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30.2 Unemployment Fluctuations - Coggle Diagram
30.2 Unemployment Fluctuations
Non-Market-Clearing Theories
economists that reject usage of market-clearing theories; latter emphasizing that labor markets do not operate in extreme manner of Dn and Sn (view textbook)
downward sticky wages are CENTRAL to theories
; downward sticky wages = nominal wages reluctant to fall → cyclical unemployment
during recession: workers who are unemployed answer help-wanted ads and are often disappointed by not getting job, and employees pick and choose until no spots are left;
result of wage stickiness leads people in becoming involuntarily unemployed when demand for labor falls during a recession
involuntary unemployed
: workers would accept an offer of work in jobs for which they are trained, at the going wage rate, if such an offer were made*; ex: 2008 recession
MAIN CHALLENGE
=
explaining
why
wages do not quickly adjust to eliminate involuntary unemployment
REASONS FOR Downward Sticky Wages
Long-Term Employment Relationships
WHAT IS IT?
→ obvious reason for wage stickiness over business cycle is that;
wages and conditions of work are determined for extended periods of time, often for one or more years; ex: schoolteachers, professors, office workers, etc.
Why do people prefer it over employment that fluctuates but pays more?
workers prefer having financial security for long-term plans EVEN if they have to work lower wages
employers want to retain workers who have the knowledge required for a particular job – knowledge of firm's organization, production techniques, etc.; if a firm laid off a worker and hired another, the knowledge of first worker would be lost and time taken to teach second worker the ropes would be a loss for business...
therefore, wages tend to be insensitive to fluctuations in economy; wages are long-term relationships
employers tend to "smooth" the income of employees by paying a steady wage and letting profits and employment fluctuate to absorb effects of temporary changes in demand; these fluctuations in employment over business cycle cause fluctuations in involuntary unemployment
**HOWEVER, now "gig economies" can be seen emerging – involved in short-term contract work rather than connected to a single employer
Menu Costs
WHAT IS IT?
→**changing wages and prices in response to every fluctuation in demand is costly and time-consuming; many firms therefore keep wage structures and price lists constant for significant periods of time
firms often react to short-term changes in demand by holding prices and wages constant and responding with changes in output and employment
*IF firms did alter their prices over business cycle, they would be forced to later wages correspondingly or else suffer losses that could threaten their existence during recessions;
REASON FOR STICKY WAGES
: presence of sticky prices allows firms to keep wages relatively sticky over cycle for reasons mentioned in long-term employment relationships
Efficiency Wages
firms may find it profitable to pay workers a higher rather than a lower wage → would have a more efficient workforce that way
WHAT IS IT?
b/c employers are powerless if employees leave firms (on employees' on accord), they pay a wage premium – efficiency wage – to the workers, in excess of the wage they could get somewhere else in labor market; this will incite workers to not work less hours OR ELSE they could lose this high wage if laid off
REASON FOR STICKY WAGES:
high wages are rational responses of firms to conditions they face and imply that firms will not alter wages in the face of temporary reductions in demand
Union Bargaining
in many employment situations, those already working ("insiders") have more say in wage bargaining than those currently not employed ("outsiders")
employed workers represented by a union, which negotiates wage rates with firms
WHAT IS IT?
insiders will naturally want to bid up wages even though this can hurt prospects of outsiders → generates outcome of bargaining process b/w firms and unions IN WHICH the wage is set higher than the market-clearing level, JUST LIKE with efficiency wages
OVERALL, wage stickiness is an important explanation for existence of cyclical unemployment (rises and falls as real GDP fluctuates)
unemployment fluctuations seen over SR; can be divided into two categories
real wages adjust instantly to clear the labor market after any AD or AS shock occurs
results in real GDP always equal to Y
; U-rate still fluctuates but only due to Δ in frictional or structural unemployment;
in such "market-clearing" theories, → unemployment is frictional and structural, & u-rate is always = to NAIRU*
emphasize distinction b/w unemployment that exists when real GDP is equal to Y
, and unemployment that is due to deviations of real GDP from Y
former → NAIRU (made up of frictional and structural); latter →
cyclical unemployment
, which falls (or rises) as real GDP rises above (or falls below) Y*
refer to this theory as "non-market-clearing" theories of the labor market b/c set of theories suggests that cyclical unemployment exists b/c real wages do not adjust quickly to clear labor markets in response to shocks of various kinds
Market-Clearing Theories
two major characteristics → firms and workers continuously optimize and markets continuously clear; there can be no
involuntary unemployment
(explains unemployment as the outcome of voluntary decisions made by individuals who are choosing to do what they do, including spending some time out of employment)
explain fluctuations in employment and real wages as one of two causes
Δ in technology will affect the marginal product of labor → Δ in demand for labor
; if positive or negative, they will lead to fluctuations in level of employment and real wages (will all follow each other; ex: Δ in technology being negative → Δ in demand for labor being lower
Δ in willingness of individuals to work → Δ in supply of labor and → fluctuations in level of employment and real wages
BOTH CASES:
flexibility of real wages results in a
clearing
of labor market; whatever unemployment exists cannot be involuntary → frictional or structural causes (NAIRU)
PROBLEMS WITH THEORIES
1) empirical observation is not consistent with the predicted fluctuations in real wages
; real wages tend to be relatively stable – employment does
not
show they cyclical variation
actually
present in economy
2) market-clearing theories predict no involuntary unemployment whatsoever,
a prediction many economists argue is unsupported by empirical observation;