ECN 416: LABOR ECONOMICS

JANUARY-APRIL 2020

PARY ONE

PART ONE

Introduction

● Supply-side unemployment (the natural rate of unemployment). These are

usually microeconomic imbalances in labor markets.
● Demand-side unemployment (Unemployment caused by lack of aggregate
demand in the economy). In recessions, we can expect demand deficient
unemployment (sometimes called cyclical unemployment) to increase
significantly.

Structure of Unemployment
Supply-side unemployment

● Frictional – This occurs when people are in between jobs. For example, a
school-leaver may take some time to get his first job. There will always be
some degree of frictional unemployment in an economy. 
● Structural – This is unemployment due to occupational or geographical
immobility. Often occurs after structural change in the economy. E.g.
closure of mines, left many miners struggling to find suitable work. For
example, there may be jobs available in the service sector, but unemployed
miners don’t have the relevant skills to be able to take the jobs.
● Geographical Unemployment. This occurs when unemployment is
concentrated in certain areas. Jobs may be available in some prosperous
areas e.g. Cities. However, there may be difficulties for the unemployed to
move to these areas e.g. difficulty in finding accommodation, children in
schools, etc. Note, geographical unemployment is often considered part of
structural unemployment.
● Real Wage Unemployment. e.g. powerful trades unions bargaining for
wages above the equilibrium. This may be exacerbated by fall in aggregate
demand.

Diagram showing real wage unemployment

At W1Q1-there is equilibrium. At W2Q2 the wages are high but demand for labor
is low e.g labor unions bargaining. W2Q3 with high wages there is an increase in
demand for labor e.g skilled labor.

●Voluntary unemployment. This occurs when people prefer to remain on

benefits rather than take a job, i.e. the unemployed refuse a job offer. Some
debate exists over the extent of voluntary unemployment. But, arguably high
benefits may encourage some to stay on benefits rather than take low paid
jobs.
● Seasonal Unemployment. Unemployment may be higher during certain
periods e.g. out of tourist season.
Demand Side Unemployment

● Demand deficient unemployment – a fall in AD leads to a fall in economic

output. Therefore firms employ fewer workers. This is sometimes referred to
as ‘cyclical unemployment’ – the idea that unemployment rises and falls
with changes in the economic cycle.
Duration of Unemployment

Unemployment is both a national and a personal problem. At the national level, it

represents idle production capacity and a failure to make full use of an important
resource, thereby excluding a segment of the population from the creation and
enjoyment of wealth. Unlike other macroeconomic problems such as infation and
currency depreciation, unemployment is also such a serious personal problem
where some people would be willing to trade off an increase in the unemployment
rate for a larger increase in inflation.

However not all types of unemployment warrant the same degree of response or
the adoption of targeted policies. What is known as “frictional unemployment” is
generated by the time lag between the entry of people into the labor market and
their entry into specific jobs. This type of unemployment is self-correcting as job-
seekers and employers obtain information about the pool of workers and the pool
of available jobs. Mechanisms could be introduced, however, to expedite the
process by disseminating information more broadly.

Structural unemployment, on the other hand, is, as its name suggests, generated by
the very structure of the economy and stems from the inappropriateness of some
portion of the available supply of human capital, a technological bias that leads to
the uneven development of different sectors of the economy or simply the presence
of excess labor supply in a depressed economy.

These two types of unemployment not only have different causes and differ in
terms of their duration and, consequently, their associated costs. Frictional
unemployment is very short-lived, whereas structural unemployment is long-
lasting. The former leads to a more efficient assignment of workers to jobs that
they are suited for. While it lasts, job-seekers live off their savings or draw
unemployment insurance only for a few weeks.

The latter depletes all possible sources of funding, jeopardizes the future of job-
seekers’ families and often pushes them into underemployment or employment in
the informal sector or may even lead them to abandon their search for
employment altogether.
PART TWO

Persistence Unemployment

In persistence unemployment, it is important to find out if it is the same individuals

who experience unemployment year after year, or if unemployment incidence is
spread more equally across the labor force with a different set of individuals
observed in unemployment each year.

The first implies highly persistent unemployment amongst a group of individuals,

while the second suggests that everyone has an equal chance of being unemployed.
If there is persistence in unemployment, it is important to find out the cause. Is
persistence due to differences across workers in their propensity to work? Or is
there instead a causal link between past unemployment and current
unemployment?

Understanding the cause of any observed persistence in unemployment occurrence

will assist policy makers in determining the appropriate policy response. Thus it is
important to identify the determinants of persistence in unemployment occurrence.

For instance, are there an unobserved individual heterogeneity that may affect the
propensity of certain individuals to be unemployed? Do individuals have
unobservable characteristics but which may nonetheless be observed by the firm
and affect the arrival rate of job-offers and individuals’ retention rates in current
employment thereby affecting an individual’s propensity to be in unemployment?

These two questions can determine the past unemployment and current
unemployment, so that an individual who does not experience unemployment now
will behave differently in the future to an otherwise identical individual currently
experiencing unemployment.

Unemployment incidence and persistence at the individual level yields some facts
which can relate to microeconomic theory underpinning macroeconomic
unemployment persistence. The focus of the persistence could dwell on whether
the relationship between previous and current unemployment is different for young
or possibly more mobile workers than for older workers.

Causes of Persistence Unemployment

Identification of the extent of state dependence among men of working age is more
possible cause. There is also considerable diversity of government policies towards
the unemployed in market economies throughout the world. These policies rest on
very different assumptions about the extent to which government intervention can
alter the equilibrium, or so-called natural rate, of unemployment.

If there is no state dependence in unemployment incidence at the micro level, then

short run policies to reduce unemployment (such as job creation schemes and wage
subsidies) will have no effect on the equilibrium aggregate unemployment rate.

But if there is true state dependence, then policies reducing short run
unemployment incidence will have longer run effects by reducing the natural rate
of unemployment. The prevention of the initial unemployment experience becomes
an important policy objective, perhaps indicating the need to focus on education
and training initiatives.

But it is crucial to know whether there is genuine state dependence, or if instead it

is individual heterogeneity that causes individuals to be repeatedly observed in
unemployment. Lack of diversity in skills especially in developing countries is a
large contributor to persistence unemployment.

What causes true state dependence or scarring? Past unemployment experiences

may change preferences, prices and or constraints that help determine current
unemployment. Firms may judge workers’ productivity by their past history of
unemployment. Thus workers with a history of job mobility and unemployment
incidence may be offered less secure jobs because they lose valuable work
experience or human capital while unemployed, or because their unemployment
experience is used as a signal by employers that they are low productivity.

Alternatively, individuals in persistence unemployment may lower their

reservation wage with the passage of time, and accept poorer quality jobs that are
more likely to be destroyed, and for this reason may be more likely to experience
unemployment in the future.