Questions - Johan Lindén, Mälardalens...

Chapter 9Employment and Unemployment

Questions

1. Unemployment statistics are measured and released by the Bureau of Labor Statistics (BLS), a division of the U.S. Department of Labor.

a. When does the Bureau of Labor Statistics (BLS) officially classify a person as being employed? When are potential workers classified as being unemployed?

b. What do the following terms mean and how are they calculated?

i. The unemployment rate

ii. The labor force participation rate

Answer:

a. According to the BLS, a person who is a part of the civilian non-institutional population aged 16 and over and holds a full-time or part-time paid job is considered employed. A potential worker is considered unemployed if he or she does not have a paid job, has actively looked for work in the prior four weeks, and is currently available for work.

b.

i. The unemployment rate is defined as the percentage of the labor force that is unemployed:

ii. The labor force participation rate is defined as the percentage of the population of potential workers that is in the labor force:

2. Explain whether each of these individuals will be counted as a part of the labor force.

a. Chiara is a part-time university lecturer who is raising her daughter by herself.

b. Jan recently quit his job and has not applied for any jobs in the last four weeks because he is still trying to decide which job would best suit him.

c. Aron is volunteering at a non-profit in order to gain experience to build a career as a lawyer.

Answer:

a. Chiara will be included in the labor force because she is working part-time and is getting paid for her work.

b. Jan will not be included in the labor force because neither is he working nor applying fora job.

c. Since Aron is doing unpaid volunteer work, he will not be included in the labor force.

©2018 Pearson Education Ltd.

Chapter 9 | Employment and Unemployment 98

3. Consider Exhibit 9.2. What were the two highest rates of unemployment since 1948? When did they occur?

Answer: The two highest rates of unemployment since 1948 were 10.8 percent, which occurred during the 1981–1982 recession, and 10.0 percent, which occurred during the 2007–2009 recession. (Note: Student answers may be somewhat inexact because the exhibit is such that precise rates and times are difficult to determine. However, students should still see the peaks around the times indicated in the answer.)

4. What could explain why unemployment is lower among workers with a relatively higher level of education?

Answer: As the chapter points out, multiple factors explain why more educated workers have lower rates of unemployment. One such factor is the fact that unemployment is lower among workers with a higher level of education is consistent with the principle of optimization. More educated workers tend to earn higher wages than less educated workers when working outside the home. More educated workers, therefore, have a much higher opportunity cost of time. An unskilled worker who is unemployed is more likely to be indifferent between staying at home or working at a low-paying job. But for a skilled worker, the opportunity cost of staying at home is much higher. He or she would be better off getting back to work as quickly as possible. This is because higher wages make the opportunity cost of unemployment much higher for workers with more education.

5. What is the value of the marginal product of labor? Explain how it is computed with an example.

Answer: The value of a worker’s marginal product is the additional revenue that a worker will generate for the firm. In a competitive market, it is calculated as the marginal product of labor multiplied by the market price of the product. In a competitive equilibrium, a profit-maximizing firm will pay a worker a wage that is equal to the value of his or her marginal product.

Consider a tailor, who makes $4,000 in revenues when he works alone. Suppose the tailor hires a new worker and this increases the tailor’s total revenue to $5,300. He then hires a second worker and his total revenue increases to $6,000. This means that the value of the marginal product of the first worker is $1,300, and the value of the marginal product of the second worker is $700.

6. List two factors that can cause a shift in the labor demand curve. Explain why a change in each factor can lead to a shift of the curve.

Answer: Each of the following factors affects the entire schedule relating the quantity of labor demanded to the wage, which is equal to the value of the marginal product of labor. Hence a change in any of these factors will shift the labor demand curve.

● Changing output prices: When the price of a final good increases, the value of the marginal product of labor also increases for every quantity of labor demanded. This shifts the labor demand curve to the right. Similarly, when the price of a final good falls, the demand for labor curve shifts to the left.

● Changing technology and productivity: Technology used in production can increase productivity and the marginal product of labor, increasing the value of that marginal product, and shifting the labor demand curve to the right. Similarly, a decline in productivity can shift the labor demand curve to the left.

● Changing input prices: Firms use labor and other factors of production, like machines and tools, to produce goods and services. When the prices of these other factors fall, businesses purchase more of these other factors. This usually increases the marginal product of labor, shifting the labor demand curve to the right. Conversely, if the prices of other factors rise, the marginal product of labor falls, shifting the labor demand curve to the left.



● Changing demand for the output good or service: For example, if the demand for a product or service declines, the value of the marginal product of labor declines. This will shift the labor demand curve to the left.

7. Why does the labor supply curve slope upward, and what can cause the labor supply curve to shift?

Answer: The labor supply curve represents the relationship between the quantity of labor supplied and the wage. As the wage increases, the quantity of labor (hours) supplied rises: The opportunity cost of activities other than paid employment increases when the wage increases. So, workers have an incentive to work more hours as their wage increases. Accordingly, the labor supply curve is upward sloping.

Each of the following factors affects the entire schedule relating the quantity of labor supplied to the wage and will therefore shift the labor supply curve.

● Changing tastes and social norms: Changing social norms affect people’s willingness to take a paid job. For example, factory work during the Second World War was one early step in a worldwide shift toward acceptance of female labor force participation. This increase in the number of workers shifts the labor supply curve to the right.

● Changing opportunity cost of time: Household appliances, like dishwashers and vacuum cleaners, lower the opportunity cost of working outside the home. This encourages people to shift more time out of home production into paid employment, generating a rightward shift in the labor supply curve.

● Changes in population: For example, the influx of immigrants to a country will increase a country’s population and shift the labor supply curve to the right.

8. Should a country with a healthy economy have a zero unemployment rate?

Answer: The process of matching jobs and workers is time-consuming and results in frictional unemployment being present in any economy at any point of time. Therefore, a zero unemployment rate is totally impractical and should not be regarded as a policy goal.

9. What is meant by job search? How does it lead to frictional unemployment?

Answer: Finding the right job is not easy; a job seeker would need to determine which firms are hiring and learn how pay, benefits, and other job characteristics vary among them. He or she would also have to line up references and send out resumes. Interviews will need to be set up, but in most cases, someone else gets chosen, and then the job candidate needs to start all over again. These job-hunting activities are referred to as job search. Unemployment arising from job search is called frictional unemployment. Frictional unemployment arises because it takes time for an unemployed worker to find a firm with a well-matched job vacancy.

10. What is the difference between frictional and structural unemployment?

Answer: When firms and workers lack important information about the labor market, workers cannot always be quickly matched to open jobs, which will cause unemployment. This type of unemployment is called frictional unemployment. On the other hand, structural unemployment arises when the quantity of labor supplied is persistently higher than the quantity of labor demanded. This is often due to institutional factors (e.g., minimum-wage laws) that result in wage rigidity, thus preventing the market wage from adjusting to bring the market to equilibrium.

11. Sometimes new technology in production reduces the time that a worker takes to complete a task. Technological innovations can also completely replace a factory worker. Does this mean that technological progress will lead to large-scale unemployment? Explain your answer.



Answer: New technology can replace factory workers and make jobs redundant in a certain industry. However, historical evidence shows that technological progress does not produce unemployment in a country as a whole. Technological progress increases productivity and incomes in the overall economy. Higher incomes lead to higher demand for goods and labor. As a result, workers who lose jobs in one industry will be able to find jobs in others, though for many of them this might take time and some of them will have to accept lower wages in their new jobs.

12. What is wage rigidity? List and explain two factors that can increase wage rigidity in the labor market.

Answer: Wage rigidity refers to the situation in which wages are held above the level that clears the labor market. Because firms will not be able to hire workers who would have been willing to work at the equilibrium wage, wage rigidity leads to unemployment. Some of the factors that increase wage rigidity are the following:

● Minimum-wage legislation: The minimum wage is a legislated price floor that prevents the market price from falling to the equilibrium price. Minimum-wage legislation prevents employers from hiring workers at wages that would equalize the quantity supplied and demanded, leading to unemployment in the market.

● Collective bargaining: Collective bargaining refers to contract negotiations between an employer and a labor union representing workers. Collective bargaining agreements between unions and employers often result in wages that are above equilibrium.

● Efficiency wages: Efficiency wages are set above the market wage in order to increase worker productivity. Firms might find it profitable to pay a higher wage than the market clearing wage in order to boost productivity, lower absenteeism and turnover, boost worker morale, etc. Moreover, paying efficiency wages may well attract higher quality applicants for the available positions.

● Downward wage rigidity: Workers tend to resist a decline in their wage. In order to maintain productivity and morale, firms often prefer to fire workers than try to cut everyone’s wages. This leads to downward wage rigidity.

Problems1.

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3. A new study suggests that technology might provide improved leisure options, like video games, to potential workers, and that young men with low levels of education are increasingly staying home and playing video games instead of working. There has also been a concurrent decline in the labor force participation of young men with low levels of education.

a. Could the rapid rise in video game playing be a cause of the decreased labor force participation of low-education young men? What other factors might explain these two simultaneous trends? In your response, you should use the labor market equilibrium figure (e.g., Exhibit 23.8) and also utilize the concepts of voluntary and involuntary unemployment.

b. The authors of this new study also find that these young men, as a group, have experienced an increase in self-reported happiness through the 2000s (according to the General Social Survey).



How does this factor into your explanations in part a?

Answer:

a. Certainly, improved leisure options could change individual preferences, tilting them from work to leisure this could, in turn, increase voluntary unemployment. However, it could be that involuntarily unemployed young men are simply playing video games instead of idling; that is, the increase in video games could be an effect, rather than a cause, of unemployment. As the problem directs, students should also provide at least one chart showing the possible decrease in labor supply due to improved video game technology (see example below). Ideally, they will provide an additional chart showing the alternative explanation; a shock, for example, to demand for young workers, leading to involuntary unemployment.

b. This fact could perhaps support the authors’ contention that these individuals are voluntarily unemployed. However, it could also simply be the case that overall happiness has been improving in this age group, for reasons unrelated to employment. Alternatively, this average trend could be driven by a small group of super-happy, super-successful young men. Overall, then, this fact doesn’t necessarily help us pick between the explanations in part a.

4. Suppose Die Cast Aluminum Co. is a subcontractor for the auto industry and makes specialized auto parts. There is a bracket it manufactures that it sells for $1.50. The following table shows the number of brackets that can be produced from a given number of labor hours. Assume that the company cannot hire labor for a fraction of an hour.



Hrs. Labor Q

0 0

1 50

2 90

3 120

4 140

5 150

6 155

7 157

a. Find the marginal product (in brackets) and the value of the marginal product (in dollars), of each hour of labor.

b. If the wage paid to workers in Die Cast’s plant is $25/hour, how many hours of labor should the firm employ? How many hours will be employed if the wage increases to $35/hour? Explain.

c. How many hours will be employed if the wage is $35/hour, but the price of a bracket declines to $1?

Answer:

a. The relevant figures are provided in the following table:

Hrs. Labor Q MPL VMPL

0 0

1 50 50 75

2 90 40 60

3 120 30 45

4 140 20 30

5 150 10 15

6 155 5 7.5

7 157 2 3

b. Recall that a firm will keep hiring hours of labor as long as the additional revenue that an additional hour produces is at least as great as the wage the additional hour earns. If the wage paid for each hour of labor is $25, then the firm will hire 4 hours of labor to make the brackets. The fourth hour generates $30 in additional revenue (VMPL) but only costs the firm $25. If the firm hired a fifth hour, it would only generate $15 in additional revenue, but would still cost the firm $25. Hence, Die Cast would lose $10 on that hour.

However, if the wage increases to $35/hr., then Die Cast will only hire 3 hours. The fourth hour still only generates $30 in additional revenue, but now costs the firm $35.

c. If the price of a bracket is only $1 instead of $1.50, the value of the marginal product of labor must be recalculated. The results are shown below:



Hrs. Labor Q MPL VMPL0 01 50 50 502 90 40 403 120 30 304 140 20 205 150 10 106 155 5 57 157 2 2

Given the lower values for the value of the marginal product of labor, only two hours will be employed. The third hour now only generates $30 in additional revenue, but would cost the firm $35. Hence, it will not be hired.

5. In a recent study for the National Bureau of Economic Research (NBER), four researchers looked at the effect of generous unemployment benefits on the local unemployment rate. They compared the unemployment situation in adjoining counties, which happened to lie in two different states with different laws regarding the amount and duration of unemployment benefits.

The authors of the study found that the unemployment rate “rises dramatically in the border counties belonging to the states that expanded unemployment benefit duration” during the Great Recession. Why might this be so?

Based on Hagedorn, Karahan et al., “Unemployment Benefits and Unemployment in the Great Recession: The Role of Macro Effects.” NBER Working Paper 19499, October 2013.

Answer: The researchers found that the existence of longer duration unemployment benefits gave workers an incentive to hold out for better paying jobs, extending the duration of unemployment in the border counties in states that had expanded benefit duration.

6. The EU-27 had been heavily hit during the financial crisis of 2007–2008 and many people lost their jobs. (Note: In 2007–2008, Croatia was not yet a member of the European Union, it joined in 2013.)

a. Do an online search for long-term unemployment figures on Eurostat for EU-27 countries. Looking at the time-series between 2007 and 2016; what kind of long-term trends can you observe?

b. List some possible reasons for unemployment that would make joblessness qualify as frictional unemployment. Which of these reasons would fall under the category of structural unemployment?

Answer:

a. What is visible from the time-series is that long term unemployment reached its peak in 2013 at 5.1%. (You might want to check Problem 1 for the unemployment figures.) This is quite striking that even after four years since the start of the crisis, so many people are unemployed for a long term. In addition, long-term unemployment is still higher than before 2009.

b. Various scenarios are possible. Following are some examples of issues.

Frictional Unemployment

● The worker’s job search has been protracted due to insufficient or faulty information about job opportunities in her area.



● The worker has not been proactive about sending out resumes, gathering references, lining up interviews, networking, or following up on all opportunities.

● The positions for which the worker has applied have received multiple applications, and it is taking the employers longer than usual to process all of the applications.

Structural Unemployment

● The worker has applied for jobs in a region that has a high minimum wage—one that is set above the equilibrium wage for the labor market in which she is applying.

● Wages in the labor market in which the worker is applying are above equilibrium and downwardly rigid due to the fact that many employers in that market pay efficiency wages.

● The industry in which the worker is applying is heavily unionized, and wages are kept consistently above equilibrium.

7. In recent years, countries around the world have faced a youth unemployment crisis. According to a report by the International Labour Organization, the global youth unemployment rate in 2016 was 2.9 times higher than the global adult rate.

a. In Exhibit 23.5, we compared the curves for two types of labor, low-skill and high-skill. Suppose that the curves show the labor market for workers over the age of 22, with a minimum wage of $10. Use new charts to demonstrate two ways in which the youth labor market might feature greater structural unemployment at the same minimum wage.

b. How would you distinguish between the two different explanations you proposed in part a: what kind of data would you need to test these different explanations?

c. Some countries, like the UK, have attempted to reduce youth unemployment by implementing a lower minimum wage for workers under the age of 20. Discuss how this might influence youth unemployment, linking your answer to the two explanations discussed in parts a and b as well as to the different types of unemployment discussed in this chapter. Do you think efforts to reduce youth unemployment by setting lower minimum wages for young workers is likely to be effective?

Answer:

a. There are a few options here. For example, the student could, as in exhibit 23.5, change the elasticity of supply for the youth labor market—the youth labor market could be more elastic because young people have fewer job options. They could also shift the labor supply for the youth labor to the right, reflecting an influx of young workers; or they could shift the labor demand for the youth labor to the left, suggesting that fewer employers want to hire unskilled workers.

b. Again, this depends on the answers given in part a. A great answer will distinguish between supply-side/demand-side effects (and perhaps give some of the explanations offered in the part a. answer here, instead). The data sources should be, for example, data on how many youth are hired across industries and the associated wages—or data on wages for jobs that youth accept. Ideally, hourly wage data could give a disaggregated look at the willingness of youth to substitute work for leisure.

c. Given the features of the market discussed in a. and b. (specific answer here will depend on student’s answer to a/b), the adult minimum wage seems to generate particularly high unemployment for young people. A lower minimum wage would address structural unemployment, as we saw in this chapter, by coming closer to the equilibrium wage; we would also expect it to slightly increase voluntary unemployment, as some people wouldn’t want to



work for the lower wage (because they find leisure more valuable). It’s hard to say whether it will be effective—the amount of employment generated will depend somewhat on the elasticities of supply and demand. If both are extremely elastic, then we could see a large effect of even a small decrease in minimum wage (particularly if firms are simply hiring the cheapest labor, with no preference for age/experience). However, if young people are not good substitutes for older, more experienced, workers, then the minimum wage decrease may not make a big difference.

8. The following graph shows the demand for and supply of labor in a market with a minimum wage set at $10 per hour. Use the graph to answer the following questions.

a. How many workers will be unemployed due to the minimum wage? What kind of unemployment is this?

b. What would happen to the quantity of labor demanded and supplied if the minimum wage were less than $6?

c. Who are the winners and the losers when the minimum wage is $10?

d. In the United States, does minimum wage legislation have a significant impact on unemployment in the overall labor force? Why or why not?

Answer:

a. At a wage of $10, the quantity of labor supplied is 400, but the quantity of labor demanded is only 200. Hence, there will be structural unemployment of 200 workers in this market as a result of the minimum wage.

b. A minimum wage that is set below the equilibrium wage in the market, which is $6, will not affect the quantity of labor demanded and supplied. Because the market is already paying wages that are higher than the minimum wage, the minimum wage law will have no impact on the labor market.



c. In a labor market with a minimum wage, the winners are the workers who keep their jobs and are employed at the minimum wage when they would have been willing to work at the lower market-clearing wage. The losers are the low-wage workers who lose their jobs due to the fall in the quantity of labor demanded as well as the firms (and by implication their shareholders) who are now forced to pay higher wages.

d. Currently, minimum-wage laws do not significantly affect the employment picture in the United States. This is due to the fact that the vast majority of workers already make more than the federal or state minimum wages. In fact, only about 1 percent of all workers are paid the minimum wage. Hence, although there may be some impact on the market for low-skilled labor, the overall impact on the labor market is very minor.

9. In response to the financial crisis of 2007, the government of Hungary, in 2012, reduced the number of days for which unemployment benefit can be provided to 90 days from 270 days. What could have been the rationale behind this? What are some of the potential effects of such a policy?

Answer: The idea might have been that people would be looking to obtain a job far more intensively. Unfortunately, at that time Hungary had a scarcity of jobs; therefore, on average it took job seekers significantly more time to find a job than the 90 day-timeframe the unemployment benefit provided. Despite the effort, it was unlikely that a job seeker would find employment and, hence, would probably have to ask family and friends to support them financially. This also had an additional effect on wages. In such cases, an individual being interviewed for a job would not negotiate an appropriate wage rate and would take whatever was offered to them.

10. According to salary.com, the average salary for a software engineer level III (a higher-level position in software design and implementation) in the Silicon Valley area of California is $120,086. However, Google pays its level III software engineers an average salary of $132,869. Explain why Google would pay a salary higher than the equilibrium salary for equivalent positions in the same area.

(Salary data from http://swz.salary.com/SalaryWizard/Software-Engineer-III-Salary-Details-Mountain-View-CA.aspx; http://www.glassdoor.com/Salary/Google-Salaries-E9079.htm)

Answer: This salary differential can be explained using the concept of efficiency wages. Paying a wage above the “going rate” for a certain category of labor serves to increase the productivity of workers and the profitability of the firm. This is due to several factors: Reduction of worker turnover, lower worker absenteeism, enhancement of worker morale, and the ability to attract higher quality applicants.

11. The following figure shows the demand and supply curves in the market for workers in Starbucks coffee shops, (called “baristas”). The hourly wage in this market has been fixed at $7.25, and cannot be changed.



a. Suppose that, due to concerns about the high number of calories in many Starbucks drinks, the demand for Starbucks products declines. Use a graph to explain what will happen to employment in the market for baristas.

b. Now suppose the wage is flexible. How would your answer to part (a) change?

Answer:

a. A fall in demand for Starbucks coffee will reduce the demand for labor by coffee shops. The demand for labor curve will shift to the left, as illustrated below. Because the wage in the market is fixed at $6 per hour, the quantity of labor supplied at that wage will exceed the quantity demanded, leading to unemployment. For example, in the graph below, 100,000 workers would be unemployed as a result of the inflexible wage.



b. With flexible wages, a shift to the left in the demand for labor reduces the equilibrium wage and employment but does not cause unemployment. The demand curve will shift to the left, the wage will fall—say, to $5 per hour as illustrated above—and the level of employment will be equal to 250,000 baristas. But at this lower wage, the number of baristas demanded will be equal to the number of baristas supplied; there will be no unemployment in the market.

12. The period from 2007 to 2009 was a time of economic contraction that some called the “Great Recession.” During periods of recession, most firms experience a decline in demand for their product. All other things being equal, macroeconomic theory predicts that the wage of most workers should decline in recessionary periods. However, this was not the case in the 2007-2009 recession, or during many other economic downturns throughout recent history.

Based on the discussion in the chapter, explain why this might be so, and what the implications are for unemployment.

Answer: As explained in the chapter, wages often do not adjust downward in response to a decline in demand. Workers are resistant to such adjustments, and employers try to avoid them.

During economic downturns like the 2007–2009 recession, the labor demand curve shifts to the left. Because of downward wage rigidity, wages do not decline to a level that would result in the quantity of labor supplied matching the quantity of labor demanded, which in turn contributes to an increase in unemployment.


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