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Econ 100b

Created 4/30/1996
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Lecture Nineteen

Unemployment
(Economics 100b; Spring 1996)

Professor of Economics J. Bradford DeLong
601 Evans, University of California at Berkeley
Berkeley, CA 94720
(510) 643-4027 phone (510) 642-6615 fax
delong@econ.berkeley.edu
http://www.j-bradford-delong.net

March 4, 1996


Administration
Costs of Unemployment
Frictional Unemployment
Structural Unemployment
Cyclical Unemployment


Administration

Now that I have gotten through the first half of the course, I have some additional thoughts about how to run the second half. My first thought is that much of what I have to say about unemployment I have already said--look back at lecture four. And that I should not repeat myself (or if I do, I should repeat myself in closer proximity to when I first said it). So I am going to compress discussion of unemployment to--I hope--today alone, and start on the international economy on Wednesday...

Costs of Unemployment

I want to stress, first, the costs of unemployment: making people broke and pounding the pavement looking for jobs is not a fair way to distribute the costs imposed by the business cycle. Unemployment is perhaps the sharpest example of how the market system functions as an economic discipline device: you fail to satisfy your employer, your income vanishes...

Unemployment has costs in addition to the obvious losses of income and security.
Some evidence that unemployment adversely affects productivity, that is:


Frictional Unemployment

Workers and firms spend time searching for each other. There are many different kinds of jobs; many different types of workers. In a complex economy, we cannot expect everyone to get matched to the best possible job (or every job to get matched to the best possible worker) instantaneously. Moreover, it may well take a considerable time for people to learn about jobs and workers.

Moreover, over time skills change, the labor force changes, and the needs of firms change.

Thus we should expect--and we should see it as a good thing--that unemployed workers will not necessarily take the first immediate job offer they see, and that firms should not necessarily hire the first immediate applicant they see, but that instead time and energy are spent in the process of search: trying to find a good match between workers and firms.

This is frictional unemployment.

Recognizing that some frictional unemployment is a good thing is the easy part. But how can we find out whether the U.S. economy has too much, too little, or the right amount of frictional unemployment? We can't, very well: it is unclear whether firms and workers spend too much or too little time and effort in the business of searching for each other.

Both firms' and workers' search decisions generate externalities. When they find a "good match," they both are likely to derive some benefit. Thus a worker who chooses to search harder is likely to get a good match--but on the other hand is likely to benefit the firm that he or she eventually chooses to work for.

Thus a worker who keeps searching until the marginal gain to him or her from searching an additional day is just smaller than the marginal cost of searching an additional day may well be searching too little from the standpoint of social welfare.

This is a reason to have an unemployment insurance system--in addition to the "insurance" motive, there is a "job search" motive to have such a system. This is also a reason to spend money on job search assistance.

Does unemployment insurance lead people to search more? Yes. Digression on Bush's signing of the unemployment insurance extension in late 1991.

Structural Unemployment

One way to think about "structural" unemployment: real wages get in a sense "stuck" too high.

Insiders and outsiders: unions that respond to desires of employed workers (and not of unemployed ex- or future members) alone. But hard to see how this should lead to overall unemployment (rather than just unemployment in a particular sector or industry). (Unions as source of collective voice: communication channels; exit vs. voice; Freeman and Medoff--unionization raises private-sector productivity by 15%, but wages by 25% or so... Hence rational for firm to want to union-bust, but far from good for social welfare).

"Fairness" as a factor keeping real wages high. Employers' (and employees') beliefs that further wage reductions would be "unfair".

As a result, I tend to be an EITC person (with all its flaws).
Efficiency wage models. The starting point here is that--whether because of fairness, or fear of losing a good thing, or whatever--that workers' productivity is in general positively related to the wages that workers are paid. Thus firms might well not wish to cut wages--even when there are people outside the business clamoring for jobs--because they fear the adverse consequences for worker effort and productivity.

Suppose that a worker's productivity depends on E, on work effort. Think about a firm trying to maximize its profits with a very over simplified production function:

Profit = k(EL) - wL

Take the derivative of profit with respect to the wage, noting that effort depends on the wage as well:

d(Profit)/dw = k[L(dE/dw)] - L

Setting the change in profit equal to zero:

k[dE/dw] = 1

Now take the derivative of profit with respect to the number of workers:

Profit = k(EL) - wL

d(Profit/dL) = kE - w; setting the change in profit to zero means: k = w/E

So: [w/E][dE//dw] = 1...

[dE/E][dw/w] = 1

So the business is going to choose the wage such that the elasticity of effort with respect to the wage is equal to 1: it will keep on raising wages as long as a 1% rise in wages brings forth a 1% or greater rise in effort whether or not there are unemployed workers out there.

This is a rather depressing line of thought: it seems to suggest that the rate of unemployment could go anywhere at all. Things probably aren't that bad. A higher level of unemployment probably makes effort more responsive to the wage: when jobs are hard to find, you care more about making employers happy in order to keep a good one.

Reserve army of the unemployed.

Henry Ford and the $5 day; $2 a day as the average wage for semi-skilled workers in 1913 in Detroit. Turnover at Ford more than 370 percent per year. Turnover rate down to 20% in 1915.


Cyclical Unemployment

Cyclical unemployment we have already talked about a lot under the headings of aggregate supply and the "Phillips curve".

Implication of Phillips curve: cyclical unemployment more-or-less balances out. You want to reduce unemployment, figure out how to reduce structural unemployment:


>

Econ 100b

Created 4/30/1996
Go to
Brad De Long's Home Page


Professor of Economics J. Bradford DeLong, 601 Evans
University of California at Berkeley
Berkeley, CA 94720-3880
(510) 643-4027 phone (510) 642-6615 fax
delong@econ.berkeley.edu
http://www.j-bradford-delong.net/