Unformatted text preview: n are willing to
work. Firms bid up the real wage w to attract workers. ◮ If w > w ﬁrms ﬁnd more workers willing to work than ﬁrms
care to hire. Jobseekers drive down the real wage. Upshot: the labor market moves toward equilibrium (w , N ).
¯¯ Frictional and Structural Unemployment
◮ Problem with supply and demand model above. No worker who wishes to work another hour at the prevailing wage w is unable to ﬁnd an employer.
Unemployment (deﬁned as people looking for work but not working)
would be zero!
◮ How can this be?
◮ Supply and demand is a useful way of thinking about the determination ¯
of w and N but doesn’t tell the whole story.
◮ Example Landlords and tenants
◮ Frictional unemployment – unemployment that arises from the matching process of workers searching for suitable jobs and ﬁrms searching for
◮ Structural unemployment – long-term and chronic unemployment arising from imbalances in skills and characteristics of workers and the needs of
ﬁrms. The Natural Rate and Cyclical Unemployment Deﬁne the natural rate of unemployment as the level of
unemployment when output and and employment are at their
full-employment levels. So it reﬂects unemployment that is dues to
frictional unemployment and structural unemployment. If denote
the unemployment rate by u , then the natural rate is u and is the
¯ and Y .
level of unemployment associated with N
Deﬁne Cyclical unemployment as the diﬀerence between the actual
unemployment rate and the natural rate. Potential Output ¯
Y = AF (K , N ) (1) ¯
where N is the market clearing quantity in labor market.
◮ Key Assumption N is determined today. K is determined in
the previous time period. That is, it takes time to build
machinery and structures.
This assumption is maintained throughout the course. ◮ ¯
Anything that changes N will change Y The Costs of Unemployment
◮ Economic costs
◮ Periods of cyclical unemployment are times of depressed
output the economy could produce more at full employment
(potential output) ◮ Broader costs
◮ ◮ Psychological rise in stress and mental illness ◮ Human capital those who are unemployed experience a
deterioration in skills Equity
◮ The costs fall on those who are unemployed
These costs fall heavily on speciﬁc groups...
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