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Chapter 14
Unemployment: A Recurring Problem
What's in This Chapter and Why
This chapter deals with unemployment-its costs, causes, and cures. In doing so, it emphasizes that unemployment has both economic and noneconomic costs.
The chapter explains how the unemployment rate is calculated and emphasizes that the average rate conceals many differences among demographic groups. The chapter also distinguishes among three types of unemployment: frictional, structural, and cyclical. This distinction is important in terms of both costs and policy. Various policies to reduce unemployment are considered. The impact of the minimum wage on unemployment is discussed in this context.
Finally, unemployment in Europe is discussed. Various factors cause unemployment to be higher in most European countries than in the United States.
Instructional Objectives
After completing this chapter, your students should know:
1. That unemployment has both economic and noneconomic costs and that these costs are different for society and the individual.
2. How the unemployment rate is calculated and how unemployment rates vary among demographic groups.
3. That three types of unemployment--frictional, structural, and cyclical--exist, and that these differ in terms of both costs and policy implications.
4. How the full employment, or natural, unemployment rate is defined.
5. How stabilization policy can be applied to achieve and/or maintain full employment.
6. That stabilization policy is unlikely to reduce frictional and structural unemployment and that other policies are, therefore, necessary.
7. That a significant increase in the minimum wage has an adverse effect on unemployment, particularly among teenagers.
8. That for various reasons, the unemployment rate in most European countries is much higher than the unemployment rate in the United States.
Key Terms
These terms are introduced in this chapter:
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Unemployment rate
Civilian labor force
Frictional unemployment
Structural unemployment
Cyclical unemployment
Full employment rate of unemployment
Natural rate of unemployment
Stabilization policies
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Suggestions for Teaching
Because this chapter covers an important social problem, it is a very important chapter. Three or four class sessions will be required to cover it.
Instructors wishing to spend less time on this chapter could cover some of the sections less systematically and omit the last section (unemployment in Europe).
Here, as elsewhere, instructors should take time to explain the importance of the problem to the individual. With unemployment, it is relatively easy.
In covering stabilization policies, instructors may wish to mention that some economists believe that stabilization policy is actually destabilizing. Similarly, instructors may wish to mention that considerable disagreement exists regarding the potency of monetary and fiscal policies.
Additional References
In addition to the references in the text, instructors may wish to read or assign one or more of the following:
1. Charles Brown, Curtis Gilroy, and Andrew Kohen, "The Effect of the Minimum Wage on Employment and Unemployment," Journal of Economic Literature 20 (June 1982), pp. 487-528.
2. David Card and Alan B. Krueger, Myth and Measurement: The New Economics of the Minimum Wage (Princeton, NJ: Princeton University Press, 1995).
3. Robert J. LaLonde, "The Promise of Public Sector-Sponsored Training Programs," Journal of Economic Perspectives 9 (Spring 1995), pp. 149-168.
4. Stephen K. McNees, "The 1990-91 Recession in Historical Perspective," Federal Reserve Bank of Boston, New England Economic Review (January/February 1992), pp. 3-22.
5. Daniel Rodriguez and Madeline Zavodnt, “Are Displaced Workers Now Finished at Age Forty?” Federal Reserve Bank of Atlanta, Economic and Financial Review (Q 2 2000), pp. 33-47.
6. Jason L. Saving, “The Effect of Welfare Reform and Technological Change on Unemployment,” Federal Reserve Bank of Dallas, Economic and Financial Review (Q 2, 2000), pp. 26-34.
Outline
I. COSTS OF UNEMPLOYMENT
A. Economic Costs
1. For the individual, the greatest economic cost of unemployment is lost income.
2. For society, the greatest economic cost of unemployment is the decrease in goods and services that occurs as a result of the unemployment.
B. Noneconomic Costs
1. For the individual, noneconomic costs include adverse effects on mental and physical health, adverse effects on the family, higher rates of alcoholism and drug abuse, and higher crime and suicide rates.
II. COUNTING THE UNEMPLOYED
A. The Unemployment Rate
1. The unemployment rate is the percentage of the civilian labor force that is unemployed.
a. The civilian labor force is the number of persons employed plus the number of persons unemployed.
b. Individuals are considered unemployed if they did not have a job, were available for work, and actively sought employment in the past four weeks.
c. Persons 16 years of age and over who are neither employed nor unemployed are not in the civilian labor force.
2. The unemployment rate differs among demographic groups.
a. Unemployment rates for teenagers, blacks, and Hispanics are higher than the overall unemployment rate.
b. This variation in unemployment rates means that not all groups suffer equally when the unemployment rate increases.
III. TYPES OF UNEMPLOYMENT
A. Frictional Unemployment
1. Frictional unemployment is temporary unemployment arising from the normal job search process.
2. Frictional unemployment helps the economy function more efficiently.
B. Structural Unemployment
1. Structural unemployment is the result of structural changes in the economy caused by technological progress and shifts in the demand for goods and services.
a. The structural changes eliminate some jobs in the economy and create others.
2. Persons who are structurally unemployed do not have marketable job skills and may face prolonged periods of unemployment.
C. Cyclical Unemployment
1. Cyclical unemployment is unemployment caused by a drop in the level of economic activity that occurs during the contraction phase of the business cycle.
IV. FULL EMPLOYMENT
A. The Full Employment Rate of Unemployment
1. The full employment rate of unemployment is the frictional rate of unemployment plus the structural rate of unemployment.
2. The full employment rate of unemployment is the lowest rate of unemployment consistent with a nonaccelerating inflation rate.
3. The full employment rate of unemployment is sometimes referred to as the natural rate of unemployment.
4. The full employment or natural rate of unemployment will change over time due to changes in the composition of the labor force and other factors.
a. Increases in the number of teenagers and women entering the labor force in the 1960s and 1970s caused the natural rate of unemployment to increase.
V. POLICIES TO REDUCE UNEMPLOYMENT
A. Reducing Cyclical Unemployment
1. Most economists believe that an increase in cyclical unemployment is caused by a decrease in aggregate demand.
2. If wages and other input prices are "sticky," the economy can experience relatively long periods of cyclical unemployment and policies will be needed to reduce the unemployment.
3. Stabilization policies, government policies intended to maintain full employment and a reasonably stable price level, can be used.
a. Expansionary fiscal and monetary policies can be used.
4. There is a tradeoff between reducing unemployment and increasing the price level.
a. If the economy is at full employment, expansionary policies will simply increase the price level and leave output unchanged.
5. Despite the use of stabilization policies, we still observe cyclical movements in the unemployment rate and price level.
a. These fluctuations occur because it is difficult to know how much to change variables such as government spending when using stabilization policy and because it is difficult to use stabilization policy in a timely manner.
B. Reducing Structural Unemployment
1. Policy suggestions to reduce structural unemployment include providing government training programs to the structurally unemployed, paying subsidies to firms that provide training to displaced workers, helping the structurally unemployed to relocate to areas where jobs exist, and inducing prospective workers to continue or resume their education.
C. Reducing Frictional Unemployment
1. Policy suggestions to reduce frictional unemployment include establishing a computerized national job bank that would provide job seekers and prospective employers with better information and implementing apprenticeship programs similar to those used in Austria and Germany.
VI. UNEMPLOYMENT AND THE MINIMUM WAGE
A. Effect of the Minimum Wage
1. Increasing the wage creates a surplus of labor.
a. Increasing the minimum wage causes the quantity of labor that firms are willing to hire to decrease and the quantity of labor willing to work to increase.
2. Only those workers who remain employed receive higher wages.
a. Over half of the low-wage workers in the United States are members of households with above average family incomes. Thus, only a part of the increase in income caused by the minimum wage benefits low-income families.
3. Because low-skill workers are laid off as the minimum wage increases, many low-income families will be adversely affected.
a. Teenagers are among those most adversely affected by the minimum wage.
4. The structurally unemployed may be adversely affected because the minimum wage provides employers less incentive to offer on-the-job training.
5. The excess supply of labor generated by the minimum wage provides employers with the chance to discriminate if they so choose.
6. Society will lose because the nation's output of goods and services will fall.
VII. UNEMPLOYMENT IN EUROPE
A. Impediments to Hiring
1. In most European countries, minimum wages are higher than in the United States.
2. Labor unions in most European countries are more powerful than those in the United States.
3. The relatively high social security and other payroll taxes that European firms must pay discourage hiring.
4. Because it is costly to discharge workers, firms are reluctant to replace workers.
5. In many European countries, government regulations and controls make it difficult for entrepreneurs to start or expand new firms.
B. Impediments to Accepting Employment
1. Unemployment benefits in most European countries are relatively higher and can be drawn for a longer time than in the United States.
2. High tax rates combined with loss of unemployment and other benefits reduces the incentive for unemployed persons to accept employment.
C. Conclusion
1. Unemployment rates in most European countries are higher than in the United States.
2. To lower unemployment rates, policymakers must reduce or eliminate impediments to hiring and accepting employment.
Answers to Review Questions
1. Briefly discuss both the economic and noneconomic costs of unemployment to the individual and society.
During periods of unemployment, the individual's economic position will deteriorate due to the loss of income that would have been received in the absence of unemployment. Society will also suffer an economic loss due to the decrease in output associated with unemployment. During periods of high unemployment, the sacrifice of goods and services can be quite large. During the Great Depression, the nation's output of goods and services fell by about 30 percent.
There are also noneconomic costs associated with unemployment. It has been suggested that prolonged periods of unemployment can have adverse effects on both physical and mental health. For example, studies show that increased unemployment rates are associated with increased rates of alcoholism, drug use, crime, child abuse, and divorce. While these noneconomic effects are difficult to quantify, they should be taken into account when considering the cost that unemployment imposes on the individual and society.
2. Suppose you are given the following information about the Simplistic economy:
Persons over 65 years not actively seeking employment / 20,000Persons over 65 years actively seeking employment / 4,000
Homemakers / 40,000
School-age children under 16 years / 60,000
Military personnel / 15,000
Persons 16 years and older working / 85,000
Persons 16 years and older not working because of illness, labor disputes, vacation, bad weather, or personal reasons / 5,000
Persons between 16 and 65 years actively seeking employment / 6,000
a. Calculate the number of persons in the civilian labor force.
b. Calculate the number of persons who are unemployed.
c. Calculate the unemployment rate.
a. The civilian labor force is the number of persons 16 years of age or older who are working plus those members of the labor force who are unemployed. A member of the labor force is defined as working if he or she is employed either full-time or part-time as a paid employee or is working a minimum of 15 hours as an unpaid employee. An individual is also working if she has a job but did not work because of illness, bad weather, vacation, labor-management disputes, or personal reasons. Members of the labor force are unemployed if they are both available for work and have actively sought employment in the previous four weeks.
Based upon this definition the civilian labor force for the Simplistic economy would be 100,000 (4,000 + 85,000 + 5,000 + 6,000).
b. Given the definition of unemployment, the number of unemployed in the Simplistic economy is found to be 10,000 (4,000 + 6,000).
c. The unemployment rate gives the number of persons unemployed as a percentage of the civilian labor force. It is calculated as the number of unemployed divided by the number of persons in the civilian labor force. This ratio is then multiplied by 100 in order to convert it to a percentage. Thus, the unemployment rate for the Simplistic economy is (10,000/100,000) x 100, or 10 percent.
3. "A decrease in the unemployment rate will benefit society; however, these benefits will not be shared equally by all groups in society." Explain why this statement is true.
To understand why this statement is true, the unemployment rates for different groups in society must be examined. These disaggregated rates show that unemployment rates differ among the various groups that make up society. For instance, teenagers are three times more likely to experience unemployment than older persons. Also, blacks and Hispanics are more likely to experience unemployment than are whites. Those with lower levels of education are more likely to experience unemployment than those that have attained higher levels of education. Presently, the unemployment rate between males and females is roughly equal; however, this has not always been true. In the past females were more likely to suffer from unemployment than males. Because there are unemployment differentials among groups, it follows that a decrease in the overall unemployment rate will bestow different benefits upon these groups. Those groups tending to have higher unemployment rates are likely to receive more of a benefit from a decrease in the overall rate than those groups whose unemployment rates tend to be lower.