Macroeconomics
CHAPTER 15
Labor Markets, Unemployment, and Inflation
PowerPoint® Slides
by Can Erbil
© 2006 Worth Publishers, all rights reserved
What you will learn in this chapter:
The meaning of the natural rate of unemployment, and why it isn’t zero
Why cyclical unemployment changes over the business cycle
How factors such as a minimum wage and efficiency wages can lead to structural unemployment
The reasons that unemployment can be higher or lower than the natural rate for extended periods
The existence of a short-run trade-off between unemployment and inflation, called the short-run Phillips curve, that disappears in the long run
Why the NAIRU, the nonaccelerating inflation rate of unemployment, is an important measure for policy-making
The Nature of Unemployment
Workers who spend time looking for employment are engaged in job search.
Frictional unemployment is unemployment due to the time workers spend in job search.
The Nature of Unemployment
Workers who spend time looking for employment are engaged in job search.
Frictional unemployment is unemployment due to the time workers spend in job search.
Structural unemployment is unemployment that results when there are more people seeking jobs in a labor market than there are jobs available at the current wage.
Distribution of the Unemployed
by Duration of Unemployment, 2000
In years when the unemployment rate is low, most unemployed workers are unemployed for only a short period.
In 2000, a year of low unemployment, 45% of the unemployed had been unemployed for less than 5 weeks and 77% for less than 15 weeks. The short duration of unemployment for most workers suggests that most unemployment in 2000 was at this time frictional.
Source: Bureau of Labor Statistics.
The Effect of a Minimum Wage on the Labor Market
When the government sets a minimum wage, WF , that exceeds the market equilibrium wage rate, WE , the number of workers, QS , who would like to work at that minimum wage, is greater than the number of workers, QD, demanded at that wage. This surplus of labor is considered structural unemployment.
Causes of Structural Unemployment
Minimum wages - a government-mandated floor on the price of labor. In the US, the national minimum wage in 2005 was $ an hour.
Unions - by bargaining for all a firm’s workers collectively (collective bargaining), unions can often win higher wages from employers than the market would have otherwise provided when workers bargained individually.
Causes of Structural Unemployment
Efficiency wages - wages that employers set above the equilibrium wage rate as an incentive for better performance.
Side effects of government policies - public policies designed to help workers who lose their jobs; these policies can lead to structural unemployment as an unintended side effect.
The Natural Rate of Unemployment
The natural rate of unemployment is the normal unemployment rate around which the actual unemployment rate fluctuates.
Cyclical unemployment is a deviation in the actual rate of unemployment from the natural rate.
The Changing Makeup of the . Labor Force
In the 1970s, the percentage of the labor force consisting of women rose rapidly, as did the percentage under age 25. These changes reflected the entry of large numbers of women into the paid labor force for the first time and the fact that baby boomers were reaching working age. The natural rate of unemployment may have risen because many of these workers were relatively inexperienced. Today, the labor force is much more experienced, which is one possible reason the natural rate has fallen since the 1970s.
Source: Bureau of Labor Statistics
Changes in the Natural Rate of Unemployment
Changes in Labor Force Characteristics
Changes in Labor Market Institutions
Changes in Government Policies
Changes in Productivity
Unemployment and the Business Cycle
The percentage difference between the actual level of real GDP and potential output is the output gap.
When actual output is equal to potential output, the actual unemployment rate is equal to the natural rate of unemployment.
When the output gap is positive (an inflationary gap), the unemployment rate is below the natural rate. When the output gap is negative (a recessionary gap), the unemployment rate is above the natural rate.
The Actual Unemployment Rate Fluctuates
Around the Natural Rate
These Fluctuations Correspond to the Output Gap
Okun’s Law
According to Okun’s law, each additional percentage point of output gap reduces the unemployment rate by less than 1 percentage point.
That is, a modern version of Okun’s law reads:
Unemployment rate = Natural rate of unemployment − ( × Output gap)
Why Doesn’t the Labor Market Move Quickly to
Equilibrium?
Some dispute about why wages adjust slowly.
Two main theories:
Misperceptions - workers are slow to realize that the equilibrium wage rate has changed.
Sticky Wages - occur when employers are slow to reduce wages in the face of a surplus of labor.
Prices of some goods and services also seem to adjust slowly: Menu costs are small costs associated with the act of changing prices.
Unemployment and Inflation: The Phillips Curve
The short-run Phillips curve is the negative short-run relationship between the unemployment rate and the inflation rate.
Unemployment and Inflation in the 1960s
Each point shows the combination of unemployment and inflation for one year from 1961 to 1969 in the United States. During the 1960s, there seemed to be a simple relationship between unemployment and inflation, corresponding to the short-run Phillips curve.
Source: Bureau of Labor Statistics.
Expected Inflation and the Short-Run Phillips Curve
The expected rate of inflation is the rate of inflation that employers and workers expect in the near future.
Expected inflation shifts the short-run Phillips curve up. SRPC0 is the Phillips curve with an expected inflation rate of 0%; SRPC2 is the Phillips curve with an expected inflation rate of 2%. Each percentage point of expected inflation raises the actual inflation rate at any given unemployment rate by 1 percentage point.
The NAIRU and the Long-Run Phillips Curve
SRPC0 is the short-run Phillips curve when the expected inflation rate is 0%. At a 4% unemployment rate, the economy is at point A with an inflation rate of 2%. The higher inflation rate will get built into expectations, and the SPRC will shift upward to SRPC2. If the unemployment rate remains at 4%, the economy will be at B and the inflation rate will rise to 4%.
Inflationary expectations will be revised again, and SPRC will shift upward to SRPC4. At a 4% unemployment rate, the economy will be at C, and the inflation rate will rise to 6%.
Here, 6% is the NAIRU, or nonaccelerating-inflation rate of unemployment. As long as unemployment is at the NAIRU, the inflation rate will match expectations and remain constant. An unemployment rate below 6% requires ever accelerating inflation. The long-run Phillips curve, LRPC, which passes through E0, E2, and E4, is vertical: no long-run trade-off between unemployment and inflation exists.
The NAIRU and the Long-Run Phillips Curve
The nonaccelerating inflation rate of unemployment, or NAIRU, is the unemployment rate at which inflation does not change over time.
It is equal to the natural rate of unemployment.
The NAIRU and the Long-Run Phillips Curve
The long-run Phillips curve shows the relationship between unemployment and inflation after expectations of inflation have had time to adjust to experience.
The long-run Phillips curve is vertical because there is no trade-off between the unemployment rate and the inflation rate in the long run.
Unemployment and Inflation, 1961–1990
During the 1970s, the short-run Phillips curve relationship that seemed to work in the 1960s broke down as the economy experienced a combination of high unemployment and high inflation. Economists believe this was the result both of adverse supply shocks and a buildup of expected inflation. Inflation came down during the 1980s, and the 1990s were a time of both low unemployment and low inflation.
Source: Bureau of Labor Statistics.
The End of Chapter 15
coming attraction:
Chapter 16:
Inflation, Disinflation, and Deflation
In years when the unemployment rate is low, most unemployed workers are unemployed for only a short period.
In 2000, a year of low unemployment, 45% of the unemployed had been unemployed for less than 5 weeks and 77% for less than 15 weeks. The short duration of unemployment for most workers suggests that most unemployment in 2000 was at this time frictional.
Source: Bureau of Labor Statistics.
When the government sets a minimum wage, WF , that exceeds the market equilibrium wage rate, WE , the number of workers, QS , who would like to work at that minimum wage, is greater than the number of workers, QD, demanded at that wage. This surplus of labor is considered structural unemployment.
In the 1970s, the percentage of the labor force consisting of women rose rapidly, as did the percentage under age 25. These changes reflected the entry of large numbers of women into the paid labor force for the first time and the fact that baby boomers were reaching working age. The natural rate of unemployment may have risen because many of these workers were relatively inexperienced. Today, the labor force is much more experienced, which is one possible reason the natural rate has fallen since the 1970s.
Source: Bureau of Labor Statistics
Each point shows the combination of unemployment and inflation for one year from 1961 to 1969 in the United States. During the 1960s, there seemed to be a simple relationship between unemployment and inflation, corresponding to the short-run Phillips curve.
Source: Bureau of Labor Statistics.
Expected inflation shifts the short-run Phillips curve up. SRPC0 is the Phillips curve with an expected inflation rate of 0%; SRPC2 is the Phillips curve with an expected inflation rate of 2%. Each percentage point of expected inflation raises the actual inflation rate at any given unemployment rate by 1 percentage point.
SRPC0 is the short-run Phillips curve when the expected inflation rate is 0%. At a 4% unemployment rate, the economy is at point A with an inflation rate of 2%. The higher inflation rate will get built into expectations, and the SPRC will shift upward to SRPC2. If the unemployment rate remains at 4%, the economy will be at B and the inflation rate will rise to 4%.
Inflationary expectations will be revised again, and SPRC will shift upward to SRPC4. At a 4% unemployment rate, the economy will be at C, and the inflation rate will rise to 6%.
Here, 6% is the NAIRU, or nonaccelerating-inflation rate of unemployment. As long as unemployment is at the NAIRU, the inflation rate will match expectations and remain constant. An unemployment rate below 6% requires ever accelerating inflation. The long-run Phillips curve, LRPC, which passes through E0, E2, and E4, is vertical: no long-run trade-off between unemployment and inflation exists.
During the 1970s, the short-run Phillips curve relationship that seemed to work in the 1960s broke down as the economy experienced a combination of high unemployment and high inflation. Economists believe this was the result both of adverse supply shocks and a buildup of expected inflation. Inflation came down during the 1980s, and the 1990s were a time of both low unemployment and low inflation.
Source: Bureau of Labor Statistics.
