributable to a small
number of long-term unemployed persons.
§ Both the 2008 and Covid recessions greatly increased long-
term unemployed.

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 CHAPTER SUMMARY, PART 3
• Unemployment in the United States
§ Multiple measures of unemployment: U-3, U-6, etc.
§ Differences across demographic groups

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of Macroeconomics