Chapter 9
Employment and
Unemployment
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9 Employment and Unemployment
Chapter Outline
9.1 Measuring Employment and Unemployment
9.2 Equilibrium in the Labor Market
9.3 Why Is There Unemployment?
9.4 Job Search and Frictional Unemployment
9.5 Wage Rigidity and Structural Unemployment
EBE What happens to employment and unemployment
if local employers go out of business?
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9 Employment and Unemployment
Key Ideas
1. Potential workers fall into three categories:
employed, unemployed, and not in the labor force.
2. The level of employment and the level of wages
are determined by firms’ labor demand, workers’
labor supply, and various wage rigidities.
3. 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.
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9 Employment and Unemployment
Key Ideas
4. Structural unemployment arises because wage
rigidities prevent the quantity of labor demanded
from matching the quantity of labor supplied.
5. Cyclical unemployment is the difference between
the unemployment rate and its long-term average.
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9.1 Measuring Employment and Unemployment
Unemployment takes
a terrible toll on the
economic, social, and
psychological
well-being of the
unemployed.
In this chapter, we look at how the
unemployment rate is measured and why it rises
during recessions.
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9.1 Measuring Employment and Unemployment
Potential workers
Everyone in the general population except:
• Children under 16 years
• Active military personnel
• Institutionalized persons
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9.1 Measuring Employment and Unemployment
Children + active
military +
institutionalized
persons, 69.8
Potential
workers, 248.4
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9.1 Measuring Employment and Unemployment
Potential workers are divided into three categories:
1. Employed persons hold a paid full-time or part-time
job.
2. Unemployed persons are without a job and are
actively searching for one.
3. Not in labor force persons are without a paid job
and not actively searching for one.
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9.1 Measuring Employment and Unemployment
What is the classification of each of these people?
• Unionized electrician
• Part-time coffee-shop barista
• Former auto worker seeking new employment
• Former auto worker collecting disability
• Full-time college student
• Retired grandmother
• Stay-at-home father
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9.1 Measuring Employment and Unemployment
Unemployed
persons, 9.3
Not in Labor
force, 92.6
Employed
persons, 146.6
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9.1 Measuring Employment and Unemployment
Labor force = Employed + Unemployed
Unemployed
Unemployment rate = 100%
Labor force
Labor force
Labor force participation rate = 100%
Potential workers
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9.1 Measuring Employment and Unemployment
Example 1: Calculate the actual labor force participation
and unemployment rates.
United States (in millions) Sep-08 Sep-14
National Population 305.9 318.2
Children + active military + institutionalized persons 71.5 69.8
Potential workers 234.4 248.4
Not in Labor force 79.8 92.6
Labor force 154.6 155.8
Employed persons 145.1 146.6
Unemployed persons 9.5 9.3
Labor force population rate = ___._% ___._%
Unemployment rate = ___._% ___._%
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9.1 Measuring Employment and Unemployment
Solution: Calculate the actual labor force participation
and unemployment rates.
United States (in millions) Sep-08 Sep-14
National Population 305.9 318.2
Children + active military + institutionalized persons 71.5 69.8
Potential workers 234.4 248.4
Not in Labor force 79.8 92.6
Labor force 154.6 155.8
Employed persons 145.1 146.6
Unemployed persons 9.5 9.3
Labor force population rate = 66.0% 62.7%
Unemployment rate = 6.1% 6.0%
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9.1 Measuring Employment and Unemployment
Example 2: Consider a different situation, an
alternative that economists call a counterfactual.
Calculate the unemployment rate today and in
September 2008 if labor force participation had
stayed the same.
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9.1 Measuring Employment and Unemployment
Calculate the counterfactual unemployment rate:
United States (in millions) Sep-08 Sep-14
National Population 305.9 318.2
Children + active military + institutionalized persons 71.5 69.8
Potential workers 234.4 248.4
Not in Labor force 79.8 84.4
Labor force 154.6 164.0
Employed persons 145.1 146.6
Unemployed persons 9.5 17.5
Labor force population rate = 66.0% 66.0%
Unemployment rate = 6.1% ___._%
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9.1 Measuring Employment and Unemployment
Answer to Example: Calculate the
counterfactual unemployment rate:
United States (in millions) Sep-08 Sep-14
National Population 305.9 318.2
Children + active military + institutionalized persons 71.5 69.8
Potential workers 234.4 248.4
Not in Labor force 79.8 84.4
Labor force 154.6 164.0
Employed persons 145.1 146.6
Unemployed persons 9.5 17.5
Labor force population rate = 66.0% 66.0%
Unemployment rate = 6.1% 10.7%
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9.1 Measuring Employment and Unemployment
Question: What happens to the unemployment
rate during the following situations:
1. A recession, when firms tend to fire workers.
2. An expansion, when firms tend to hire
workers.
3. A “normal period” when firms do neither.
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9.1 Measuring Employment and Unemployment
Exhibit 9.2 The U.S. Unemployment Rate from 1948 to 2014
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9.1 Measuring Employment and Unemployment
Question: Who would be more likely to be
unemployed?
• A high school-educated tax driver
• A college-educated electrical engineer
Hint: Think about the opportunity cost of not
working for each person.
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9.1 Measuring Employment and Unemployment
Question: Who would be more likely to be
unemployed?
Answer: A high school-educated tax driver
is more likely to be unemployed because he or
she faces a lower opportunity cost of not
working.
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9.1 Measuring Employment and Unemployment
Exhibit 9.3 Unemployment Rates for Different Educational
Groups
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9.2 Equilibrium in the Labor Market
The labor market is where the equilibrium real
wage and quantity of labor are determined.
The demand for labor is determined by firms
that want to maximize profits.
The supply of labor is determined by workers
who want to maximize utility.
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9.2 Equilibrium in the Labor Market
Firms seek to maximize profits.
A firm will hire as long as the marginal benefit
is greater than or equal to the additional cost.
Marginal benefit ≥ Marginal cost
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9.2 Equilibrium in the Labor Market
The marginal benefit is the value of the marginal
product of labor—the increase in revenue
resulting from hiring an additional worker.
The marginal cost is the market wage.
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9.2 Equilibrium in the Labor Market
A profit-maximizing firm will hire the amount
of labor that makes the value of the marginal
product of labor equal to the market wage.
Value of the
marginal product ≥ Market wage
of labor
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9.2 Equilibrium in the Labor Market
Question: Given the following information, how
many barbers will the firm hire?
Number of Total Value of the Marginal
Market Wage
Barbers Revenue Product of Labor
1 $25 $15
2 $45 $15
3 $55 $15
4 $60 $15
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9.2 Equilibrium in the Labor Market
Answer: The firm will hire two barbers:
Number of Total Value of the Marginal Market
Barbers Revenue Product of Labor Wage
1 $25 $25 > $15
2 $45 $20 > $15
3 $55 $10 < $15
4 $60 $5 < $15
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9.2 Equilibrium in the Labor Market
Question: How many cooks will the firm hire?
We need to calculate total revenue first:
Number of Total Meals Price per Total
Cooks Produced Meal Revenue
1 4 $10
2 7 $10
3 9 $10
4 10 $10
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9.2 Equilibrium in the Labor Market
Question: How many cooks will the firm hire?
Number of Total Value of the Marginal
Market Wage
Cooks Revenue Product of Labor
1 $40 $20
2 $70 $20
3 $90 $20
4 $100 $20
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9.2 Equilibrium in the Labor Market
Answer: The firm will hire three cooks:
Number Total Value of the Marginal
of Cooks Revenue Product of Labor Market Wage
1 $40 $40 > $20
2 $70 $30 > $20
3 $90 $20 = $20
4 $100 $10 < $20
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9.2 Equilibrium in the Labor Market
Labor demand curve
A curve that depicts the relationship between
the quantity of labor demanded and the wage.
The labor demand curve is the value of the
marginal product of labor because profit-
maximizing firms hire workers until that value
equals the wage.
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9.2 Equilibrium in the Labor Market
The labor demand curve slopes downward
because the marginal product of labor diminishes
as more labor is used.
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9.2 Equilibrium in the Labor Market
Exhibit 9.4 The Value of the Marginal Product of Labor Is the
Labor Demand Curve
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9.2 Equilibrium in the Labor Market
The labor demand curve shifts when a change in
any of the following occurs:
1. Output price of the good or service
2. Demand for the good or service
3. Technological progress and high productivity
4. Input prices of labor, capital, and land
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9.2 Equilibrium in the Labor Market
Exhibit 9.5 Downward-Sloping Labor Demand Curve
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9.2 Equilibrium in the Labor Market
Each of the following will shift the labor supply
curve to the left in our cook example
1. A decrease in labor force participation
2. An increase in child care costs
3. A decrease in immigration
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9.2 Equilibrium in the Labor Market
Workers supply labor to optimally allocate their
time between paid work, leisure, and other
activities, like child care and other home
production.
Question: What will happen if the worker is
offered a higher wage?
Answer: The worker will work more, play less,
and try to reduce home production.
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9.2 Equilibrium in the Labor Market
Labor supply curve
A curve that depicts the relationship between
the quantity of labor supplied and the wage.
The labor supply curve slopes upward because
workers respond to higher wages by wanting to
work more hours.
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9.2 Equilibrium in the Labor Market
Exhibit 9.6 Upward-Sloping Labor Supply Curve
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9.2 Equilibrium in the Labor Market
The labor supply curve shifts when a change in
any of the following occurs:
1. Tastes or preferences
2. Opportunity cost of time
3. Population and demographics
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9.2 Equilibrium in the Labor Market
Equilibrium in a competitive labor market occurs
at the intersection of the labor demand and labor
supply curves.
At the equilibrium wage (w*), the quantity of
labor demanded is equal to the quantity of labor
supplied.
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9.2 Equilibrium in the Labor Market
Exhibit 9.7 Equilibrium in the Labor Market
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9.3 Why Is There Unemployment?
Answer 1: Job seekers looking for the right job
(frictional unemployment).
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9.3 Why Is There Unemployment?
Answer 2:
Unemployed workers
would be willing to
work at the prevailing
wage rate but are unable
to find employers who
will hire them
(structural
unemployment).
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9.4 Job Search and Frictional Unemployment
Firms do not have
complete
information on the
skills, experiences,
and preferences of
job seekers.
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9.4 Job Search and Frictional Unemployment
Job seekers do not have complete information
on the specifics of each job opening.
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9.4 Job Search and Frictional Unemployment
As a result, workers must undertake a time-
consuming job search (i.e., sending resumes,
interviewing, networking) to find the right job.
Unemployment that arises because workers have
imperfect information about job openings and
need to engage in a time-consuming job search is
called frictional unemployment.
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9.5 Wage Rigidity and Structural Unemployment
There also could be wage rigidity, where the
market wage, w, is held above the market-clearing
level, w*.
Unemployment that results from a persistent gap
between the quantity of labor supplied, L, and the
quantity of labor demanded, L*, is called
structural unemployment.
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9.5 Wage Rigidity and Structural Unemployment
Exhibit 9.8 Labor Supply and Labor Demand in a Market with a
Minimum Wage
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9.5 Wage Rigidity and Structural Unemployment
Question: What can cause wage rigidity?
• Minimum wage laws are imposed.
• Labor unions negotiate higher wages.
• Firms pay higher wages to raise worker
productivity.
• Workers resist wage reductions.
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9.5 Wage Rigidity and Structural Unemployment
The U.S. federal government, most states, and a
few cities have minimum wage laws, which
prohibit employers from hiring workers for less
than a given (or minimum) hourly wage rate.
Minimum wage laws can keep the wage above
the market-clearing wage, w*, and thus create
structural unemployment.
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9.5 Wage Rigidity and Structural Unemployment
Exhibit 9.8 Labor Supply and Labor Demand in a Market with a
Minimum Wage
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9.5 Wage Rigidity and Structural Unemployment
Minimum wage laws cannot be the main cause
of unemployment.
Why? In 2013, 1.5 million workers (1% of total)
were paid the minimum wage.
There were 1.6 million unemployed college
graduates whose median hourly wage rate was
close to $30 per hour.
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9.5 Wage Rigidity and Structural Unemployment
Labor unions negotiate
contracted wage rates
through collective
bargaining that may be
above the market-clearing
wage, w*.
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9.5 Wage Rigidity and Structural Unemployment
Collective bargaining cannot be the main cause
of unemployment.
Why? In 2013, only 14.5 million workers (11%
of total) were members of public- and private-
sector unions.
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9.5 Wage Rigidity and Structural Unemployment
Firms may willingly pay above the market-
clearing wage to increase worker productivity.
These efficiency wages increase productivity by:
1. Reducing worker turnover
2. Reducing shirking
3. Motivating workers to work harder
4. Improving the quality of job applicants
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9.5 Wage Rigidity and Structural Unemployment
Efficiency wages cannot be the main cause of
unemployment.
Why? Although there are large wage
differences across industries and professions,
most of this is explained by productivity
differences.
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9.5 Wage Rigidity and Structural Unemployment
Workers are highly adverse to reductions in
wages, resulting in what economists call
downward wage rigidity.
As a result, most firms would rather fire some
workers than cut wages of all or many workers.
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9.5 Wage Rigidity and Structural Unemployment
Exhibit 9.9 Shifts in Labor Demand Affect Equilibrium in the
Labor Market
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9.5 Wage Rigidity and Structural Unemployment
We can see the importance of downward wage
rigidity by looking at the distribution of wage
increases at one large firm in 2008 during the
Great Recession.
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9.5 Wage Rigidity and Structural Unemployment
Exhibit 9.10 The Distribution of Wage Increases at One Large
Firm in 2008
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9 Employment and Unemployment
Evidence-Based Economics Example
Question: What happens to employment and
unemployment if local employers go out of
business?
Data: Community-level data on employment,
unemployment, and industry composition plus
national data on industry-by-industry growth in
Chinese imports from 1990 to 2007.
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9 Employment and Unemployment
From 1990 to 2007, the unemployment rate in
Pittsburgh, Pennsylvania, fell from 7.3% to 5.5%.
From 1990 to 2007, the unemployment rate in
Raleigh-Durham, North Carolina, rose from 4.0%
to 5.9%.
Why the difference?
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9 Employment and Unemployment
Exhibit 9.11 A Tale of
Two Cities
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9 Employment and Unemployment
Pittsburgh specialized in industries such as paper,
printing, and metal products that had “low
exposure” to competition from Chinese imports.
Raleigh-Durham specialized in industries such as
textiles, apparel, and electronic products that had
“high exposure” to competition from Chinese
imports.
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9 Employment and Unemployment
As a result, the labor demand curve in Raleigh-
Durham shifted more to the left than in
Pittsburgh, and this, combined with wage rigidity,
led to more unemployment in Raleigh-Durham.
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9 Employment and Unemployment
Evidence-Based Economics Example:
Question: What happens to employment and
unemployment if local employers go out of business?
Answer: Communities with a high level of exposure
to competition from Chinese imports between 1990
to 2007 experienced an increase in the local rate of
unemployment relative to communities with low
exposure.
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