Labour Markets 03-06-2013
Types of Unemployment
Structural – mismatch in skills, industry or location between available jobs and
Frictional – results from turnover in the labour market as workers move
Cyclical – due to deviations of GDP from Y*
Generally, we’re only worried/concerned with cyclical unemployment.
Natural Rate of Unemployment
Natural Rate of Unemployment (U*) – rate of unemployment where Real GDP is
equal to Y*
At U*, there is no cyclical unemployment, BUT there still exists some
Usually about 7% - structural, season, or frictional reasons
Theories of Cyclical Unemployment
Put it in a demand and supply framework:
How does the hourly wage change over the business cycle?
We’re looking at one stat across all industries. Some industries will be doing
better than others.
Supply for labour: individuals willingness to work
o Goes up when wage goes up (aggregate, not individual representation)
Demand: downward sloping – the more producers have to pay for labour, the
less they’ll want it
How the labour market responds to cyclical unemployment (2 theories):
New Classical Theories
Agents are continuously optimizing o Change their mind everyday on how many hours they wanna work each
o Respond instantaneously
Markets continuously clear
o Market changes in response to people’s decision of how much labour they
want to supply
Prediction: This implies that there can be no involuntary unemployment.
There’s a job out there that you want, but there’s a reason you can’t have it.
Voluntary: “none of these are gonna pay me enough, I’m gonna sit on my
Causes of fluctuations:
o Changes in technology that affect the MP of labour
Affects demand for labour
o Changes in the willingness of individuals to work
Affects the supply of labour
Decrease in Demand for Labour
Ex. recession decrease in real GDP recessionary gap firms produce less
stuff you require less labour leftward shift in demand wage falls
Given our earlier assumption, this adjustment process will happen
Wage is assumed to adjust instantly from W0 to W1
Employment falls from L0 to L!
Those workers with reservation wages below W1 are not willing to work
All unemployment is voluntary Problems with New Classical Theory