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Chapter 31

ECON 295 Chapter 31: Chapter 31
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Department
Economics (Arts)
Course
ECON 295
Professor
Mayssun El- Attar Vilalta
Semester
Winter

Description
1. Macroeconomics policy – Chapter 31: Unemployment fluctuations and the NAIRU 30.1 Employment and unemployment  In the long-run, increases in the labor force are more or less matched by increases in employment  In the short-run, the unemployment rate fluctuates considerably because changes in the labor force are not exactly matched by changes in employment  They fluctuate considerably  The labor force is more stable Changes in employment - Net increase in employment is the difference between all the jobs that are created and all those that are lost - In most years, enough new jobs are created both to offset the number of jobs that have been eliminated and also to provide jobs for the growing labor force. The result is a net increase in employment in most years Changes in unemployment - Short term fluctuations  During the periods of rapid economic growth, the unemployment rate usually falls  Recessions or periods of slow growth, the unemployment rate usually rises - Over longer periods, unemployment changes more due to structural changes in the labour force Flows in the labor market - The amount of activity in the labor market is better reflected by the flows into and out of unemployment than by the overall unemployment rate:  Roughly 400,000 workers flow in both directions each month  Flow into unemployment represents: o Workers loosing jobs, workers quitting jobs, new entrants to the labor force searching for jobs  Flow out of unemployment represents: o Unemployed individuals finding new jobs or becoming discouraged and leaving the labour force Measurement problems - The official data understate the full effects of recession on unemployment because they don’t include:  Discouraged workers leaving the labor force  Underemployed workers Consequences of unemployment Lost output and income The output that I not produced by the not-employed Personal costs - Social unrest - Loss of self-esteem - Dislocation of families 30.2 Unemployment fluctuations - Cyclical unemployment: The difference between actual unemployment and the amount that would exist when Y = Y* - When Y = Y*, there is still some unemployment  Frictional  Structural Market-clearing theories - Shocks to technology and tastes can explain unemployment fluctuations - Major characteristics:  Agents continuously optimize  Markets continuously clear o Wage and price flexibility plays a leading role - It assumes that real wages always adjust to clear the labor market. People who are not working are assumed to have voluntarily withdrawn from the labor market for one reason or another. There is no involuntary unemployment - Why employment fluctuates?  Changes in demand for labor: Changes in the technology that affects the marginal product of labour  Changes in supply for labour: Changes in the willingness of individuals to work: They may leave voluntarily the labour force if wages are too low Non-market clearing theories - Wages are sticky and the market does not clear  Involuntary unemployment or labour shortages - Four explanations for wage stickiness:  Long-term employment relationships: In labor markets in which long- term relationships are important, the wage rate does not fluctuate to continuously clear the market  Economic climate versus economic weather: Changes in labor demand and labour supply, if sustained, are important for determining variates in real wages  Efficiency wages: Firms may find it profitable to pay higher-than- market-clearing wages so that workers put forth greater effort  Union bargaining: Wages may be more influenced by “insiders” than by “outsiders” – this may keep wages high, even in the face of declining demand  Menu costs and wage contracts: Continuously changing prices and wages is costly. Many firms change them only occasionally Convergence of theories - Both theories predict that in the long run, the unemployment rate comes back to U* (NAIRU) - But they differ strongly in the short run:  New classical models predict U is always U*  SR is no different than LR  New Keynesian models have U away from U* until LR  clear distinction between SR and LR 31.3 What determines the NAIRU? Frictional unemployment - Frictional unemployment: Unemployment that results from the turnover in the labor market as workers move between jobs  Search behavior is important  Voluntary or involuntary? - The normal turnover of labor causes frictional unemployment to persist, even if the economy is at potential output Structural unemployment - Structural unemployment: Caused by a mismatch in skills, industry, or location between available jobs and unemployed workers  Regional mismatches  Occupational or industrial mismatches - Structural unemployment will rise if:  Greater pace of structural change in economy  Some government policies restrict mobility  Firing costs are high Frictional-structural distinction - Common characteristic:  Both suggest that there are as many unfilled vacancies as there are unemployed persons - Despite different conceptual meanings, it’s often difficult to clearly distinguish the two types of unemployment - Length of time unemployed is likely the best practical distinction – an after the fact criterion - Can be separated from cyclical unemployment Why does the NAIRU change? Demographic shifts - Greater labour-force participation by groups with high unemployment increases the NAIRU -
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