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Chapter 31

Chapter 31.docx

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ECON 110
Ian James Cromb

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Chapter 31: Unemployment Fluctuations and the NAIRU Employment and Unemployment  Over many years, increases in the labour force are more or less matched by increases in employment – in SR, the unemployment rate fluctuations a lot more because changes in the labour force are not exactly matched y changes in employment Changes in Employment  Employment may change due to a rising population, increased labour force participation, increased immigration of working-age people  In most years, enough new jobs are created both to replace old jobs that have been eliminated and to provide jobs for the growing labour force o The result in a net increase in employment in most years Changes in Unemployment  During periods of rapid economic growth, the unemployment rate usually falls  During recessions/periods of slow growth, the unemployment rate usually rises Flows in the Labour Market  Every year many existing jobs are eliminated (firms downsize/shut down)  Many jobs are also created every year (new firms, expansions)  Most media focuses on the overall change of employment leading people to think that not much is happening during the year when it is actually the opposite o The amount of activity in the labour market is better reflected by the flows into and out of unemployment than the overall unemployment rate Consequences of Unemployment Lost Output  Every person that is unemployed is willing and able to work and is seeking a job o Hence, these people are not producing any output  The output that could have been produced for society by these individuals during the year is lost forever Personal Costs  For those workers that are unemployed for an extended period of time there may be many personal costs (not including the cost of lost wages) o They may give up and leave the labour force o They may lose self-esteem and even lose family members that are dissatisfied Unemployment Fluctuations  New Keynesians emphasize the distinction between the unemployment that exists when real GDP = Y*, and unemployment that is due to deviations of real GDP from Y* o Argue that cynical unemployment (unemployment not due to frictional or structural factors; due to deviations of GDP from Y*) exists because real wages do not quickly adjust to clear labour markets in response to various shocks  In the models of New Classical economists, real wages adjust immediately to labour markets, and as a result real GDP always = Y*  New Keynesians said workers who are suffering from cynical unemployment are presumed to be involuntarily unemployed  New Classical economists say all employment is deemed to be voluntary New Classical Theories  Explain fluctuations in employment and real wages as having two causes o Changes in technology the affect the marginal product of labour will lead to changes in the demand for labour o Changes in the willingness of individuals to work will lead to changes in the supply of labour and thus fluctuations in the level of employment and real wages  Two problems with this theory o Empirical observation is not consistent with the fluctuations in real wages predicted by the theory  employment tends to be volatile, but not the real wages o Predicts no involuntary unemployment  which is supported by emp observation New Keynesian Theories  Argue that most people react in ways that do not cause markets to clear at all times  Believe that people are involuntarily unemployed in the sense that they would accept an offer of work in jobs for which they are trained and at the going wage rate  Try to explain why wages don’t quickly adjust to eliminate involuntary unemployment o If wages don’t respond quickly to shifts in supply and demand, labour supplied will not equal demanded for an extended period of time  These theories start with the observation that wages do not change every time D/S shifts o Several reasons why wages don’t adjust quickly to all shocks in the labour market Long-Term Employment Relationships  Advgs to workers & employers of relatively long-term/stable employment relationships o Workers want job security, employers want workers that understand the business o Both parties care about things in addition to the wage rate, and wages are somewhat insensitive to fluctuations in current economic conditions o Wages = reg payments to workers for an extended employee relationship  Employers have a tendency to maintain the wage for employees and let profits absorb the effects of temporary decreases/increases in demand for a firm’s product Menu Costs and Wage Contracts  A typical firm sell numerous products so responding to every fluctuation is costly and time consuming  tend to keep price lists (menus) constant for long periods of time o Only respond with changes in output and employment, not prices o Many prices & wages are slow in adjusting to shocks as a result (inflexible in SR) Efficiency Wages  Employers may find that they get more output per dollar (a more efficient workforce) when they pay labour somewhat more than the minimum amount necessary  If it is costly for employers to monitor workers, some people can shirk duties and get away with it  generally can’t on these employees since they could leave job & not pay  Instead may choose to pay a wage premium (efficiency wage) to the workers o Employees won’t want to lose job since it pays much better than everywhere else  When a wage premium is paid, it means that the quantity of labour supplied may exceed the quantity demanded by firms  creates involuntary unemployment Union Bargaining  In labour markets with powerful unions, wages are set in a bargaining process o If unions act in the interests of the current “insiders” (decentralized bargaining),
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