Chapter 27

Unemployment

David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,

6th Edition, McGraw-Hill, 2000
Power Point presentation by Peter Smith
Some key terms
■ Unemployment rate:
– the percentage of the labour force without a job but
registered as being willing and available for work
■ Labour force
– those people holding a job or registered as being
willing and available for work
■ Participation rate
– the percentage of the population of working age
declaring themselves to be in the labour force

27.2
Unemployment in the UK, 1950-99

14
12
10
8
% p.a.

6
4
2
0
50

70

90
19

19

19
Source: Economic Trends Annual Supplement, Labour Market Trends

27.3
Unemployment (%) in selected countries

14
12
10
8
%
6
4
2
0
1972 1982 1999

UK Ireland France EU USA

27.4
Labour market flows
It is tempting to see the labour market in static terms

Working Unemployed

Out of the
labour force but...

27.5
Labour market flows

New hires
Recalls
Working Unemployed
Job-losers
Lay-offs
Quits

Retiring Discouraged
Temporarily workers
leaving

Out of the Re-entrants

Taking New entrants
a job
labour force

27.6
More on labour market flows

■ The size of these flows is surprisingly

high
■ In 1999 unemployment in the UK
began at 1.29 million
■ During the year:
– 3.14 million became unemployed
– but 3.3 million left the ranks of the
unemployed

27.7
The composition of unemployment

■ Different
groups in society are
more vulnerable to
unemployment, varying by:
– age
– gender
– region
– ethnic origin

27.8
Types of unemployment
■ Frictional
– the irreducible minimum level of unemployment in a
dynamic society
■ people between jobs
■ the ‘almost unemployable’

■ Structural
– unemployment arising from a mismatch of skills and job
opportunities when the pattern of demand and
production changes
■ it takes time for ex-coal miners to retrain as international
bankers

27.9
Types of unemployment (2)

■ Demand-deficient unemployment
– occurs when output is below full capacity
– ‘Keynesian’ unemployment occurs in the
transitional period before wages and prices have
fully adjusted
■ Classical unemployment
– created when the wage is deliberately maintained
above the level at which labour supply and labour
demand schedules intersect

27.10
A ‘modern’ view of unemployment
■ A similar categorization is retained, but an
important distinction is to be noted
between:
■ Voluntary unemployment
– when a worker chooses not to accept a job at
the going wage rate
■ Involuntary unemployment
– when a worker would be willing to accept a
job at the going wage but cannot get an offer.

27.11
 The natural rate of unemployment
LD: labour demand
AJ LF: size of labour force
Real wage

LF AJ: the number of workers

prepared to accept jobs
AJ is to the left of LF
w* E F because some members
of the labour force are
between jobs, others are
LD waiting for better offers.
Equilibrium is at w*, N*.
N* N1 The distance EF is the
Number of workers
natural rate of unemployment.
27.12
The natural rate of unemployment

■ The natural rate of unemployment is

the rate of unemployment when the
labour market is in equilibrium.
■ This is entirely voluntary.
■ It includes:
– frictional unemployment
– structural unemployment

27.13
 Classical unemployment
Suppose that union power
AJ succeeds in maintaining a
Real wage

LF real wage of w2.

A B Equilibrium is at A
w2 C
w* and unemployment is AC,

of which BC is voluntary
LD and AB is involuntary
To the extent that this
unemployment reflects a
N2 N* N1 conscious decision by
Number of workers unions to restrict employment,
it is voluntary unemployment.
27.14
UK unemployment 1956-95
12
10

8
% 6

4
2
0
56-59 60-8 69-73 74-80 81-87 88-90 91-95

Actual rate Natural rate

27.15
Supply-side economics
■ entails the use of microeconomic incentives to
alter
– the level of full employment
– the level of potential output
– the natural rate of unemployment
■ In the long run the performance of the
economy can only be changed only by
affecting the level of full employment and the
corresponding level of potential output.

27.16
 Tax cuts and unemployment
With an income tax, the
Real wage

gross wage paid by firms (w1)

AJ
LF is higher than the take-home
net pay of workers (w3).
A
w1 E Equilibrium is at N1
w2 F
B AB is the amount of tax
w3 C
Unemployment is BC
Without tax, equilibrium
LD is at E.
Unemployment is now EF.
N1 N2 Number of workers
EF is less than BC because of the relative slopes of LF & AJ
but the differences may not be substantial.
27.17
Other supply-side policies
■ Trade union reform
– reducing the power of trade unions may limit distortions in the
labour market
■ Other labour supply policies
– training and retraining measures
– improving the efficiency of the labour market
■ such measures may affect frictional and structural unemployment

■ Investment
– higher investment may increase the demand for labour
■ may be achieved via tax incentives or low interest rates

27.18
Hysteresis
■ The idea that a (short-run) fall in
labour demand may lead to a
permanent fall in labour supply

■ This could help to explain high and

persistent unemployment in Europe
in the 1980s

27.19
Hysteresis (continued)
■ Four channels:
– Insider-outsider distinction
■ only those in work take part in wage bargaining & they protect
their own positions
– Discouraged workers
■ people stop looking for jobs
– Search and mismatch
■ firms and workers get used to low search
– capital stock
■ low levels of investment in recession lead to permanently low
capital stock levels

27.20