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Chapter 31

Economics 102: Chapter 31

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ECON 102
Robert Gateman

Economics 102: Principles of Macroeconomics Chapter 31 31.1 Employment and Unemployment Changes in Employment:  Rising population, increased labour force participation and net immigration has expanded the labour force  Net increase in employment: difference between jobs created and jobs lost Changes in Unemployment:  During periods of rapid economic growth, the unemployment rate usually falls  During recessions or periods of slow growth, the unemployment rate usually rises Flows in the Labour Market:  The amount of activity in the labour market is better reflected by the flows into and out of unemployment than by the overall unemployment rate o The unemployment rate may stay near constant must job creation may be changing Consequences of Unemployment:  Some unemployment is socially desirable as it reflects the necessary time spent searching to make appropriate matched between firms and workers Lost Output:  The unemployed are valuable resources who are currently not producing output o The output not being produced, but potentially could be, is a loss for society o The loss of output accompanied by unemployment is forever lost Personal Costs:  Those effected by long-term unemployment, in terms of disillusioned who have given up trying to make it within the system, contribute to social unrest o Loss of self-esteem and dislocation of families are results of prolonged unemployment 31.2 Unemployment Fluctuations  New Keynesians distinguish unemployment when Y*=Y and when there are output gaps  Cyclical unemployment: unemployment not due to frictional or structural factors o Due to deviations of GDP from Y*  New Classical economists believe real wages adjust immediately to clear labour markets and as a result real GDP is always equal to Y* o Unemployment rate changes but only because of changes in the amount of frictional or structural unemployment (no cyclical unemployment) New Classical Theories:  Agents continuously optimize and markets continuously clear  Believe unemployment is the outcome of voluntary decisions made by individuals who are choosing to do what they do, including spending some time out of employment Economics 102: Principles of Macroeconomics  Changes in technology that affect the marginal product of labour will lead to changes in labour demand o Positive and negative technological shocks lead to fluctuations in the level of employment/wages o Flexibility of real wages results in a clearing of the labour market o Whatever unemployment exists must be either frictional or structural (NAIRU) New Keynesian Theories:  Most people, despite reading market signals correctly, react in ways that do not cause markets to clear at all times  People are involuntarily unemployed in the sense that they would accept an offer of work in jobs for which they are trained, at the going wage rate, if such as offer were made  If wages do not respond quickly to shifts in supply/demand in labour markets, QS and QD may not be equated for extended periods of time  Unemployed wait to be needed, rather than seek out employment for lower real wages Long-Term Employment Relationships:  Firms and workers care about things in addition to the wage rate, and wages are somewhat insensitive to fluctuations in current economic conditions  Wages are regular payments over the long-term rather than supply/demand devices Menu Costs and Wage Contracts:  Changing prices and wages in response to every minor fluctuation in demand is a costly and time consuming  Firms often react to small changes in demand by holding prices constant and responding with changes in output and employment o If many firms react this way, output and employment will respond to changes in AD o The amount of involuntary unemployment will fluctuate over the business cycle  New Keynesians believe that sticky prices are a result of firms' optimal responses to adjustment costs  Inflexibility of wages implied that changes in AD and AS will tend to cause changes in the amount of involuntary employment Efficiency Wages:  Employers may find they receive more efficient workforces if they pay more than the minimum amount  Firms may choose to pay a wage premium (efficiency wage) to worker, in excess of the wage that the workers will get elsewhere in the labour market o Workers will be less likely to neglect work because if they get laid off, they lose premium wages o QS of labour may exceed QD by firms (creating involuntary unemployment) o Wages do not fall to clear the labour market because firms would rather pay a high wage to motivate workers than a lower wage to workers who neglect their duties Union Bargaining: Economics 102: Principles of Macroeconomics  New Keynesians believe those already employed have more say in wage bargaining that those unemployed  Wages that are bid up cause a market-clearing level but cause involuntary unemployment  When bargaining is decentralized, unions can push for higher wages for the insiders without worrying about the effects on outsiders or on the rest of the economy o Leads to higher-than-market-cleaning wages and higher unemployment as the outsiders are excluded from jobs  Centralized bargaining will produce an outcome closer to the market-clearing outcome o Unemployment will be lower Convergence of Theories?  New Classical theories: wages and prices adjust instantly to clear markets and so Y is always equal to Y* o Unemployment fluctuates, but it is always equal to the NAIRU (U*), no cyclical unemployment  All unemployment is structural or frictional  AD shocks don't cause changes in output because AS curve adjusts instantly to bring Y to Y*  New Keynesian models: emphasize the gradual adjustment of wages and prices and thus the existence of periods in which Y is either above/below Y* o Unemployment fluctuates around the value of U* o Cyclical unemployment
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