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CHAPTER 12. “Now joblessness isn’t just for philosophy majors.” -Kent Brockman. History of Unemployment In the United States.

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Chapter 12


“Now joblessness isn’t just for philosophy majors.”

-Kent Brockman

History of unemployment in the united states

History of Unemployment Inthe United States

Although the unemployment rate in the United States drifted upward between 1960 and 1990, the economic expansion of the 1990s reduced the unemployment rate substantially.

Unemployment rose to 9.6 percent by 2010 following deterioration of economic conditions in 2008

Recent unemployment rates in the U.S. have exceeded unemployment rates in Germany and France

Unemployment in the u s from 1900 to 2010

Unemployment in the U.S. from 1900 to 2010

Unemployment rates by education attainment 1970 2010

Unemployment Rates by Education Attainment, 1970-2010

Frictional unemployment

Frictional Unemployment

Frictional unemployment arises when workers and firms need time to locate each other and to digest information about the potential job match.

Even a well-functioning competitive economy experiences frictional unemployment, because some workers will unavoidably be “between” jobs.

Structural unemployment

Structural Unemployment

Structural unemployment arises when there is an imbalance between the supply of workers and the demand for workers or when unemployment arises because of a mismatch between worker skills and the skills needed by firms.

Structural unemployment is the most concerning type of unemployment for an economy as the skills embedded in labor are no longer being put to productive use.

The rate of unemployment

The Rate of Unemployment

The steady-state rate of unemployment depends on the transition probabilities among employment, unemployment, and the nonmarket sector.

Letl = the fraction of employed workers who lose their jobs and become unemployed

Let h = the fraction of unemployed workers who find work and get hired

In the steady state lE = hU, and since the Labor Force is LF = E + U, then

The Unemployment Rate, UR = U/LF = l/(l + h)

Unemployed persons by reason for unemployment 1967 2010

Unemployed Persons by Reason for Unemployment, 1967-2010

Unemployment duration

Unemployment Duration

Although most spells of unemployment do not last very long, most weeks of unemployment can be attributed to workers who are in very long spells.

Unemployed persons by duration of unemployment 1948 2010

Unemployed Persons by Duration of Unemployment, 1948-2010

Trends in alternative measures of the unemployment rate 1994 2007

Trends in Alternative Measures of the Unemployment Rate, 1994-2007

Flows between employment and unemployment

Flows Between Employment and Unemployment

Job Losers (E)


(E workers)


(U Workers)

Job Finders (h U)

Suppose a person is either working or unemployed. At any point in time, some workers lose their jobs and unemployed workers find jobs. If the probability of losing a job equals , there are E job losers. If the probability of finding a job equals h, there are hU job finders.

Dynamic flows in the u s labor market

Dynamic Flows in the U.S. Labor Market

1.8 million


7.4 million


130.0 million

2.0 million

3.6 million

1.8 million

1.6 million

3.4 million

Out of Labor Force:

69.3 million

Job search

Job Search

The asking wage makes the worker indifferent between continuing his search activities and accepting the job offer at hand.

An increase in the benefits from search raises the asking wage and lengthens the duration of the unemployment spell.

An increase in search costs reduces the asking wage and shortens the duration of the unemployment spell.

The wage offer distribution

The Wage Offer Distribution







The wage offer distribution gives the frequency distribution of potential job offers. A given worker can get a job paying anywhere from $5 to $25 per hour.

Determination of the asking wage

Determination of the Asking Wage




Wage Offer

at Hand







The marginal revenue curve gives the gain from an additional search. It is downward sloping because the better the offer at hand, the less there is to gain from an additional search. The marginal cost curve gives the cost of an additional search. It is upward sloping because the better the job offer at hand, the greater the opportunity cost of an additional search. The asking wage equates the marginal revenue and the marginal cost of search.

Discount rates unemployment insurance and the asking wage

Discount Rates, Unemployment Insurance, and the Asking Wage














(a) Increase in discount rates

(b) Increase in unemployment benefits

Unemployment insurance

Unemployment Insurance

Unemployment benefits are typically paid up to 26 weeks of unemployment, but this length is frequently extended by Congress during recessions.

The level of unemployment benefits depends on previous earnings. The replacement ratio averages about 60 percent for low-wage workers and about 25 percent for high-wage workers.

Unemployment insurance lengthens the duration of unemployment spells and increases the probability that workers are laid off temporarily.

The probability of finding a new job and ui benefits

The Probability of Finding a New Job and UI Benefits

Funding the ui system imperfect experience rating

Funding the UI System: Imperfect Experience Rating

Tax rate



Layoff Rate in the Past




If the firm has very few layoffs (below threshold l0), the firm is assessed a very low tax rate to fund the UI system. If the firm has had many layoffs in the past (above some threshold l1), the firm is assessed a tax rate, but this tax rate is capped at tMAX.

The intertemporal substitution hypothesis

The Intertemporal Substitution Hypothesis

The intertemporal substitution hypothesis argues that the huge shifts in labor supply observed over the business cycle may be the result of workers reallocating their time so as to purchase leisure when it is cheap (that is, during recessions).

The sectoral shifts hypothesis

The Sectoral Shifts Hypothesis

The sectoral shifts hypothesis argues that structural unemployment arises because the skills of workers cannot be easily transferred across sectors.

The skills of workers laid off from declining industries have to be retooled before they can find jobs in growing industries.

Efficiency wages and unemployment revisited

Efficiency Wages and Unemployment (Revisited)

Efficiency wages arise when it is difficult to monitor worker output.

The above-market efficiency wage generates involuntary unemployment.

The determination of the efficiency wage

The Determination ofthe Efficiency Wage

If shirking is not a problem, the market clears at wage w* (where supply S equals demand D). If monitoring is expensive, the threat of unemployment can keep workers in line. If unemployment is high (point F), firms can attract workers who will not shirk at a very low wage. If unemployment is low (point G), firms must pay a very high wage to ensure that workers do not shirk. The efficiency wage wNS is given by the intersection of the no-shirking supply curve (NS) and the demand curve.














The impact of an economic contraction on the efficiency wage

The Impact of an Economic Contraction on the Efficiency Wage
















A fall in output demand shifts the labor demand curve from D0 to D1. The competitive wage falls from w*0 to w*. If firms pay an efficiency wage, the contraction in demand also reduces the efficiency wage but by a smaller amount.

The relation between wage levels and unemployment across regions

The Relation Between Wage Levels and Unemployment Across Regions






Geographic regions (such as B) that offer higher wage rates also tend to have lower unemployment rates. Efficiency wage models help explain this pattern: firms located in regions with high unemployment rates do not need to offer a very high wage to discourage shirking.

Implicit contracts

Implicit Contracts

Implicit contract theory argues that workers prefer employment contracts where incomes are relatively stable over the business cycle, even if such contracts imply reductions in hours of work during recessions.

The phillips curve

The Phillips Curve

A downward-sloping Phillips curve can only exist in the short run.

In the long run, there is no trade-off between inflation and unemployment.

Chapter 12

Rate of Inflation







The Phillips Curve

The Phillips curve describes the negative correlation between the inflation rate and the unemployment rate. The curve implies that an economy faces a trade-off between inflation and unemployment.

Inflation and unemployment in the united states 1961 2005

Inflation and Unemployment in the United States, 1961-2005

The short run and long run phillips curves

The Short-Run and Long-Run Phillips Curves

Rate of Inflation

Long Run





Short Run





The short run and long run phillips curves1

The Short-Run and Long-Run Phillips Curves

The economy is initially at point A (on the previous graph); there is no inflation and a 5 percent unemployment rate.

If monetary policy increases the inflation rate to 7 percent, job searchers will suddenly find many jobs that meet their reservation wage and the unemployment rate falls in the short run, moving the economy to point B.

Chapter 12

Over time, workers realize that the inflation rate is higher and will adjust their reservation wage upward, returning the economy to point C.

In the long run, the unemployment rate is still 5 percent, but there is now a higher rate of inflation. In the long run, therefore, there is no trade-off between inflation and unemployment.

The Short-Run and Long-Run Phillips Curves

Percent of unemployed in spells of unemployment lasting at least 12 months

Percent of Unemployed in Spells of Unemployment Lasting at Least 12 Months

Unemployment in europe

Unemployment in Europe

The combination of…

high unemployment insurance benefits

employment protection restrictions

wage rigidity…

…probably accounts for the high levels of unemployment observed in Europe in the 1980s and 1990s.

Unemployment in western europe 1960 2010

Unemployment in Western Europe, 1960-2010

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