Employment and Unemployment

These are my notes on employment factors in economics.

Potential workers fall into three categories: employed, unemployed, and not in the labor force. 

The level of employment and the level of wages are determined by firms’ labor demand, workers labor supply, and various wage rigidities. 

Frictional unemployment arises because it takes time for an unemployed worker to learn about the condition of the labor market and find a new job.

Structural unemployment arises because wage rigidities prevent the quantity of labor demanded from matching the quantity of labor supplied. 

Cyclical unemployment is the difference between the unemployment rate and its long term average.

Potential workers include everyone in the general population with three exceptions: children under 16 years of age, people on active duty in the military, and people who are living in institutions where the residents have restricted personal mobility, like long term medical care facilities or prisons. 

A person holding a full time or part time job is employed.

A worker is unemployed if she does not have a job, has actively looked for work in the prior four weeks, and is currently available for work.

The labor force is the sum of all employed and unemployed workers.

The unemployment rate is the percentage of the labor force that is unemployed.

The labor force participation rate is the percentage of potential workers who are in the labor force. 

The value of the marginal product of labor is the contribution of an additional worker to a firm’s revenues.

The labor demand curve depicts the relationship between the quantity of labor demanded and the wage. The value of the marginal product of labor is also the labor demand curve because they both show how the quantity of labor demanded varies with the wage.

The labor supply curve represents the relationship between the quantity of labor supplied and the wage.

The competitive equilibrium wage is the market clearing wage. At this wage, every worker who wants a job can find one: the quantity of labor demanded matches the quantity of labor supplied.

Job search refers to the activities that workers undertake to find appropriate jobs.

Frictional unemployment refers to the unemployment that arises because workers have imperfect information about available jobs and need to engage in a time consuming process of job search.

Wage rigidity refers to the condition in which the market wage is held above the competitive equilibrium level that would clear the labor market.

Structural unemployment arises when the quantity of labor supplied persistently exceeds the quantity of labor demanded. 

Collective bargaining refers to the contract between firms and labor unions.

Efficiency wages are wages above the lowest pay that workers would accept: employers use them to increase motivation and productivity. 

Downward wage rigidity arises when workers resist a cut in their wage and firms respond to this resistance by holding nominal wages fixed.

The natural rate of unemployment is the rate of unemployment around which a healthy economy fluctuates.

The long run rate of unemployment is the average historical rate of unemployment.

Cyclical unemployment is the deviation of the actual unemployment rate from the long run rate of unemployment.

Potential workers are defined as the civilian non-institutional population ages 16 and older. Those holding a paid full time or part time job are classified as employed, while those without a paid job who have actively looked for work are unemployed. Potential workers who are employed and unemployed make up the labor force, while the rest of the potential workers are classified as out of the labor force. The unemployment rate is the percentage of the labor force that is unemployed.

The unemployment rate fluctuates significantly over time. It is higher during and in the immediate aftermath of recessions.

Employment is determined by labor demand and labor supply. The labor demand curve is downward-sloping because of the diminishing marginal product of labor and profit maximization by firms. In contrast, the labor supply curve tends to be upward-sloping because higher wages generally encourage workers to supply even more hours to the labor market.

The competitive labor market equilibrium is given by the intersection of the labor demand and labor supply curves. The competitive equilibrium wage is also called the market clearing wage.

In a competitive labor market equilibrium in which all workers know the market clearing wage, there will be very little unemployment because every worker willing to work at the market clearing wage can find a job. Workers who are not willing to work at the market clearing wage will stop searching and will therefore not be counted as unemployed.

Frictional unemployment exists because workers need time to learn about the condition of the labrador market, and search for a job that suits them. Even in a healthy labor market, there will always be some unemployed workers in the process of changing jobs, or finding a new job after losing their previous one, or finding their first job after entry into the labor market.

Structural unemployment results when the market wage is above the market clearing level, causing the quantity of labor supplied to be greater than the quantity of labor demanded. This is often referred to as wage rigidity. It can result from institutional features of the labor market like minimum wage legislation or collective bargaining. More importantly, it can result from efficiency wages or from downward wage rigidity. Efficiency wages arise when employers pay wages higher than the market clearing wage to increase worker productivity. Downward wage rigidity arises because of the unwillingness of workers to accept wage cuts, which prevents wages from immediately falling in response to a leftward shift of the labor demand curve.

The most important cause of unemployment fluctuations is a shifting labor demand curve. When wages are flexible, a shift to the left of the labor demand curve reduces both employment and wages but does not increase unemployment because the labor market clears. When wages are rigid, the same leftward shift creates a larger decline in employment because the wage does not decline and unemployment increases.

The natural state of unemployment is the rate of unemployment around which a healthy economy fluctuates. The long run rate of unemployment is the average historical rate of unemployment, which tends to be higher than the natural rate of unemployment due to the presence of structural unemployment. Cyclical unemployment is the difference between the current rate of unemployment and the long run rate of unemployment. Cyclical unemployment is positive in recessions and negative in economic booms.