Chapter Study Outline

22.1 Unemployment: Concepts, Measurement, and the U.S. Experience

  • The going wage is defined as the typical wage earned by productively identical workers employed in the occupation or industry of interest.
  • Nonemployed workers are defined as voluntarily unemployed if they are unwilling or indifferent in regard to working for the going wage.
  • Individuals are involuntarily unemployed if they would strictly prefer to work at the going wage but cannot find a job.
  • Sectoral shocks impact employers in a particular sector of the economy.
  • An aggregate shock refers to a disturbance that affects many or all of the sectors of the economy.
  • Frictional unemployment refers to individuals who are between jobs and searching for work because of labor market frictions
    • Usually these frictions arise from informational imperfections that render the process of finding work and filling vacancies both costly and time-consuming.
  • A definition of full employment is that it is the level of unemployment that would prevail in an idealized frictionless economy without involuntary unemployment.
  • The U.S. Bureau of Labor Statistics (BLS) and other such agencies classify nonemployed members of the working population as
    • unemployed if they actively searched for work over a given four-week reference window
    • not in the labor force if they did not actively search for work over a given four-week reference window
    • The official statistics deliberately exclude marginally attached workers, nonemployed individuals who search for work within the last year but not within the four-week reference window, and discouraged workers, who are not actively searching for work only because they believe there are no jobs available.
  • Policy makers are often especially concerned with the plight of the long-term unemployed.
    • The long-term unemployed are those experiencing an unemployment spell of 27 weeks or more.
    • The members of this group may suffer severe economic hardship.
    • The skills of this group may atrophy during a lengthy period without work, which could render them virtually unemployable.
  • The historical record reveals that the Great Depression and the recent Great Recession stand out as the two most significant economic events that have affected U.S. unemployment patterns over the last 100 years.

22.2 The Theory of Unemployment

  • The unemployment literature can be partitioned into three complementary groups.
    • Contractual frictions arise because, in the face-to-face meeting between and employer and an unemployed worker, an assortment of informational and legal impediments may prevent the two parties from reaching a mutual beneficial agreement that results in the worker’s employment.
    • Market frictions may result in costly and time-consuming delays in the consummation of the employment match, during which time workers remain unemployed and vacancies remain unfilled.
    • Unemployment is part of a broader time allocation problem in which workers allocate their time among several competing uses: paid work in the market, unpaid work at home, searching for work, and leisure.
  • In the basic supply-demand framework, the only reason that unemployment of any interest can arise and persist is because the real wage is downwardly rigid and exceeds its competitive level.
    • There are two distinct explanations that have been advanced to explain the downward inflexibility of real wages.
      • Employers or workers may resist reductions either in the real wage or the nominal wage.

22.3 Efficiency Wage Models

  • There are several distinct branches of the efficiency wage literature, but they are all grounded on a the premise that the wage may indirectly affect worker productivity.
    • A firm may decline to lower the wage because the resulting decline in productivity can outweigh the direct benefits of the wage cut.
  • Possible wage-productivity linkages include
    • Nutrition—at extremely low-income levels, workers’ productivities may suffer because of insufficient caloric intake.
    • Worker effort—if the wage is too low, workers may be disinclined to work hard.
    • Adverse selections—if the wage is too low, the firm may only attract low-ability job applicants/
    • Costly turnover—workers are more likely to quit if the wage is low.
  • The Shapiro-Stiglitz model is one of the best known in the literature and is based on the idea that a high wage discourages shirking but leads to the emergence of equilibrium involuntary unemployment.
  • To deter shirking, the firm’s wage offer must be such that the worker’s expected utility from not shirking is greater than or equal to the expected utility from shirking.
    • The no-shirking constant is the wage that causes a worker to be indifferent between shirking and not shirking.
  • There are a number of potential contractual remedies to the moral hazard problem that eliminate involuntary unemployment.
    • entry fees
    • exit fees
    • performance bonds
    • back-loaded wages

22.4 Other Models of Unemployment

  • The hallmark of the efficiency wage model is the existence of some positive link that connects wages to worker productivities.
  • According to the adverse selection and turnover variants of the efficiency wage approach, the firm attracts high-ability workers and reduces costly turnover by setting a high wage.
  • The value of economic rents for a given employer are equal to the value generated by the current workforce relative to the alternative value that would be generated by replacing them with a new set of workers.
  • The principal insight of the insider-outsider approach is that insiders can capture some of these rents by demanding higher wages.
  • According to basic microeconomic precepts, maximized worker utility depends on the real wage rather than the nominal wage.
  • Despite theoretical hazards, several papers have sought to explain why the nominal wage may itself be downwardly rigid, using explanations such as
    • staggered contracts
    • uncertainty about price level
    • the signaling function of the wage
    • the idea that contracts can be structured to foster specific human capital investments

22.5 Wage Rigidity: The Empirical Evidence

  • A considerable body of evidence suggests that both real and nominal wages do exhibit a degree of stickiness in general and downward stickiness in particular.
    • The stickiness is not absolute bec ause wages also exhibit a lot of flexibility, just not as much as would be anticipated in the context of a well-functioning competitive spot market.
  • Employment rent refers to a utility surplus enjoyed by workers relative to their next-best alternative employment opportunities.
  • The survey evidence indicates that managers deem worker effort, turnover, insurance, and fairness concerns as reasons for not cutting the wage—all themes emphasized by the efficiency wage approach.