Session-7

7 MACROECONOMICS

Biswa Swarup Misra

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What Does the U-Rate Really Measure?The u-rate is not a perfect indicator of joblessness or the health of the labor market:excludes discouraged workersdoes not distinguish between full-time and part-time work, or people working part time because full-time jobs are not available.Also, some people may misreport their work status in the BLS survey. Despite these issues, the u-rate is still a very useful barometer of the labor market & economy.

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Cyclical Unemployment vs. the Natural RateTheres always some unemployment, though the u-rate fluctuates from year to year. The natural rate of unemploymentthe normal rate of unemployment around which the actual unemployment rate fluctuates cyclical unemploymentthe deviation of unemployment from its natural rate associated with business cycles, which well study in later sessions

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U.S. Unemployment Since 1960

0

2

4

6

8

10

12

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

(per

cent

age

of la

bor f

orce

)

Unemployment rate

Natural rate of unemployment

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Explaining the Natural Rate: An OverviewEven when the economy is doing well, there is always some unemployment, including:Frictional unemploymentOccurs when workers spend time searching forthe jobs that best suit their skills and tastesshort-term for most workersStructural unemploymentoccurs when there are fewer jobs than workersusually longer-term

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Job SearchWorkers have different tastes & skills, and jobs have different requirements. Job search is the process of matching workers with appropriate jobs. Sectoral shifts are changes in the composition of demand across industries or regions of the country. Such shifts displace some workers, who must search for new jobs appropriate for their skills & tastes. The economy is always changing, so some frictional unemployment is inevitable.

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Public Policy and Job SearchGovt employment agencies:give out information about job vacancies to speed up the matching of workers with jobsPublic training programs:aim to equip workers displaced from declining industries with the skills needed in growing industries

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Unemployment Insurance

Unemployment insurance (UI): a govt program that partially protects workers incomes when they become unemployed UI increases frictional unemployment. To see why, recall one of the Ten Principles of Economics: People respond to incentives.

UI benefits end when a worker takes a job, so workers have less incentive to search or take jobs while eligible to receive benefits.

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Unemployment InsuranceBenefits of UI:reduces uncertainty over incomesgives the unemployed more time to search, resulting in better job matches and thus higher productivity

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Explaining Structural Unemployment

Structural unemployment occurs when not enough jobs to go around. W

LD

S

WE

actual wageW1

unemp-loyment

Occurs when wageis kept above eqm. There are three reasons for this

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1. Minimum-Wage LawsThe min. wage may exceed the eqm wage for the least skilled or experienced workers, causing structural unemployment. But this group is a small part of the labor force, so the min. wage cant explain most unemployment.

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2. UnionsUnion: a worker association that bargains with employers over wages, benefits, and working conditions Unions exert their market power to negotiate higher wages for workers. The typical union worker earns 20% higher wages and gets more benefits than a nonunion worker for the same type of work.

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2. UnionsWhen unions raise the wage above eqm, quantity of labor demanded falls and unemployment results. Insiders workers who remain employed, they are better offOutsiders workers who lose their jobs, they are worse offSome outsiders go to non-unionized labor markets, which increases labor supply and reduces wages in those markets.

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2. UnionsAre unions good or bad? Economists disagree. Critics: Unions are cartels. They raise wages above eqm, which causes unemployment and/or depresses wages in non-union labor markets. Advocates: Unions counter the market power of large firms, make firms more responsive to workers concerns.

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3. Efficiency Wages

The theory of efficiency wages: firms voluntarily pay above-equilibrium wages to boost worker productivity. Different versions of efficiency wage theory suggest different reasons why firms pay high wages.

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3. Efficiency Wages

1. Worker healthIn less developed countries, poor nutrition is a common problem. Paying higher wages allows workers to eat better, makes them healthier, more productive. 2. Worker turnoverHiring & training new workers is costly. Paying high wages gives workers more incentive to stay, reduces turnover.

Four reasons why firms might pay efficiency wages:

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3. Efficiency Wages

3. Worker qualityOffering higher wages attracts better job applicants, increases quality of the firms workforce. 4. Worker effortWorkers can work hard or shirk. Shirkers are fired if caught. Is being fired a good deterrent?Depends on how hard it is to find another job. If market wage is above eqm wage, there arent enough jobs to go around, so workers have more incentive to work not shirk.

Four reasons why firms might pay efficiency wages:

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A C T I V E L E A R N I N G 3: ExerciseWhich of the following would be most likely to reduce frictional unemployment?

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A. The govt eliminates the minimum wage.B. The govt increases unemployment insurance benefits. C. A new law bans labor unions. D. More workers post their resumes at Monster.com, and more

employers use Monster.com to find suitable workers to hire.E. Sectoral shifts become more frequent.

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A C T I V E L E A R N I N G 3: AnswersWhich of the following would be most likely to reduce frictional unemployment?

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A. The govt eliminates the minimum wage.

C. A new law bans labor unions.

These are likely to reduce structural unemployment,

not frictional unemployment.

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A C T I V E L E A R N I N G 3: AnswersWhich of the following would be most likely to reduce frictional unemployment?

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B. The govt increases unemployment insurance benefits.

E. Sectoral shifts become more frequent.

These are likely to increasefrictional unemployment, not reduce it.

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A C T I V E L E A R N I N G 3: AnswersWhich of the following would be most likely to reduce frictional unemployment?

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D. More workers post their resumes at Monster.com, and more employers use Monster.com to find suitable workers to hire.

Likely to speed up the process of matching workers & jobs, which would

reduce frictional unemployment.

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Explaining the Natural Rate of Unemployment: A SummaryThe natural rate of unemployment consists of frictional unemploymentit takes time to search for the right jobs occurs even if there are enough jobs to go aroundstructural unemploymentwhen wage is above eqbm, not enough jobs due to min. wages, labor unions, efficiency wagesIn later sessions, we will learn about cyclical

unemployment, the short-term fluctuations in unemployment associated with business cycles.

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Capturing Unemployment in IndiaThe NSSO collects data on employment and unemployment using alternative reference periods relating to three approaches. These are: the 'usual status' (US) approach, based on the a reference period of one year;the 'current weekly status' (CWS) approach, based on a reference period of one week; and the 'current daily status' (CDS), based on the activity pursued on each day of the reference week. While all three approaches are used for collection of data on employment and unemployment in the quinquennial surveys, the first two approaches are only used for the intervening annual surveys. The definitions of these three approaches are set out below.

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Capturing Unemployment in IndiaIn a number of earlier rounds, the NSSO has experimented with various concepts and methodologies in trying out and standardizing a proper framework to estimate, in quantitative terms, the characteristics of labour force, employment, unemployment and under-employment. The experimental surveys were followed by regular annual sample surveys till late sixties. Afterwards, the quinquennial surveys started in 27th round (1972-73), with the follow up surveys in 32nd round (1977-78), 38t h round (1983) and 43rd round (1987-88) and 50t h Round (1993-94). The NSSO now also gives annual estimate of employment and unemployment on the basis of a thin sample.

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Capturing Unemployment in IndiaThe data are obtained through sample surveys conducted by the National Sample Survey Organisation (NSSO). Every fifth year, the sample size is of the order of 120,000 households. In intervening years, the sample size is of the order of 40,000 households. Each survey is divided into four sub-rounds, with each sub-round of three months duration. (The results of each sub-round are not presently compiled separately.) The survey covers the whole of the rural and urban areas of India, except for a few inaccessible and difficult pockets. The activity status of each person in the household is collected with reference to the previous 365 days, the previous 7 days and daily for 7 days.

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'Usual Status' Approach'Usual Status' approach. This is based on the status of the activity on which a person spent the majority of the 365 days preceding the date of the survey. A person is considered to be 'working or employed' if he/she was engaged for a relatively longer time during the past year in any one or more work-related (economic) activities. A person is considered to be 'seeking or available' for work or 'unemployed' if the person was not working but was either seeking or available for work for a relatively longer period of time during the past year.

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Concept of workThe NSSO has defined work or gainful activity as the activity pursued for pay, profit or family gain or in other words, the activity which adds value to the national product. Normally, it is an activity, which results in production of goods and services for exchange. However, all activities in agricultural sector in which a part or whole of the agricultural production is used for own consumption and does not go for sale are also considered as gainful.

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'Current Weekly Status' Approach'Current Weekly Status' approach. A person is considered to be working or employed if the person was engaged for at least one hour on any one day of the previous week on any work related (economic) activity. A person who has not worked for even one hour on any one day of the week, but has been seeking or has been available for work at any time for at least one hour during the week, is considered to be 'seeking/available for work' (unemployed). Others are considered to be 'not available for work' (not in the labour force).

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Relevance of CWS, CDS and USCWS reflects the unemployment during the current week of those classified as being employed in the US criterion.The difference between the unemployment rates on the CWS and US provides one measure of seasonal unemployment.CDS captures the within week unemployment status of those classified as employed as per the CWS status.US unemployment rate gives us the percentage of individuals in the labour force classified as unemployed.CDS tells us unemployment in terms of person days.

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'Current Daily Status' Approach'Current Daily Status' approach. This approach attempts to classify employment by person-days, rather than by persons. A person is considered to be 'working' (employed) for the entire day if he/she has worked 4 hours or more during the day. If a person has worked one hour or more, but less than 4 hours, he/she is considered to be 'employed' for half the day, and 'seeking/available for work' (unemployed) or 'not available for work' (not in the labour force) for the other half of the day depending on whether he/she is seeking or available for work.