CHAPTER 7

(Unemployment and the Labor Market)

Statement

1. Suppose in an economy we have 2,300 employed and 200 unemployed. Also, we assume
that 23% or 0.23 of the unemployed people find a job every month, and 2%, or 0.02, of the
employed lose their job every month. We can infer that the country has reached long-run
equilibrium.

There are 2 ways (methods) to answer this statement and determine whether if it is true or
false:

I. The country is in long-term equilibrium if in the respective period, the number of people
finding a job = number of people losing job

From the exercise data we have:

f = 0.23 dhe s = 0.02

First month:

 Unemployed at the end of the first month = unemployed + people who lose their job
in the first month - people who find a job in the first month.

 Employed at the end of the first month = employed - people who lose their job in the
first month + people who find a job in the first month.

People who find a job = f * unemployed = 0.23 * 200 = 46

People who lose their job = s * Employed = 0.02*2300 = 46

Also, in the second month the values do not change, since in the first month, people who find
job = people who lose job. Continue with the same formulas for the second month.

II. The country is in long-run equilibrium if the current unemployment rate = the natural
unemployment rate. We find them and see if they are equal.

Unemployment rate = unemployed / labor force = unemployed / (unemployed + employed) =

200 / (200 + 2300) = 0.08 or 8%.

We find the natural rate of unemployment. If it equals the unemployment rate for the period,
then we can say that we are in long-run equilibrium.

f = 0.23 and s = 0.02

Natural rate of unemployment = 0.02/(0.23+0.02) = 0.08 or 8%.

The unemployment rate is equal to the natural unemployment rate.

The country has reached long-run equilibrium. The statement is true.

Exercises

1. During the ‘50s and ‘60s, most Western European countries managed to keep
unemployment rates very low. Comparing North American labor markets with those of
Western Europe, some economists found that there was very little movement from employed
to unemployed in Western Europe. This was related to the existence in the Western Europe of
many laws that limited firms' ability to lay off (fire) workers.

a. In America the probability of finding a job every month was 0.2 or 20% and the
probability of losing a job was 0.01 or 1%. In Western Europe, these probabilities were
respectively 23.4% and 0.6%. Calculate the natural unemployment rate of the Western
Europe in the ’60s and compare it to the natural rate of America.

In America: u = 0.01/ (0.01+0.2) = 0.047 or 4.7%.

In Western Europe: u = 0.006/ (0.006+ 0.234) = 0.025 or 2.5%

b. In the early ‘70s, a series of changes that took place in the Western European countries
also caused a change in the rates of f and s. Calculate the new natural unemployment rate in
Europe if the probability of finding a job decreases to 9.2%, while the probability of leaving
the job increases to 0.8%.

u = 0.008/(0.008+0.092) = 0.008/0.1 = 0.08 ose 8%

Multiple choice exercises

1. The main determinant of the natural rate of unemployment is:

a. the rate of job finding and the rate of job separation.
b. average period of unemployment.
c. the size of the labor force.
d. job vacancies.

2. A government policy that increases frictional unemployment is:

a. increase the number of training programs.
b. increase social assistance.
c. reduce the minimum wage.
d. dissemination of information on job vacancies.
3. If the rate of unemployment is neither rising nor falling, then the number of people finding
jobs must equal the number of people:
a. unemployed.
b. losing or leaving jobs.
c. looking for jobs.
d. leaving the labor force.

4. If the rate of job finding rises, the natural rate of unemployment will:
a. remain constant.
b. increase.
c. decrease.
d. rise or decline, depending on the rate of job separation.

The higher the rate of job finding, the lower the natural rate of unemployment.

5. Unemployment insurance schemes mainly increase:

a. frictional unemployment.
b. seasonal unemployment.
c. teenage unemployment.
d. cyclical unemployment.

Since unemployment insurance programs reduce the economic hardships associated with
unemployment, they increase the amount of frictional unemployment.

6. If the government increases the amount of unemployment insurance that unemployed

workers can collect, the amount of frictional unemployment would be expected to:
a. fall.
b. remain constant.
c. rise
d. first rise and then fall.

If the amount of unemployment insurance rises, the economic hardships of unemployed

workers are reduced, so there is less incentive to search for a new job. This causes frictional
unemployment to rise.

7. When the real wage is above the level that equilibrates supply and demand, then the
quantity of labor supplied:
a. depends on the nominal wage.
b. is smaller than the quantity of labor demanded.
c. is equal to the quantity of labor demanded.
 d. is greater than the quantity of labor demanded.

If the real wage is above its equilibrium values, the supply for labor will be higher than the
demand for labor.

8. The unemployment resulting from wage rigidity and job rationing is called:
a. the natural rate of unemployment.
b. the discouraged-worker effect.
c. structural unemployment.
d. insiders versus outsiders.

Workers are unemployed not because they can't find a job that best suits their skills, but
rather, at the going wage, the supply of labor exceeds the demand.
9. Which of the following is NOT a cause for real wage rigidity?
a. minimum-wage laws
b. unemployment insurance
c. union power
d. efficiency wages

10. Efficiency wage theories claim that firms may pay high real wages in order to:
a. avoid the threat of unionization.
b. make workers more productive.
c. discourage unskilled workers from applying.
d. reduce the level of frictional unemployment.

11. Measured unemployment may be lower than actual unemployment because:

a. measured unemployment does not include the frictionally unemployed.
b. some individuals may want a job but have become discouraged and
stopped looking for one.
 c. some individuals claim to be unemployed when they are not looking very
seriously for a job.
d. measured unemployment does not include teenage unemployment.

If there are individuals who want jobs, but are discouraged and no longer looking for
them, actual unemployment will be higher than measured unemployment.
12. Discouraged workers who want jobs but have stopped looking for jobs are:
a. frictionally unemployed.
b. unemployed due to structural unemployment.
c. no longer in the labor force.
d. helped by minimum-wage legislation.