Assignment-I

Unemployment
Course No.: 0311 15 Econ 5111
Course Title: Labor Economics

Submitted To, Submitted By,

Dr. Shahnewaz Nazimuddin Ahmed Md. Reajul Jannat
Professor Student Id: 201533
Economics Discipline Year: 3rd; Term: 2nd
Khulna University Economics Discipline
Khulna University

Date of Submission: 10 March, 2025

 Unemployment in Labor Economics: Issues and Policy Responses

1.0 Introduction
Unemployment is one of the most significant and complex issues in labor
economics, affecting individuals, businesses, and the overall economy. It represents
the condition where individuals who are willing and able to work at prevailing wage
rates are unable to find jobs. Economists study unemployment to understand its
causes, persistence, and impact on economic growth. High unemployment rates can
lead to economic inefficiencies, lower consumption, and social instability, while
extremely low unemployment can lead to labor shortages and inflationary pressures.
This assignment aims to provide an in-depth analysis of various aspects of
unemployment. The discussion will cover wage offer distribution, sequential and non-
sequential job searches, the asking wage, temporary layoffs, and the Phillips Curve.
These topics help explain the dynamics of unemployment and its interaction with
wages, inflation, and economic structure. By understanding these fundamental
concepts, we gain valuable insights into the labor market and the policies that can
help manage unemployment effectively.

2.0 Concept of Unemployment

Unemployment refers the situation when there is more workers available but
there is less demand for workers that means more job seekers than the available of job
opportunities (Alam et al., 2020). Modern economic theories demonstrate that the
primary cause of unemployment is the existence of imbalances on the labor market,
while classical and neoclassical economic theories only acknowledge voluntary and
frictional unemployment (Felbermayr et al., 2011). International labor Organization
(ILO) stated that unemployment is the state in which a person is unemployed despite
actively seeking employment for the previous five weeks. Generally, the number of
jobless persons divided by the total labor force is used as a formula to calculate
unemployment (Alam et al., 2020). Unemployment is considered as an important
economic and social indicator, as all countries, whether rich, developed or poor,
struggle to reduce unemployment rates, especially among young people (Uddin and
Chowdhury, 2020). The standard of living for individuals in a certain location
decreases when the number of unemployed persons increases there. Bangladesh
witnessed a slight decrease in its unemployment rate from 4.30 percentage in 2022 to
4.20 percent.

3.0 Types of Unemployment

3.1 Frictional Unemployment: This type of unemployment occurs due to the normal
turnover in the labor market. It includes people who are temporarily unemployed
while transitioning between jobs or entering the workforce for the first time.
Causes:
 Job seekers searching for the best employment match.
 Employers taking time to find suitable candidates.
 Recent graduates entering the job market.
 Individuals re-entering the workforce after a career break.
Characteristics:
 It is short-term and voluntary in most cases.
 It exists even in a healthy economy.
 It results from imperfect information in the labor market—workers don’t
instantly find jobs, and employers don’t immediately find the right employees.
3.2 Structural Unemployment: Structural unemployment arises when there is a
mismatch between the skills that workers have and the skills that employers need. It is
often linked to changes in the economy, such as technological advancements or shifts
in industry demand.
Causes:
 Automation and technological progress replacing certain job roles.
 Globalization leading to the relocation of jobs to other countries.
 Decline of certain industries (e.g., coal mining) and the rise of new ones (e.g.,
renewable energy).
 Changes in consumer preferences affecting demand for goods and services.
Characteristics:
 It is long-term and can persist even during economic booms.
 Workers may need retraining or relocation to find new employment.
 Government policies, such as education programs and job training, can help
reduce structural unemployment.
3.3 Cyclical Unemployment: Cyclical unemployment occurs due to fluctuations in
the business cycle, meaning it rises during economic downturns (recessions) and falls
during economic booms.
Causes:
 A decline in aggregate demand leads to reduced production and layoffs.
 Economic recessions force businesses to cut costs by reducing their
workforce.
 A slowdown in investment and consumption affects job creation.
Characteristics:
 It is directly linked to economic conditions and is temporary.
 Government policies, such as fiscal stimulus (increased government spending)
or monetary policies (lower interest rates), can help mitigate its impact.
 High cyclical unemployment can turn into structural unemployment if workers
remain unemployed for too long and lose their skills.
3.4 Seasonal Unemployment: Seasonal unemployment occurs because certain jobs
are only available during specific times of the year. This type of unemployment is
predictable and happens regularly.
Causes:
 Weather changes affecting industries like agriculture, construction, and
tourism.
 Holiday seasons leading to temporary hiring and layoffs afterward.
 Education schedules affecting part-time job availability (e.g., teachers on
summer break).
Characteristics:
 It is temporary and expected.
 Many workers find alternative employment during the off-season.
 Some governments offer unemployment benefits to seasonal workers during
the off-season.
4.0 Steady-state rate of unemployment
The steady-state rate of unemployment, often referred to as the natural rate of
unemployment, represents the level of unemployment that persists in an economy
when it is in long-run equilibrium. At this rate, the number of people entering
unemployment equals the number exiting, leading to a stable unemployment rate over
time.
Economists commonly model this steady-state rate using the following relationship:
s
u=
s+ f
Where:
 u is the unemployment rate.
 s is the job separation rate, indicating the fraction of employed individuals
who lose or leave their jobs each period.
 f is the job finding rate, representing the fraction of unemployed individuals
who find and accept jobs each period.
This formula illustrates that the steady-state unemployment rate increases with a
higher job separation rate (more frequent job losses) and decreases with a higher job
finding rate (more successful job searches). For instance, if 1% of employed
individuals lose their jobs each month (s=0.01 s = 0.01s=0.01) and 20% of
unemployed individuals find jobs each month (f=0.20 f = 0.20f=0.20), the steady-state
unemployment rate would be:
0.01 0.01
u= = ≈ 0.0476
0.01+ 0.20 0.210
This equates to an unemployment rate of approximately 4.76%.
It's important to note that various factors, including labor market policies,
economic conditions, and demographic trends influence the steady-state
unemployment rate. Additionally, while this model provides a theoretical framework,
actual unemployment rates can fluctuate due to cyclical economic changes and other
dynamic factors

5.0 Wage offer distribution

The wage offer distribution refers to the range of wages that job seekers may receive
while searching for employment. In any economy, different firms and industries offer
varying wages due to factors such as productivity differences, worker skills, industry
profitability, and geographical location. The wage offer distribution is not uniform—
some workers receive high wage offers, while others receive lower ones.
The wage offer distribution is crucial because it directly affects unemployment
duration and job search behavior. If the distribution is narrow (i.e., wages offered by
different employers are similar), workers can quickly find acceptable jobs. However,
if the distribution is wide, workers may take longer to search for higher-paying jobs,
leading to longer unemployment spells.
Several key factors influence the wage offer distribution:
Worker’s Education and Skills: Higher-skilled workers tend to receive higher wage
offers, as their productivity is greater.
Industry Differences: Some industries, such as technology and finance, offer higher
wages than retail or hospitality.
Location Variability: Urban centers often have higher wage distributions due to cost-
of-living adjustments and greater demand for labor.
Economic Conditions: In a booming economy, firms offer competitive wages to
attract workers, leading to an upward shift in the wage offer distribution. During a
recession, firms may offer lower wages, and the distribution may shift downward.
Impact on Unemployment:
Workers who receive low initial offers may choose to remain unemployed longer,
hoping for better wage offers. This behavior extends the duration of unemployment
and contributes to frictional unemployment—temporary unemployment due to job
search. The wage offer distribution, therefore, plays a significant role in determining
overall unemployment rates.

Example:
Consider two job seekers, A and B. Job seeker A is offered a job at $3,000 per month,
while job seeker B is offered $5,000. If job seeker A expects to receive a better offer
by searching longer, they may remain unemployed for a more extended period,
contributing to overall unemployment statistics.

5. Sequential and non-sequential search

Job search theory helps explain how workers look for jobs and how they make
decisions when presented with different wage offers. There are two primary job
search strategies: sequential search and non-sequential search.
Non-Sequential Search
In a non-sequential search, a worker pre-determines the number of job applications
they will submit before making a final decision. Once they receive all offers, they
accept the highest-paying job.
Advantages: This method is structured and avoids the uncertainty of continuous
searching.
Disadvantages: Workers may reject high-paying jobs early in the search due to a lack
of complete information, leading to inefficiencies and longer unemployment spells.
Sequential Search
A sequential search strategy involves workers setting a reservation wage (minimum
acceptable wage) and continuing their search until they find a job that meets or
exceeds this threshold. This method allows for real-time adjustments, as workers can
accept jobs immediately when a suitable offer arises.
Advantages: More efficient, as it reduces unnecessary job rejections.
Disadvantages: Can lead to prolonged unemployment if the reservation wage is set
too high.
Impact on Unemployment:
Sequential search tends to reduce unemployment duration because workers accept job
offers that meet their expectations earlier. Non-sequential search may lead to longer
unemployment, as workers wait for the highest offer without adjusting expectations
dynamically.

Example:
A worker with a reservation wage of $4,500 per month may reject offers below this
threshold and accept the first offer that meets or exceeds it. If their expectations are
realistic, they will find employment quickly.
6. Asking wage
The asking wage (also called reservation wage) is the minimum wage at which a
worker is willing to accept a job. It varies based on several economic and personal
factors.
Factors Influencing the Asking Wage
Unemployment Benefits: Generous unemployment benefits allow workers to wait
longer for better offers, increasing their asking wage.
Savings and Financial Security: Workers with significant savings can afford to hold
out for higher wages.
Cost of Living: Higher living costs push workers to demand higher wages.
Education and Experience: More skilled workers expect higher wages and set their
asking wage accordingly.
Time Preference: Workers who prioritize short-term earnings over long-term gains
may set lower asking wages.
Impact on Unemployment:
A high asking wage leads to longer unemployment spells, as workers reject low
offers. A low asking wage reduces unemployment duration but may result in workers
accepting suboptimal jobs.

Example:
A highly skilled software engineer may have an asking wage of $100,000 per year,
whereas a fresh graduate may accept a job at $50,000. If the skilled engineer refuses
all lower offers, they may remain unemployed longer.

6. Temporary layoffs
Temporary layoffs occur when firms dismiss workers with the intention of rehiring
them later. These layoffs are common in industries with seasonal employment
patterns, such as construction, agriculture, and tourism.

Why Do Firms Use Temporary Layoffs?

Cost Savings: Instead of permanently hiring and firing workers, firms recall
previously trained employees.
Unemployment Insurance (UI) Influence: Many firms rely on UI benefits to support
workers during layoffs, indirectly subsidizing temporary layoffs.
Seasonal Variability: Firms in agriculture and tourism anticipate slow seasons and
temporarily lay off workers.
Impact on Unemployment:
Temporary layoffs create cyclical unemployment, as workers become unemployed
during downturns but re-enter the workforce when demand increases.

Example:
A ski resort may lay off workers during the summer and rehire them for the winter
season.
The Sectoral Shifts Hypothesis
The Sectoral Shifts Hypothesis explains how changes in the economy lead to
structural unemployment—a type of unemployment caused by mismatches between
worker skills and job requirements in different sectors. As industries grow or decline
due to technological advancements, globalization, policy changes, or consumer
preferences, workers must adjust by retraining, relocating, or switching professions.
This transition period often results in temporary unemployment.

This concept is crucial for understanding why unemployment can persist even during
economic expansion, as displaced workers struggle to find new jobs that match their
existing skills.

How Sectoral Shifts Cause Unemployment

Sectoral shifts occur when labor demand declines in one industry while increasing in
another. This results in friction in the labor market, as workers cannot immediately
transition between sectors. Some key causes include:

Technological Advancements

Automation and artificial intelligence (AI) replace jobs in manufacturing and routine
office work.
Growth in high-tech sectors demands new skills that displaced workers lack.
Example: Factory workers losing jobs to robotics may struggle to transition into
software engineering.
Globalization and Outsourcing

Manufacturing jobs shift from high-wage countries to low-wage economies.

Service-based economies grow, but displaced workers from manufacturing may lack
necessary skills.
Example: U.S. manufacturing jobs moving to Asia, while job growth occurs in
finance and technology.
Policy and Regulatory Changes

Environmental regulations may shut down coal mining, increasing demand for
renewable energy jobs.
Workers need new training to transition from fossil fuels to solar or wind energy.
Consumer Demand Shifts

Declining demand for print media leads to job losses in traditional journalism, while
demand for digital content creators rises.
Impact on Unemployment
Longer Job Search Periods: Workers must undergo retraining or relocation, leading to
extended unemployment.
Higher Structural Unemployment: Unemployment persists even during economic
growth if displaced workers lack relevant skills.
Wage Disparities: Declining industries experience stagnant wages, while growing
sectors offer higher wages for skilled workers.
Example:
A coal miner losing their job due to environmental policies cannot immediately work
in the solar energy sector without retraining. This results in temporary unemployment
until they acquire new skills.

Policy Implications
To reduce unemployment from sectoral shifts, policymakers should:
✔ Invest in workforce retraining programs for transitioning industries.
✔ Encourage labor mobility by offering relocation support.
✔ Promote STEM and digital education to prepare workers for emerging sectors

8.0 Philips curve

The Phillips Curve is a key concept in labor economics that explores the inverse
relationship between unemployment and inflation. First introduced by A.W. Phillips
in 1958, it suggests that low unemployment is associated with high inflation, while
high unemployment corresponds with low inflation. This trade-off presents a
fundamental challenge for policymakers aiming to reduce unemployment without
causing excessive inflation.
the Phillips Curve in the context of unemployment, highlighting how inflation
expectations and economic policies influence its dynamics. Over time, economists
have debated the validity of the Phillips Curve, leading to the distinction between its
short-run and long-run versions. This assignment examines its theoretical foundations,
empirical evidence, and policy implications.
The Short-Run Phillips Curve
The short-run Phillips Curve illustrates a negative relationship between inflation and
unemployment. It suggests that when the unemployment rate is low, firms compete
for workers by raising wages, increasing consumer spending and price levels
(inflation). Conversely, when unemployment is high, there is an excess labor supply,
reducing wage growth and inflationary pressures.
Mathematically, it can be expressed as:
π=πe−α ¿
where:
 π = actual inflation rate
 πe = expected inflation rate
 U = actual unemployment rate
 U* = natural rate of unemployment
 α = sensitivity of inflation to changes in unemployment
Graphically, the short-run Phillips Curve is downward-sloping, reflecting the inverse
relationship between inflation and unemployment. In the 1960s, policymakers
believed they could permanently lower unemployment by tolerating higher inflation.
However, this assumption proved incorrect in the long run.
The Long-Run Phillips Curve and Inflation Expectations
In the 1970s, the relationship between inflation and unemployment broke down due to
stagflation—a period of high inflation and high unemployment, contradicting the
Phillips Curve’s predictions. Economists Milton Friedman and Edmund Phelps
explained this phenomenon by introducing the Natural Rate Hypothesis and the
Expectations-Augmented Phillips Curve.
Friedman and Phelps argued that in the long run, unemployment returns to its natural
rate (U⁎), regardless of inflation levels. Workers and firms adjust their expectations to
inflation, demanding higher wages, which increases production costs and further
raises prices. As a result, the Phillips Curve shifts upward, causing the economy to
experience both inflation and unemployment.
In the long run, the Phillips Curve becomes vertical, meaning that unemployment
remains constant at its natural rate, and there is no trade-off between inflation and
unemployment. This implies that policymakers cannot reduce unemployment below
U⁎ by increasing inflation, as inflation expectations will adjust accordingly.

Policy Implications and Criticism

The breakdown of the Phillips Curve led to changes in monetary and fiscal policies.
Central banks now focus on inflation targeting rather than trying to manipulate
unemployment through expansionary policies. The Federal Reserve and European
Central Bank use interest rate adjustments to control inflation and stabilize the
economy.
Despite its relevance, the Phillips Curve has faced criticism:
1. Stagflation Challenge (1970s): The model failed to predict high inflation and
high unemployment occurring simultaneously.
2. Inflation Expectations: The curve does not account for changes in inflation
expectations over time.
3. Globalization and Technology: Labor markets have changed, reducing wage
inflation even when unemployment is low.

The Phillips Curve remains an essential tool in labor economics, explaining how
inflation and unemployment interact. While the short-run Phillips Curve suggests a
trade-off, the long-run Phillips Curve shows that unemployment returns to its natural
rate, independent of inflation. Understanding this relationship helps policymakers
balance economic growth, inflation control, and labor market stability. Although
modern economies exhibit weaker inflation-unemployment relationships, the Phillips
Curve continues to shape discussions on economic policy and labor market behavior.

Conclusion
Unemployment is a crucial indicator of labor market performance, reflecting the
mismatch between labor supply and demand. It arises from various factors, leading to
different types such as frictional, structural, and cyclical unemployment. The steady-
state rate of unemployment helps measure the equilibrium level at which job creation
and job destruction balance over time.
Workers navigate unemployment through wage offer distributions and job search
strategies, including sequential and non-sequential search. Their decision-making is
influenced by the asking wage, which determines the duration of unemployment
spells. Temporary layoffs, common in seasonal industries, create fluctuations in
employment levels, while the sectoral shifts hypothesis explains how economic
transformations displace workers, requiring skill adaptation.
The Phillips Curve historically suggested an inverse relationship between
unemployment and inflation, but long-run evidence shows that unemployment returns
to its natural rate, making inflation expectations a key driver of wage dynamics.
Understanding these concepts provides a comprehensive view of labor market
inefficiencies, helping policymakers design strategies to promote sustainable
employment, wage stability, and economic growth.