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ECON202 Study Guide - Final Guide: Real Wages

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Maryann Vaughan
Study Guide

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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.
Labour Force Survey deliberately excludes individuals in all of the following categories:
Persons younger than 15 years old
Persons residing in the territories and aboriginal settlements
Full time members of the armed forces
Inmates in institutions
First Model for the Natural Rate
L = # of workers in labor force
E = # of employed workers
U = # of unemployed
U/L = unemployment rate
1. L is exogenously fixed.
2. During any given month,
a. s = rate of job separations, the fraction of employed workers that become separated
from their jobs
b. f = rate of job finding, fraction of unemployed workers that find jobs
c. s and f are exogenous

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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” U Rate
f U = s E
= s (L U )
=  
 
  
Policy Implication
A policy will reduce the natural rate of unemployment only if it lowers s or increases f.
Why is there Unemployment
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:
o job search
o 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:
L s f
If the labour market is in a steady state, then the number of people fining
jobs = the number people losing their jobs
Recall :L = E+U
This equation shows that the steady state rate of unemployment (U/L)
depends on the rate of job separation and the rate of job finding
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