ECON7002

Lecture 8
Unemployment and Inflation

University of Queensland
Semester 1, 2021
Long-run & Short-run Movements
• (Note: Unless stated otherwise, GDP means real GDP.)
• In analyzing changes in GDP over time,
it is useful to distinguish between
• short-run and
• long-run movements.
• It can be done by decomposing GDP movement into
• a trend (i.e. long-run movement)
• and fluctuations around the trend (i.e. short-run movement).

• Sidenote: This definition of Long-run and short-run has nothing to do with the definition used in microeconomics.

2
Note
• When economists talk about economic growth over time, they
typically refer to the trend.
• When economists talk about business cycles, they refer to the
movements of GDP around the trend.

23
Real Income of Iceland & Australia

Source: World Economic Outlook from Google Public Data

4
Iceland GDP (billion, constant 2000$)

Source: World Development Indicators

Iceland GDP (billion, constant 2000$)

Source: World Development Indicators

Note
• The real GDP per capita of Iceland has grown faster than Australia’s
but has also been more volatile.

7
Potential GDP
• A country’s long-run trend GDP value is often interpreted as
Potential GDP.
• The level of (real) GDP attained when all firms are producing at full capacity
• i.e. when firms operate on their normal hours using a normal workforce.
• The level of GDP that can be sustained in the long run.
• A country’s potential GDP is not its maximum GDP.
• Maximum GDP is attained when firms operate for as many hours per day as
they can and use as many workers as they can hire.
• Actual GDP can be bigger or smaller than potential GDP.
𝐴𝑐𝑡𝑢𝑎𝑙 𝐺𝐷𝑃 = 𝑃𝑜𝑡𝑒𝑛𝑡𝑖𝑎𝑙 𝐺𝐷𝑃 × 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 𝑈𝑡𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛
8
S
Potential GDP
Example:
• A car plant can produce
• 100 cars per 8-hour shift
• Normally operates 2 shifts a day
• Produces 200 cars per day
• Remaining 8 hours used for daily maintenance of machinery etc.
• Potential Output/Full Capacity is 200 Cars per day.
• Can the Plant actually produce >200 cars/day I.e. above Full Capacity?
• Yes, run a 3rd shift to produce 300 cars/day
• Is this sustainable in the long-term?
• No – without downtime for maintenance, eventually machinery breakdowns will lower output below
300 cars per day.
Potential GDP (See HGLO p. 419)
• Level of a country’s Potential GDP determined by
• Capital stock – number of factories, machines etc
• Technology used in production
• Size of Labor force
• Potential GDP changes over time due to investments, technological
changes and changes in population demographics.
• How Potential GDP is measured – a very technical issue, beyond the
scope of this course. We’ll just use the LR trend GDP as a proxy for
Potential GDP of a country.
Output Gap

𝐴𝑐𝑡𝑢𝑎𝑙 𝐺𝐷𝑃 = 𝑃𝑜𝑡𝑒𝑛𝑡𝑖𝑎𝑙 𝐺𝐷𝑃 × 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 𝑈𝑡𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛

• Notice that if Capacity Utilization > 100%

• Actual GDP > Potential GDP
• Interpreted as firms working “overtime” or over-capacity
• Economy experiencing an (inflationary) economic expansion

• if Capacity Utilization < 100%

• Actual GDP < Potential GDP
• Firms production below full-capacity
• Economy experiencing an economic contraction.
Output Gap

(Actual GDP - Potential GDP)

Output gap (%) = ´ 100
Potential GDP

• Notice that if Output Gap > 0%

• Actual GDP > Potential GDP (GDP > LR Trend GDP)
• Economy experiencing an (inflationary) economic boom

• if Output Gap is Negative

• Actual GDP < Potential GDP (GDP < LR Trend GDP)
• Economy experiencing an economic contraction.
Output Gaps of Australia & Iceland

Source: OECD Economic Outlook

13
 Er

Business Cycles
• Fluctuations of the Output Gaps (i.e. Actual GDP moving about
Potential GDP) are called Business Cycles
• Alternating periods of expanding and contracting economic activity.
• Side Note: Why did Iceland encounter such a volatility around the GFC
(~2007-2008)? Check out the following links

https://www.brookings.edu/wp-
content/uploads/2018/02/benediktsdottirtextfa17bpea.pdf

https://www.bis.org/fsi/fsicms1.pdf
Positive Output Gap and Inflation
• When actual GDP is larger than potential GDP, the economy is
producing beyond its normal capacity.
• This means higher demand for workers and materials.
• Firms hire more and more workers
• Until no more workers are available
• Have to ‘steal’ workers from other firms by increasing wages
• Rapid increases in wages, material prices cause production costs and
hence output prices to rise faster, i.e. higher inflation.
• The opposite is true when there is a negative output gap.

15
S
Negative Output Gap and Unemployment
• When actual GDP is smaller than potential GDP, the economy
is producing below its normal capacity.
• This means lower demand for workers.
• This then may cause workers to be laid off, Et

i.e. higher unemployment.

• The opposite is true when there is a positive output gap.

16
I
Why care about Inflation and Unemployment
• Unemployment and inflation are two problems constantly concerning
economists and policymakers.
• Reflected by persistent coverage in economic news.
• Arguably, the discipline of macroeconomics was invented (by J. M. Keynes) in the
1930s as a response to the Great Depression of the time – when unemployment
rates around the world rose above 20%.
• Economists care about Inflation and Unemployment because they provide
information about the underlying state of the economy.
• Policy Makers (Politicians) care because Inflation and Unemployment have
immediate impacts on people’s lives.
• Inflation means that people can’t afford as much as before
• Unemployment means that people can’t find jobs, can’t earn incomes
• Governments facing high inflation and unemployment are unlike to be returned to
office.

E
17
Arab Spring

“The causes of the Arab Spring, or as some call it, Arab

Awakening, were many and long-gathering. For
decades, Arab populations had faced repression...
…[T]his region of 300 million people was producing an
unprecedented youth bulge, with around two-thirds of
the population below 29 years of age. This youthful
army is plagued by 25 percent unemployment,
frustrated by diminished dreams, driven by aspirations
for greater personal freedoms, and equipped with the
revolutionary tools of social media...”
https://www.trinitydc.edu/magazine-2012/the-arab-
spring-the-uprising-and-its-significance/
Arab Spring

http://civilianledpolicing.org/map-of-the-arab-spring/map-of-the-arab-spring-7-be-society-me-0/
Impacts of Unemployment – Personal Costs
• Unemployment has negative personal impacts as well as social impacts.
Personal Costs
• Loss of income – potentially causing poverty and financial hardship
• E.g. NewStart Allowance (Unemployment benefits) – max $300/week (Pre-COVID)
• Approximately 45% of minimum wage and 20% of average full time wage (after-tax)
• The size of the impacts depends on the duration of unemployment.
• The longer people are unemployed, the more they lose their skills and workplace
contacts, and thus the harder it is for them to get a job.
• Long-term unemployed (unemployed > 1 year) are more likely to suffer health,
family and other personal problems (social costs)

S
20
Impacts of Unemployment –
Costs to Economy
• Unemployed workers represent an Opportunity cost to GDP
• Unemployed workers represents underutilized labour resources that could
have been used for productive activities.
• i.e. if everyone gets a job, Labour inputs into economy will increase, raising
output.

• Loss of human capital

• Economy loses access to skills and experience of unemployed workers
• Deterioration of skills for people who have been unemployed for long periods
of time.

3
21
Impacts of Unemployment
• Retraining Costs (due to loss of human capital)
• People who have been unemployed for a long time will need to be retrained, due to
• Deterioration of skills and knowledge from lack of use
• Existing skills become obsolete due to changes in job requirements.
• Retraining can be costly, though might result in a more productive workforce in the
long run.

• Costs to Public Finances (increase in govt. deficits)

• Unemployment benefits
• Loss of tax revenue
• Opportunity cost – govt. spending could have gone to alternatives like education,
infrastructure etc.

s
22
Question Time
• What does the unemployment rate (UER) figure mean?
• If the Unemployment Rate is 5.4%
• Does it mean that about 5.4 out of 100 people of working age don’t have a job?
• If more people have part-time jobs and fewer people have full-time jobs,
• Will that affect the UER?
• When the UER declines,
• does it necessarily mean that more people are working and
• therefore the economy is in better shape?
• Does the UER fully reflect
• the amount of Labour employed in a country’s economy?
• the rate of joblessness (people who want jobs but can’t get one?)

23
Who is Employed?
• The Australian Bureau of Statistics (ABS) surveys ~0.33% of the
working age population: people who are aged 15 or above.

• A person is classified as Employed if the person

• Worked for at least 1 hour in paid employment
in the week prior to the survey

24
Who is Unemployed?
• A person is classified as Unemployed if the person
• worked for less than one hour (e.g. 0 hours)
in a paid employment in the week before the survey; and
• actively looked for work in the previous four weeks; and
• is currently available to start work in the survey week.

• Is my wife employed or unemployed?

• She used to work in a car dealership but now…
• She works ~8 hours a day at home taking care of our baby boy, and will be able to
start work next year.
• Question 1: Does she produce socially valuable services?
• Question 2: Are housewives (or house husbands) counted as being un/employed?

S
25
Labour Force
• Labour Force = Employed + Unemployed
• The number of people who want to and are available for work in a country.
• People who either are working or looking for and available to work.

• Not in Labour Force

• Everyone else of working age (>15 years old) who are
neither Employed nor Unemployed
• i.e. neither working for pay; nor actively looking and available for work
• For example: Full-time homemakers, Retirees, Discouraged Workers
• E.g. My wife is not in the Labour Force because she is not immediately
available for work (in paid employment)

26
Unemployment Rate &
Labour Force Participation Rate
• Unemployment Rate measures the proportion of unemployed in the
labor force.
𝑁𝑢𝑚𝑏𝑒𝑟 𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑
𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡 𝑅𝑎𝑡𝑒 =
𝐿𝑎𝑏𝑜𝑢𝑟 𝐹𝑜𝑟𝑐𝑒

• Labour Force Participation Rate measures the proportion of the

working age (15-64 in Oz) in the Labour Force

𝐿𝑎𝑏𝑜𝑢𝑟 𝐹𝑜𝑟𝑐𝑒
𝐿𝐹 𝑃𝑎𝑟𝑡. 𝑅𝑎𝑡𝑒 =
𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐴𝑔𝑒 𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛
d

T
Exercise
Using the information in the previous slide
• Calculate the Unemployment Rate

0.767 𝑀
𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡 𝑅𝑎𝑡𝑒 = = 6.22%
12.329 𝑀

• Calculate the Labour Force Participation Rate

12.329𝑀
𝐿𝐹 𝑃𝑎𝑟𝑡. 𝑅𝑎𝑡𝑒 = = 65.05%
18.953𝑀
Exercise
Using the information in the previous slide
• Calculate the Unemployment Rate

𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡 𝑅𝑎𝑡𝑒 =
0.721 𝑀 0
= 5.7%
12.686 𝑀

• Calculate the Labour Force Participation Rate

12.686𝑀
𝐿𝐹 𝑃𝑎𝑟𝑡. 𝑅𝑎𝑡𝑒 = = 64.8%
19.587𝑀
Note: Unemployment Statistics
• The unemployment rate and participation rate statistics together do not
necessarily give us the full picture of labour utilization.
• i.e. how many hours of available labour hours are actually used by the economy.
• E.g. replacing a full-time worker working 8 hours/day
with two part-time workers working 4 hours/day each
• Could reduce the unemployment rate
• but has no impact on the utilization of labor for the economy as a whole.
• Furthermore, Unemployment statistics might be further biased as
a measure of joblessness due to
• Discouraged workers
• Underemployment

Z
31
Discouraged Workers
• Some people are not in the labour force because they don’t want to
or are unable to engage in formal paid work
• Caregivers at home
• Disabled
• Ill-health
• Retirees
• Discouraged Workers are not in the Labour Force
• Not because they don’t want to or cannot work
• But because they have given up on looking for work
• E.g. In a recession, jobs are hard to find as firms cut back on labour
• People who have been looking for work for a long time might rationally believe that no jobs are available,
and so stop looking at least until the recession is over.
Measured Unemployment Rate
might be Biased.
• In Recessions, Unemployment Rate may underestimate the true rate
of Joblessness.
• i.e. underestimates the true numbers of people who want to work but
cannot find paid employment
• Underestimation due to Discouraged Workers
• Discouraged Workers want work
• But not actively looking for work so
not counted as either Unemployed or in the Labour Force.
• In fact, during recessions the number of discouraged workers
increases, which may decrease the measured rate of unemployment,
even though the number of employed people may actually be falling.
Increase in Number of Discouraged Workers may
cause the Unemployment Rate to Decrease.
• Before the recession
𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑 = 10
𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑 = 5
• After the recession starts
• Jobs harder to find
• 3 unemployed people became discouraged and stopped looking for work.

• Calculate the Unemployment rate before and after the recession.

Increase in Number of Discouraged Workers may
cause the Unemployment Rate to Decrease.
• Before Recession
5
𝑈𝐸𝑅0 = × 100% = 33.3%
10 + 5
• After Recession
𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑 = 10
𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑 = 5 − 3 = 2
𝐿𝑎𝑏𝑜𝑟 𝐹𝑜𝑟𝑐𝑒 = 10 + 2 = 12

2
𝑈𝐸𝑅1 = × 100% = 16.7%
12

• Notice that even though there are less jobs available when the recession occurred, the
unemployment rate decreased – due to discouraged workers exiting the labor force.
Exercise
Suppose we want to estimate the rate of joblessness calculated as

𝑁𝑜. 𝑜𝑓 𝑃𝑒𝑜𝑝𝑙𝑒 𝑤ℎ𝑜 𝑤𝑎𝑛𝑡 𝑡𝑜 𝑤𝑜𝑟𝑘 𝑏𝑢𝑡 𝐽𝑜𝑏𝑙𝑒𝑠𝑠

𝑁𝑜. 𝑜𝑓 𝑃𝑒𝑜𝑝𝑙𝑒 𝑤ℎ𝑜 𝑤𝑎𝑛𝑡 𝑡𝑜 𝑤𝑜𝑟𝑘

• Use the information from Employment Status in 2016 slide and

calculate the “Rate of Joblessness”, assuming that the number of discouraged workers is 1 million.

0.123 M + 0.767 M
= 7.15%
0.123 M + 0.767 M + 11.562 M

• Does the unemployment rate underestimate joblessness?

• Yes. We previously calculated Unemployment rate as 6.22%
Exercise
Suppose we want to estimate the rate of joblessness calculated as

𝑁𝑜. 𝑜𝑓 𝑃𝑒𝑜𝑝𝑙𝑒 𝑤ℎ𝑜 𝑤𝑎𝑛𝑡 𝑡𝑜 𝑤𝑜𝑟𝑘 𝑏𝑢𝑡 𝐽𝑜𝑏𝑙𝑒𝑠𝑠

𝑁𝑜. 𝑜𝑓 𝑃𝑒𝑜𝑝𝑙𝑒 𝑤ℎ𝑜 𝑤𝑎𝑛𝑡 𝑡𝑜 𝑤𝑜𝑟𝑘

• Use the information from Employment Status in 2016 slide and

calculate the “Rate of Joblessness”, assuming that the number of discouraged workers is 1 million.

1 M + 0.721 M
= 12.6%
1 M + 0.721 M + 11.965 M

• Does the unemployment rate underestimate joblessness?

• Yes. We previously calculated Unemployment rate as 5.7%
Underemployment
• The ABS classifies workers as Underemployed if

• They are employed, AND

want to and are available to work more hours than they currently have.
• Intuitively, a person is Underemployed if
s/he works less hours than s/he wants.
• An underemployed worker can be considered to be an underutilized resource
for an economy – can provide more hours of labor than ‘used’.
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑢𝑛𝑑𝑒𝑟𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑
𝑈𝑛𝑑𝑒𝑟𝑒𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡 𝑟𝑎𝑡𝑒 𝑖𝑛 % = × 100
𝐿𝑎𝑏𝑜𝑢𝑟 𝑓𝑜𝑟𝑐𝑒
Labour Force Underutilization Rate (LFUR)

• Underemployment and Discouraged Workers cause Unemployment

Rate to underestimate Joblessness
• Read this article to for current example in the Australian economy.
• But other reasons may cause Unemployment to
Overestimate Joblessness
• Some people may report being unemployed when
• They are employed in Illegal activities
• They are actually employed in paid work for welfare benefits or taxation
reasons
Exercise
• If a large number of 60 year-olds currently employed workers choose
to retire now, then the labour force participation rate will
immediately ____ and the unemployment rate will immediately ____.
A.go up; go up
B.go down; go up
C.go up; go down
D.remain unchanged; go up
E.go down; remain unchanged.

S
41
Answer: B
• Because they are of 50-60 years of age, they are counted as part of
the working age population. Their departure from the labour force
means a smaller labour force as well as a lower labour force
participation rate (=100*labour force/working age population).
• However, since they are currently employed workers, their earlier
retirement does not change the number of unemployed people in the
work force. As a result, unemployment rate
(=100*unemployed/labour force) goes up.

42
Types of Unemployment
• Economists typically classify Unemployment into 3 different categories.

1. Cyclical Unemployment
• Due to Business Cycles (i.e. economic recessions and expansions.)

2. Frictional Unemployment
• Due to costs of Job search

3. Structural Unemployment
• Due to Workers who lack skills for new jobs in the economy.
Cyclical Unemployment
• Cyclical unemployment is caused by business cycles
• When economy is neither in a contraction or expansion:
Cyclical Unemployment = 0.
• During Economic contractions
• when the economic grows slower than “normal” – firms lay off excess workers
• Net job destruction → higher unemployment
• Cyclical Unemployment > 0 during economic contractions
• During Economic expansions
• when the economic grows faster than “normal” – firms hire more workers
• → Net job creation → lower unemployment
• Cyclical Unemployment < 0 during economic expansions

t
51
Cyclical Unemployment - Lags
• However, unemployment changes with business cycles
with a long lag.
• i.e. After a change in the economic situation, it may take a while before changes in
unemployment appear.

• When a country enters a recession

• Number of Discouraged Workers Increase as people (correctly) believe that it is
pointless to look for work as jobs aren’t available.
• Unemployment decreases slower than underlying rate of joblessness.
• Firms hesitate to lay workers off
• Down-turn may be temporary – expensive to rehire and retrain workers
• Mass layoffs may create negative perceptions of the firm and may require large severance
payments.
• Takes a while for unemployment to increase after the economy suffers a contraction.

52
Cyclical Unemployment - Lags
• When a country enters an expansion
• Previously Discouraged Workers return to the Labour Force
• But may take a while to find work
• Big increases in Unemployment
• Unemployment Rate may suddenly increase before slowly decreasing.
• Firms may hesitate to Hire
• Fear that expansion is temporary
• May still be producing under-capacity because they didn’t fire as many workers as
“economically optimal” during the recession for factors prev. discussed.
• May take a while before the firms’ full production capacity is reached and they need to
expand output by hiring more workers.

53
Frictional Unemployment
• Frictional Unemployment
• Short-term unemployment that arises from the process of matching job-seekers with jobs.
• i.e. caused by the fact that it takes time for workers to find the “right job” and for firms to find the
“right employee”.
• In economic terms, we say that that job-search is costly or involves friction.

• Job Search and Matching

• Different workers have different skills, interests and ability.
• Different jobs have different job requirements, working conditions and pay levels.
• Both firms and job-seekers will be willing to spend time looking for employee/employer that best
fits their requirements.
• Frictional Unemployment always exists – even if there are more job openings than job-seekers.

• The longer the searching process, the longer the unemployment duration of a worker.
• And the higher the level of frictional unemployment.

54
Frictional Unemployment
• Is Frictional Unemployment Bad for the Economy?
• Not Really

• Ideally, we want the most suitable worker for each job

• We want the worker with the right skills, education and interests for each job.
• Basically matching the right set of human capital for each job’s requirement.
• Example: My Wife and Me
• My Wife was the No. 1 ranked Nissan Sales Manager in Australia (for several years)

2
• I got 5 teaching awards in 2017, and won best casual Econs lecturer for 2018.
• Should we change jobs?

• Increasing job-search duration

• Increases frictional unemployment
• But also increases the probability of good matches between workers and jobs
• Potentially increasing labour productivity.

55
Structural Unemployment
• Structural Unemployment
• Long term unemployment (faced by a person) due to persistent mismatch between the skills of the person
and the requirements of jobs in the economy.

• E.g. Technological change leads to creation of new jobs that require new skills and destroy old
jobs that require old skills.
• Consider the loss of the automotive manufacturing industry in Australia.
• Many of the workers who lost their jobs in the process might not have the skills to be employed in growing
industries such as Telecommunications, Medical Care, childcare, Logistics etc.

• In some other countries

• It used to be the case that people who are illiterate were able to gain employment in manual labour
• With the introduction of machinery, manual labour jobs eventually disappeared
• The now unemployed manual workers lack the basic skills for employment in newly industrialised economies.
Structural Unemployment
• The structurally unemployed are likely to face longer periods of
unemployment
• Just as Frictional unemployment, Structural unemployment involves
mismatches between the skills of the job-seeker and available jobs
• But in the case of the Structurally Unemployed, jobs matching their skills may
not exist anymore.
• Structurally unemployed have higher chances of being long-term
unemployed
• Suffering greater costs of being unemployed.
• Governments may have a role to play in retraining etc.
Question
• Which of the following is an example of frictional unemployment?

a) A construction worker is not able to work anymore due to injury.

b) An aspired actor fails in every audition due to the lack of acting
talent.
c) A graduate weighs up which of the three job offers she should
accept.
d) A teacher quits after deciding to move to another city.
e) Both (C) and (D).
58
Full Employment
• Cyclical unemployment may eventually fall to 0
• E.g. when the economy recovers from a contraction and returns to full capacity
• But there will always be some level of unemployment due to
• Frictional Unemployment – Unemployed looking around for the best job
• Structural Unemployment – Unemployed due to lack of jobs matching skills.

• Natural Rate of Unemployment =

Rate of Structural Unemployment
+ Rate of Frictional Unemployment
• i.e. rate of unemployment if the economy is functioning “normally”
at full capacity or at Potential GDP.
Natural Rate of Unemployment
• Sometimes also called
• Full Employment Rate of Unemployment
• Also called Non-Accelerating Inflation Rate of Unemployment (NAIRU)
• Basically because NAIRU is rate of unemployment when the economy is at full
employment – Potential GDP
• Not in a scenario when economy is at overcapacity – in which firms attempt
to bid up wages to attract workers – which eventually results in higher
production costs and output prices – accelerating inflation
Some Policies affecting Unemployment Rates
• Lowering costs of Job search
• Increasing costs of hiring
• Social Security and Unemployment Benefits
• Labour Market Regulations
• Minimum Wages
• Trade Unions
• Efficiency wages
Lowering Costs of Job search
• Job seeking takes time on part of workers and employers
• The harder job-seeking is – the longer it takes, the greater the natural
rate of unemployment
• Governments can lower the costs of job search (i.e. helping to match
workers’ skill sets with jobs)
• By subsidising recruitment agencies
• Job Services Australia – network of recruitment agencies paid by government to match
workers with jobs – higher payments for harder to match workers
• By providing workers with retraining to meet requirements of new jobs
• E.g. See: Vocational Education and Training
Increasing the Cost of Hiring
• Governments often impose restrictions on the ability of firms to hire
and fire workers to protect the Rights of workers
• But over regulation might increase (potential) costs of hiring new staff
• Deterring Firms from creating new jobs and increasing unemployment.

• Example: French Labour Laws

• See: OECD Summary of French regulations for dismissal
Increasing the Cost of Hiring
• Example: French Labour Laws
• French companies face severe restrictions on firing existing staff.
• Firing for personal reasons
• Firms must formally demonstrate that the fired worker either engaged in misconduct or gross
incompetence
• Firing for economic reasons – e.g. due to technological change or to keep the firm viable
• The specific job cannot be relisted
• The firm must take all possible steps to retrain staff and redeploy them elsewhere in the
organization
• Compensation for unfair dismissal – typically 12 to 24 months pay.
• Result: French firms hesitant to hire new full-time employees, especially
young job-seekers without established work histories
Social Security and Unemployment Benefits
• Job-search causes frictional unemployment
• How long should a person search for a job?
• Should he take the first job offer that comes along?

• Benefits of prolonging job search

• More likely to find a job that best suits my skills, education, interests, personal
circumstances
• Should I take a job with Woolworths when I have a PhD?

• Costs of extending job search

• Opportunity costs- Wages foregone (less unemployment benefits)
Social Security and Unemployment Benefits
• Unemployment Benefits lowers the opportunity costs of job-search
• Diminishes the financial pressures while unemployed.
• Extends duration a person is willing to search for the ‘best’ job
• Hence increases the probability that a person finds a job that makes best use of his
human capital.

• Some people claim that Unemployment Benefits is a net cost to society

• Allows unemployed to be ‘picky’ at the expense of the taxpayer
• Others claim the opposite, makes society better off
• In the long run, workers can be allocated to jobs that best matches their skills
• Increasing labour productivity in the economy as a whole.
Minimum Wages (Self-Study)
• In Australia, the minimum wage is set at $18.93/hour
• From the 1st of July 2018
• Set by the Fair Work Commission
• Minimum Wage – a price floor on the price of labour
• Minimum Wage (Price Floor) typically binds only in the market for
low-skilled, low-paid labour
• Most workers in Australia earns more than the minimum wage
• E.g. Tutors in UQ (the lowest of the low in the academic hierarchy) earns
around $43/hour TTRg
Labour Market (Self-Study)
• Let’s assume that the labour market for low-skilled workers is
perfectly competitive.
• Demand for Labour is downward sloping
• The higher the wage, Firms will demand (want to hire) less workers
• Supply of Labour is upward sloping
• The higher the wage, the more hours people are willing to work
• If the minimum wage binds, then structural unemployment is created
• In this case, structural unemployment is created because more people want
to work than jobs are available.
• Structural because it is neither cyclical nor frictional.
Binding Minimum Wage
and Structural Unemployment (Self-Study)
Wage (A$
per hour) Structural
unemployment Supply

minimum wage
= 15.51
14

Demand

0 35 40 45
Partial Equilibrium Analysis of Minimum Wage
(Self-Study)
• The demand-supply model of the minimum wage is only a partial
equilibrium analysis.
• That is, it only looks at what happens in the labour market without
considering the linkages between the labour market and other markets.
• E.g. although a higher minimum wage might potentially in unemployment, it also
increases the income of incumbent workers. The impact on total income of workers
is unclear.
• But if total worker income increase, this is likely to increase demand for goods and
services, which in term increases demand for workers, which will lower
unemployment.
• So the actual impact of higher minimum wages on structural unemployment is
theoretically ambiguous.

72
Partial Equilibrium Analysis of Minimum Wage
(Self-Study)
• In fact, while some research have found that increases in minimum wages
have lowered employment, many other economists found that minimum
wages have very little impact on employment.
• So the protection of workers’ wages may outweigh employment considerations.
• Furthermore, our demand-supply analysis assumed a perfectly competitive
labour market – i.e. one in which no one has market power
• But is it true that employers have no market power – i.e. ability to set prices/wages?
(See Krugman’s blog post on this.)
• Further more, high search cost of changing jobs also imply that workers do not go
work for the highest paying employer, contradicting an assumption that must hold
for perfectly competitive labour markets (i.e. that sellers (workers) always sell (their
labor) to the buyer (employer) offering the highest price (wages)).

73
Other sources of Structural Unemployment
(Self-Study)
• Minimum wages may cause wages to be above the market
equilibrium level of wages.
• But there are two other reasons why wages for other workers may
also be above the market clearing level.
• Powerful trade unions may successfully bargain a wage level above the
market rate.
• While it will benefit those who have a job (“insider”), it is costly to those who do not
(“outsider”).
• Firms may also be willing to pay a higher than market clearing rate to induce
them to work more productively: the efficiency wage.
• Please read Pages 453 of HGLO for more information.
74