Macroeconomics

N. Gregory Mankiw

Unemployment and
the Labor Market

Presentation Slides

© 2019 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

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1 National
Unemployment
Science
Income
of Macroeconomics
and the Labor Market
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,
U.S., 1960–2014
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
Assumptions

1. L is exogenously fixed.
2. During any given month,
s = rate of job separation, fraction of employed workers
who lose or leave his/her jobs
f = rate of job finding, fraction of unemployed workers
who find jobs

s and f are exogenous

The transitions between employment and
unemployment
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:
Finding the “equilibrium” unemployment rate

f ×U = s ×E
= s ×(L – U)
= s ×L – s ×U
Solve for U/L:
(f + s) × U = s × L
so,

U s
=
L s+f
Example:

• Each month,
• 1% of employed workers lose their jobs (s = 0.01)
• 19% of unemployed workers find jobs (f = 0.19)
• Find the natural rate of unemployment:

U s 0.01
= = = 0.05, or 5%
L s + f 0.01+ 0.19
Policy implication

A policy will reduce the natural rate of unemployment only if

it lowers s or increases f.
Why is there unemployment? (1 of 2)

• If job finding were instantaneous (f = 1), then all spells of

unemployment would be brief, and the natural rate would
be near zero.
• There are two reasons why f < 1:
1. job search
2. wage rigidity
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, preferences
• jobs have different skill requirements
• geographic mobility of workers 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
• Energy crisis (1970s): demand shifts from larger cars to
smaller ones
• Health care spending as % of GDP:
1960: 5.2 2000: 13.8
1980: 9.1 2010: 17.9

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 his/her job.
• UI increases frictional unemployment because it reduces
• the opportunity cost of being unemployed
• the urgency of finding work
• f
• Studies: The longer a worker is eligible for UI, the longer
the average spell of unemployment.
Benefits of UI

• By allowing workers more time to search:

• UI may lead to better matches between jobs and
workers
• which would lead to greater productivity and higher
incomes
Why is there unemployment? (2 of 2)

U s
The natural rate of unemployment: =
L s +f

• Two reasons why f < 1:

DONE  1. job search
Next  2. wage rigidity
 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.
 Unemployment from real wage rigidity, part 2

If the real
Then, firms must ration the
wage is stuck
above its scarce jobs among workers.
equilibrium
level, there
aren’t enough Structural unemployment: The
jobs to go unemployment resulting from real
around. wage rigidity and job rationing.
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, especially teenagers.
• Studies: a 10% increase in minimum wage reduces teen
employment by 1–3%
• But, the minimum wage cannot explain the majority of the
natural rate of unemployment, as most workers’ wages
are well above the minimum wage.
2. Labor unions

• 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 non-union workers who prefer
equilibrium wages, so there would be enough jobs for
them
 Union membership and wage rations by industry, 2013

Industry # Employed U % of Wage ratio

(1,000s) total
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)

3. Efficiency wages

• Theories in which higher wages increase worker

productivity by:
• attracting higher-quality job applicants
• increasing worker effort, reducing “shirking”
• 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
NOW YOU TRY
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.
 The median duration of unemployment
The duration of unemployment typically
rises in recessions—but its rise in 2008–
2010 was unprecedented.
Discouraged workers

• discouraged workers: workers who have given up on

looking for a job and are considered out of the labor force
• 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.
 Other measures of unemployment
Variable Description Rate
U-1 Persons unemployed 15 weeks or longer, as a percent of the
civilian labor force (includes only very long-term unemployed) 1.7
U-2 Job losers and persons who have completed temporary jobs, as
a percent of the civilian labor force (excludes job leavers) 2.1
U-3 Total unemployed, as a percent of the civilian labor force (official
unemployment rate) 4.3
U-4 Total unemployed, plus discouraged workers, as a percent of the
civilian labor force plus discouraged workers 4.7
U-5 Total unemployed plus all marginally attacehd workers, as a
percent of the civilian labor force plus all marginally attached
workers 5.3
U-6 Total unemployed, plus all marginally attached workers, plus total
employed part time for economic reasons, as a percent of the
civilian labor force plus all marginally attached workers 8.6
Labor force participation
Unemployment in Europe, 1960–2013
Why unemployment rose in Europe but not the United
States
Shock
Technological progress shifting labor demand from unskilled
to skilled workers in recent decades
Effect in 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
Percentage of workers covered Turkey 7%
South Korea 12
by collective bargaining, United States 12
selected countries Poland 15
Japan 17
Israel 26
Canada 29
United Kingdom 30
Greece 42
Switzerland 49
Germany 58
Australia 60
Spain 78
Italy 80
Netherlands 85
Sweden 89
Belgium 96
France 98
 CHAPTER SUMMARY, PART 1
• The natural rate of unemployment
 definition: the long-run average, or “steady-state,” rate of
unemployment
 depends on the rates of job separation and job finding
• Frictional unemployment
 due to the time it takes to match workers with jobs
 may be increased by unemployment insurance

3 The
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Unemployment
Science
Income
of Macroeconomics
and the Labor Market
 CHAPTER SUMMARY, PART 2
• Structural unemployment
 results from wage rigidity: the real wage remains above
the equilibrium level
 caused by: minimum wage, unions, efficiency wages
• Duration of unemployment
 most spells are short term
 but most weeks of unemployment are attributable to a
small number of long-term unemployed persons

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 CHAPTER SUMMARY, PART 3
• Unemployment in the United States.
 multiple measures of unemployment: U-3, U-6, etc.
 decline in the labor-force participation rate

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and the Labor Market
 CHAPTER SUMMARY, PART 4
6. European unemployment
 has risen sharply since 1970
 probably due to generous unemployment benefits,
strong union presence, and a technology-driven shift in
demand away from unskilled workers

3 The
CHAPTER 7
1 National
Unemployment
Science
Income
of Macroeconomics
and the Labor Market