Understanding Unemployment and Its Impacts

In this chapter we want to talk about unemployment, measuring unemployment, and the problems associated with looking at the unemployment rate. So we've talked previously about measuring income. We use the income of a nation. We use gross domestic product, GDP. We've talked also about how to measure changes in the cost of living. And remember, our goal with these chapters is to think about different ways of gauging the economic health of an economy. And so another thing that we can look at to gauge the economic health of an economy is the unemployment rate. And what we'll see is that the unemployment rate is going to measure the number of people in an economy that want to work but aren't working. And the higher the unemployment rate, other things equal. the worse off the economy is because those are people that want to be productive and aren't being productive. And so, again, all other things equal, the economic pie is going to end up being smaller the higher the unemployment rate is. So, let's think about, first off, thinking about kind of the different type of unemployment that we're going to be thinking about. We can divide unemployment up. into what we're going to call the natural rate of unemployment. And then we can think about what we're going to call the cyclical rate of unemployment. So let me give you kind of a quick idea of what that looks like. If I were to graph what unemployment looks like over time, if we put time down here and we put percent up here and we graphed the unemployment rate from, say, one year to the next, It's going to fluctuate. There are going to be times when it's high and times when it's low, and it's going to kind of move around like this. And when the unemployment rate is low, that's good for the economy. When the unemployment rate's high, that's bad for the economy. But it's going to fluctuate. If we looked at kind of what we could think of as maybe the average rate of unemployment, we could draw a line through that to think about kind of what average unemployment looks like from one year to the next. And so if we did that, we could call this the natural rate of unemployment. You can think about that kind of as the average rate of unemployment that the economy typically experiences. But from one year to the next, it's going to fluctuate around that. Not necessarily higher than lower. Maybe for several years it's higher and several years it's lower. What we talk about here would be cyclical unemployment. And we can think about what causes the natural rate of unemployment to be what it is in an economy and then we can also think about what causes unemployment to kind of fluctuate from one year to the next. This is something that we're going to think about a little bit later on in a later video. where we think about what causes the unemployment rate to fluctuate, you know, in a short amount of time, in the short run. In this chapter, we're going to focus more on what determines this natural rate of unemployment, what determines whether or not that's 3% or 6% or 8% in an economy. In the U.S. economy, the natural rate of unemployment is somewhere in the neighborhood of 4.5% to 5%, somewhere in there. So we want to know what is it that determines that that's four and a half to five percent versus one percent or zero percent. Why is there always typically going to be some unemployment? So in this chapter we're going to be focusing kind of on that. We'll come back to that cyclical unemployment a little bit later. Let's talk about identifying the unemployed people that are in an economy. So the Bureau of Labor Statistics is the organization that calculates the unemployment rate and then reports it. It's reported monthly by the Bureau of Labor Statistics, and the way they calculate it is they do a survey of about 60,000 households. A lot of times in a face-to-face class, I'll ask my class, what do you think about that sample size? Do you think that a... A sample of about 60,000 households is a big enough sample to get a good estimate. of the unemployment rate for an economy the size of the U.S. economy, and most students, their knee-jerk reaction is, no, gosh, that's not anywhere close to being big enough. That's a pretty good-sized sample. That is a big enough sample to get a pretty good estimate of what the unemployment rate is across the economy. We'll talk about some shortcomings, some problems with the unemployment rate. It's not perfect, but... Don't be bothered by that sample size. That's a pretty good size sample. So what the Bureau of Labor Statistics does is they sample 60,000, survey 60,000 households, and then each adult in that household is placed in one of three categories. The first category is employed. So if you spent part of the previous week... Working at a paid job, you would be recorded by the Bureau of Labor Statistics as being employed. It doesn't have to be the job you want or the job you think you are going to find someday. If you spent part of the previous week at a paid job, then you are counted as employed. The second category is unemployed. So you are counted as unemployed if you have a temporary layoff. Or you're looking for a job within the last four weeks. So it could be a temporary layoff or looking within the last four weeks. Looking within last four weeks. If the last time you looked for a job was five weeks ago, then you're not counted as unemployed anymore. The third category is not in the labor force. So you would be counted as not in the labor force if you are in neither of these categories. So if you're, say, a full-time student or somebody who is running a household, a homemaker, you're not counted in the labor force. Not being in the labor force doesn't mean you're not working. If you're running a household, that means you're going to be working a lot, but you're not officially in the labor force because you're not working at a paid job. So, that's the three categories that the Bureau of Labor Statistics is going to put you in. And then once we have the numbers for these three categories, then we can calculate some different statistics. So, the first thing we want to think about is the labor force, the size of the labor force. So, the labor force is going to be equal to the number of employed plus the number of unemployed. So, number of employed. plus number of unemployed. Those two numbers capture all the people who want to work and have a job, plus the people who want to work and don't have a job, and are actively looking for a job. So that's the labor force, number of employed plus the number of unemployed. Once we've got that, we can calculate the unemployment rate. Unemployment rate, very easy to calculate. You simply take the number of unemployed and divide by the labor force. Unemployed divided by labor force, we multiply it by 100 to turn it into a percent. So that gives us the unemployment rate. That tells us the percent of the labor force that doesn't have a job but is actively looking for a job. The Bureau of Labor Statistics calculates the unemployment rate for different subgroups of the population. So we could think about the overall unemployment rate across all workers. We could think about the unemployment rate for people in a particular state or a particular region within the country. We could think about the unemployment rate based upon the race. of people. We could think about the unemployment rate based upon age. So we could look at the unemployment rate, say, for people 18 to 24. So the Bureau of Labor Statistics calculates a whole bunch of different unemployment rates for subcategories of the population. We can also think about something else that's going to be interesting to consider, and that's the labor force participation rate. Labor force. Participation rate. And what that, the way that's calculated, is going to be the labor force divided by the adult population. Labor force divided by the adult population, and then we multiply by 100 to turn it into a percent. So that tells us the percent of the total adult population that's actually participating in the labor force. Let's think about a numerical example. You can see calculating these things is not challenging. As long as you remember what to divide by what, it should be pretty easy. Let's look at an example. Let's use some numbers from 2009. 2009 was kind of an interesting year in terms of the employment situation in the U.S. So let's think about that. In 2009... We had 139.9 million people employed. Million employed. There were 14.3 million unemployed. And then let's look at the adult population. The adult population was 235.9 million. Say adult population. So let's use those numbers to calculate these things that we've defined here. Let's start by thinking about the labor force. So the labor force is going to be the number of employed plus the number of people unemployed. So it's going to be 139.9 plus 14.3. That gives us a labor force of 154.2 million. We can calculate the unemployment rate. Unemployment rate. So we have to take the number of people unemployed, 14.3, divide by the labor force, which is 154.2. We multiply by 100. That gives us an unemployment rate of 9.3% in 2009. We could think about the labor force participation rate. Labor force participation rate. There we're going to be thinking about the labor force divided by the adult population. That's 154.2 divided by 235.9. We multiply by 100. That gives us a labor force participation rate of 65.4%. So approximately 65% of the adult population was participating in the labor force. Obviously that means approximately 35% of the adult population is not participating in the labor force. Not working, not looking for a job, at least not working at a paid job. They could be homemakers, they could be students. Could be working real hard, but not at a paid job. So you can see that calculation of these things is not challenging. One of the things that you would tend to see on an economics test is that I might ask you questions about who's in the labor force and who isn't. So I could say, consider a person who used to work as a carpenter. They don't have a job now, and the last time they applied for a job was seven weeks ago. Is this person? Unemployed, employed, not in the labor force. Well, if the last time they looked for a job was was seven weeks ago, then they're not in the labor force. They're not unemployed because they're not looking within the last four weeks. So those are the types of questions you might get asked on a test. Of course, there would be questions where you'd have to calculate these. So you might be given some numbers that look like this and then be asked to calculate. Unemployment rate, labor force participation rate. Remember that anytime you've got a formula, like this formula for the unemployment rate, let's use this one, this formula for the unemployment rate, you've got three things in here. You've got the rate over here, you've got the number of people unemployed, and you've got the labor force. You could be given any two of these and asked to solve for the third one. So I could give you the unemployment rate and the size of the labor force, and then ask you how many people are unemployed. So just keep that in mind. This is all relatively straightforward, but you have to kind of consider the ways that questions can be asked. What we want to do now is clear this off and then think about whether or not the unemployment rate, whether or not that really measures what we want it to. We have to think about some challenges with interpreting what this number of 9.3% actually tells us. So let's clear this off and then we'll take a look at that. All right, let's consider some of the challenges with the unemployment rate. One of the main challenges is interpreting or... deciding which category to put somebody in. So if you think about what we just discussed here, about the fact that the Bureau of Labor Statistics is going to put each adult in the household into one of those three categories, it's really easy to distinguish the difference between somebody who's working and somebody who's not. So it's not hard to tell when somebody's employed versus when they're not employed. But what is hard to figure out sometimes is whether somebody is unemployed or not in the labor force. And so that creates a challenge when we think about interpreting the unemployment rate. Let's think about some characteristics of just how people choose to work or not. It's very common for people to move in and out of the labor force. So more than one-third of all unemployed at any particular time are new entrants into the labor force. So those could be young workers looking for a first job. So people maybe getting out of college or getting out of high school that are looking for a first job. It could be older workers who left the labor force and now are coming back. So it's not the case that if somebody leaves the labor force, they're just out of it for the rest of their life. It's very common for people to leave the labor force for a while and then go back into it. It also turns out that about half of the spells of unemployment end with the person leaving the labor force, not with them finding a job, but leaving the labor force. So that can make it challenging. Because people move in and out of the labor force so frequently, it can be really hard to understand exactly how to interpret unemployment statistics. It's also the case that some people who report not being in the labor force are actually what we would call a discouraged worker. A discouraged worker is somebody who has become so discouraged with the process of finding a job that they've just given up. And so that's the kind of person that's challenging to kind of get a grip on and figure out how much of that is taking place in the economy. Because they haven't looked for a job in the last four weeks, but it's somebody who, if offered a job, would probably take it because they want to be working. They've just given up looking. They're frustrated with the process. So it can be hard to measure how many discouraged workers there are. Actually, if you go back to 2009, let's revisit that. We just used those numbers to calculate some. measures of unemployment, what we saw was that there was about 9.3% unemployment in 2009. 2009, we were in the midst of a recession. Actually, the recession was probably over by then, technically, because remember, a recession is two consecutive quarters of declining GDP. So the recession was over, but things were still not that good. Things were actually pretty bad and continue to be pretty bad. unemployment-wise for quite a while. There were a lot of discouraged workers. It can be hard to estimate how many, but if you were to include the number of discouraged workers, it's estimated that the actual unemployment rate, if discouraged workers were included, if discouraged workers were included, It's estimated that the unemployment rate was closer to about 16.3%. So you may have heard somebody say, well, the official unemployment rate, that doesn't really capture the full story. And there's some truth to that because discouraged workers are hard to pin down how many of them there are. And so it depends on exactly how you estimate the number of them. But. You can see that if we would have included discouraged workers in 2009, the unemployment rate would have been significantly higher than 9.3%. And so the Bureau of Labor Statistics tries to get a grip on how many unemployed or how many discouraged workers there are, but it's not precise. That's one of the challenges. Let's think about how long the unemployed are typically without work. So what we want to think about here is whether or not being unemployed is kind of a short-term problem or whether it's a long-term problem for the people who are unemployed. And the reason we want to think about that is that we want to figure out how much help the government needs to give people who are unemployed. If it's typically short-term, then maybe it's not that big of a problem. On the other hand, if it's typically long-term, then maybe it is a problem, and we need to think about how we might help those people find a new job. Let me give you a sentence that will kind of summarize whether unemployment is a long-term problem or a short-term problem. Let's write this sentence out. The sentence is going to appear contradictory, but let's write it out, and then we'll kind of take a look at it. Turns out... That most spells of unemployment are short. Most spells are short, but most unemployment is long-term. Let's say it this way. Most unemployment observed at any given time is long-term. Most spells of unemployment are short, but most unemployment observed at any given time is long-term. If I just said that and then moved on, you'd probably say, well, gosh, that doesn't really seem like it's consistent with itself. But it turns out that it is. We need to think about why this sentence makes sense, and the way to do it is just to think about maybe a nice, simple, numerical example. Let's suppose that you wanted to get a grip on... the unemployment situation of people in your town. And so let's suppose that every week you went down to the unemployment office and you just observed who was there. And let's suppose that when you did that, you did that every week for a year. So let's suppose that every week you observed four unemployed people. Every week there were four people that were unemployed. Let's suppose that each week three of those was a new person, so three new people, but then suppose that fourth person, now let's suppose that three the same person. That'll make it, that'll make things work out. So three of them are always the same person. Then there's always one new person. So, every week you see these three people. They're always there. You get to know them within the first couple weeks by name. You walk in, there's those three people. But then there's always this fourth person. There's always a new person. So, now let's think about it. At the end of that year, if you had always seen those three people there for that full year, but then you also all observed a fourth person, a new person every week, let's think about how you would summarize The unemployment situation in your hometown. So you've met a total of 55 unemployed people in that year. 55 unemployed people. You met these three people every week for 52 weeks, but then you met this new person, 52 other people that you saw each there for one week. That means, let's summarize that, 52 were unemployed for a week, unemployed one week, and three were unemployed a full year. So 52 out of 55 people, that's 95% of the spells of unemployment ended in one week. 95% of the unemployment spells ended in one week. So most spells of unemployment are short. Three of the spells of unemployment lasted a full year, but 95% of them... ended in a week. But now let's think about the number of weeks of unemployment that you've observed. So let's think about the total amount of unemployment. So if we were to consider it that way, total amount of unemployment, what we've had is three people each unemployed for 52 weeks. Those three people account for 156 weeks of unemployment. Three people accounted for 156 weeks of unemployment. You've got 52 people that each are accounting for one week. That's another 52 weeks. So there were a total of 208 weeks of unemployment. 208 weeks total. 156 of them were attributable to three people, long-term unemployment. So 156 out of 208, that's 75% of the unemployment, of the unemployment, total weeks of unemployment, that were attributable to three people. In other words, most unemployment observed at any given time is long-term. Those three people were unemployed long-term. 75% of the unemployment. So, what's the kind of takeaway from this? Well, what I would say is that you have to be really careful with how you interpret unemployment statistics. What I always tell my students is that if you're not aware of the way that the story can be... fashioned, then it's going to be easy to fool you with the numbers. What you find out as you start looking at statistics is that it's very easy to tell the story that you want to tell. So if somebody were to ask me, describe unemployment. Is unemployment a big problem or not a big problem? If I wanted to make it look like it's not a big problem, I could say, well, most bills of unemployment are short. Most people who become unemployed are going to find a job very rapidly. If on the other hand I wanted to make unemployment sound like a big problem, I could say, well, most unemployment that we observe is long term. Most of the unemployment that we observe is attributable to people who have a really, really difficult time finding a job and the government needs to step in and help them. So you can tell whatever story you want. And I think as a As a consumer of information from other people, it's up to you to be smart about how you might be told a story in an effort to influence your behavior. It's up to you to be smart about how to interpret things like this. So it's kind of a mixed story. Most spells are short, most unemployment is long term. Let's talk about why there are... always going to be some unemployed people. So I started this video with a little picture over there where we looked at the natural rate of unemployment and then we looked at cyclical unemployment that fluctuated around that. What we want to think about is why is it that there are always some unemployed people? Why is that natural rate of unemployment not down there by zero? And so what we need to do, let's clear this off and then we'll talk about what some of the causes of unemployment are. So let's think about what goes into that natural rate of unemployment. And we're going to think about two different types of unemployment. The first one is what we're going to call frictional unemployment. And frictional unemployment you can think about as being the unemployment that results from the matching of workers with jobs. And we'll talk more about that here in just a second. Then there's what we call structural unemployment. Structural unemployment is a situation where there's just not enough jobs to go around. So let's call this, let's just say matching. This is what happens when somebody says, you know what, I don't like my job, I'm going to quit this job and find a different job. That would be what we would call frictional unemployment. And we'll talk more about that here in a second. Structural unemployment is where there's not enough jobs. So it's not a matter of just quitting a job and then finding another one. It's that it doesn't matter how long you look, there's not enough jobs to go around. Now both of these are going to be explanations for why that natural rate of unemployment is somewhere, at least in the U.S., around 4.5% to 5%. So we talked about cyclical unemployment, and we talked about the natural rate of unemployment. These are not two things additional to that. These are two explanations for what causes the natural rate of unemployment to be what it is. So let's start by thinking about... Let's go back just a little bit and think about demand and supply. So if we were to think about what's going on with, say, a labor market. Let's think about a labor market where we've got, if we had a demand and supply picture, we've got price up there, we've got quantity down there, we've got demand, and we've got supply. We've been thinking about this as if it was the output market, so say the market for gasoline. We've talked a lot about how that market works. It would also work the same way if this was the market for labor. So if we were thinking about this as being the market for labor, instead of just calling this price, we might call it the wage, because that's the price of labor. And this quantity down here we could think about in terms of the amount of hours of labor purchased, or we could think about it you could think about in terms of number of workers. There's lots of different ways to think about that. But what we know is from our study of how a market works is that the law of demand and supply tells us that as long as the price is allowed to adjust, it will adjust until quantity demanded is equal to quantity supplied. And so we know that if the price is allowed to adjust, it's going to move to right there and our quantity is going to move to right there. And this is the price at which there's no surplus or shortage. So what we know is that if the labor market functioned exactly like the markets that we were thinking about in our previous videos, there would be no surplus of labor or shortage of labor, or at least not long term. The price would adjust to eliminate any surplus or shortage, and unemployment is a surplus of labor. So what we need to think about is what's going on? Why is it that in the labor market this isn't happening, or the various labor markets? Why is it that this is not happening? Why is there always some unemployment? And so that's where these two things come in. There's always going to be some unemployment. Some of it's going to be coming from frictional unemployment. Some of it's going to be coming from structural unemployment. So let's start by thinking about frictional. The first cause of frictional unemployment we can think about is job search. So here's a, there are a couple of things that are happening here. The economy is constantly changing. So let's start with that. The economy is constantly changing. What that means is. Consumer demand for different goods and services is constantly changing. Input prices are changing. What happens is that as the economy changes, some jobs vanish and other jobs open up. So if we think about what happens in, say, a market, let's think of this as, say, the market for some good or service. This could be, say, the market for potato chips or the market for tennis shoes or it doesn't matter. We've got a demand and we've got a supply. Let's think about the quantity that's bought and sold in the market and then let's think about what happens if consumer demand decreases. If consumer demand shifts from D1 to the left to D2, then the equilibrium quantity in this market is going to fall from Q1 to Q2. What that means is if firms are now producing a smaller quantity than before, Because less of the good is being bought and sold, firms are not going to need as much labor in this particular industry. And so that means they're going to let some workers go, some jobs are going to vanish. And so if consumer demands decrease in one particular industry or increase in that industry, that can affect the number of jobs in that industry. And so because our economy is constantly changing, some jobs vanish, other jobs are appearing. And this is just a characteristic of a healthy economy. It can be tempting to say, oh, well, you know, the introduction of the ATM has caused some bank tellers to lose their jobs. And it can be tempting to say, well, we need to keep that from happening. But you have to think really carefully about whether or not you want to prohibit technological progress to try to protect some jobs. It could be the case that if your job vanishes because of changes in consumer demand, it's not a comfortable situation to be in. So we're not saying that it's good for the people whose jobs vanish at all, but what's happening here is just something that happens in a healthy economy. We can also think about another aspect of this as people are free to... quit their job. So people, some people, let's say, quit their job to find a better one. You're free to do that if you want. Better one. Some people quit their job to find a better one. Well, that's part of this matching yourself with the right job for you. We can look at that from the perspective of the employer too. Employers are free to fire a worker and find a better worker. So if you've got, if you're an employer and you've got a worker that's not doing the job or maybe they're stealing stuff from the job site or maybe they just don't do the job right, you can let them go and find somebody who will do the job right. So there what you're trying to do is match up your job with the right worker for you as an employer. And so because that is constantly happening in the economy, there's always going to be some unemployment. Another cause of frictional unemployment is unemployment insurance. So what unemployment insurance is, is something that you can apply for from the government. If you don't have a job and you're in the process of looking for a job, the government will give you, typically in the U.S., it's half of your previous salary for half of a year, for 26 weeks. So that gives you kind of a safety net, a little bit of a cushion so that you don't go from earning a certain amount to earning nothing. It allows you to ease the pain of being without a job. And that can happen if your job vanishes because of changes in the economy, if you get fired. So how generous these benefits are, of course, is going to determine the pain that you feel or the discomfort that you feel from not having a job. And the more generous these benefits are, the less hard people will look for a job. So we have to be careful with how generous we make them. If, for example, we said that if you don't have a job, we'll give you your full salary for a full year, well, then that starts to feel like a paid year's vacation. And so if people were to be without a job, they're probably not going to look very hard for a job, at least for a while. So we have to be careful as to how generous those are, but there needs to be some type of safety net for people who find themselves without a job. So in terms of frictional unemployment, it's typically going to be job search. The economy is constantly changing. Some people will quit their job to find a better one or a different one. Some employers will fire workers to find a better worker. And then the generosity of unemployment in benefits affects how quickly people find another job. Those are all part of frictional unemployment. This we would describe as being a characteristic of a healthy economy. I would hesitate to describe it as the good kind of unemployment because if you're one of the people unemployed, it doesn't feel good. But this is not a situation where there aren't enough jobs to go around. It's a situation of matching yourself with the right job. Let's talk now about some causes of structural unemployment. Structural unemployment. is going to be a worse type of unemployment. This is going to be a situation where there are not enough jobs to go around. So it doesn't matter how hard you look for a job, there simply is not enough to go around. The first cause of structural unemployment would be the minimum wage. So let's think about how the minimum wage works. If we draw a picture of a labor market here, we're going to have the wage. The type of labor market we're thinking about here would be the market for unskilled labor. Down here we're going to have the quantity of labor. I'm trying to squeeze that in there, quantity of labor. We've got a demand for labor. We've got a supply of labor. Let's think about who's behind the demand curve and who's behind the supply curve. So if we go to this picture right here, if we were thinking about this as being the demand and supply for some good, like say potato chips, then the buyers of potato chips would be consumers, and the people that are behind the supply curves would be the businesses, the firms. If we think about the labor market, then the buyers of labor are going to be the firms. And the suppliers of labor are typically going to be the households or the consumers, people like us. So who's behind the supply curve in this picture is the opposite of who's behind the supply curve in that picture, and who's behind the demand curve is opposite. But the market works like any other type of market. In the absence of any type of restrictions on wage, the wage would go to right there, and the quantity of labor bought and sold would go to right there. But if the government were to establish a wage minimum above the equilibrium, and let's use this symbol to describe that minimum wage, W with a bar below it, in economics we would call that a price floor. It's a legal minimum on the price. It's a law that says it's illegal to buy and sell the good for anything less than that amount. If we think about what happens if we establish a minimum wage, then that means that the allowable range for prices is going to be anything above that. These wages are allowable. But the market is going to want to push the wage down to that point. Well, the law won't allow that, so the wage will be at the minimum. Right there is going to be quantity demanded. There's quantity supplied. The number of, the amount of labor that firms want to buy, here's the quantity supplied, the amount of labor that households want to sell, that of course is a surplus. There's your surplus, that's unemployment. So if you have a minimum wage, that's going to create unemployment in the market for unskilled labor. It can be tempting to think, I've been in discussions with people who say something like, well, okay, I guess I can see that that's going to create some unemployment, but over time that's going to go away. No, actually it's not. It turns out that typically demand and supply tend to be a little bit flatter over longer time horizons. And you can tell that if the demand curve was flatter and the supply curve was flatter, There's going to be more unemployment over longer time horizons, so it's not just going to go away. There is some disagreement amongst economists as to exactly how much unemployment is created. You can see that if the demand curve and the supply curve were steeper, the amount of unemployment would be less. And so economists disagree amongst themselves as to how much unemployment is actually created and whether or not it's that big of a deal. But you can see that the unemployment... that the minimum wage is going to create some unemployment. If the minimum wage were increased, if we had an increase in the minimum wage to this point, then you can see that the amount of unemployment that is created is actually going to go up. It's going to get bigger. So increases in the minimum wage will increase unemployment. And the problem with this is that though it helps some people, it clearly hurts other people. So it's not all bad for workers. If you're a worker that still gets to keep your job, then you're going to be earning more as long as the businesses don't cut your hours. One way that businesses can adjust to a minimum wage is that they can not necessarily fire people, but buy less labor from them. So it could be that you don't lose your job, but your hours get cut. And so that's not going to show up as an increase in unemployment, but it's going to show up for you as being able to work less hours. So we have to keep this in mind. This is a situation where there's not enough jobs to go around. What most economists would say is that if we were to think about why politicians argue for a minimum wage or why anybody would argue for a minimum wage, the argument is typically that we need to help people. Maintain an adequate standard of living. People who are the heads of household, if they're working for the minimum wage, then it can be nearly impossible to raise a family with this. Turns out if you look at who's working for the minimum wage, a majority of people working for the minimum wage are teenagers from middle income families. It's not heads of households. So most economists would describe it as, at best, as a poorly targeted policy. It's not actually going to be. targeting the people that you're really interested in helping. And if you were to ask, well, okay, so what's a better policy? If the minimum wage is not a good policy to help workers that we want to help, what's a better alternative? Well, wage subsidies would be a better alternative. Simply subsidizing the income of people who you want to help, which we do in every industrialized economy. There is some of that that's going on. That's a better way to help those people rather than establishing some law that restricts price from moving. Remember, we talked about the law of demand and supply that says the price of any good or service will adjust if it's allowed to until quantity demanded equals quantity supplied. Well, this is a situation where we're not allowing price to adjust. And so quantity demanded and quantity supplied are not going to come together if... price is not allowed to adjust. Those typically are bad policies because you're restricting price. A better policy is to not restrict price and instead target more closely the people that you're trying to help. So the minimum wage, an example of one of the causes of structural unemployment, probably not a very big cause of the amount of unemployment in the economy, but it is a cause. If we think about another cause, we could think about unions, collective bargaining. So what a union is, is an organization that represents workers in a particular industry. Collective bargaining is the term that we use to describe the negotiation process between the union and the firm or the management of the firm. If the union's not happy with the way that the collective bargaining process is going, then the union can withhold labor, and we call that a strike. So a strike is just a withdrawal of labor in a way to put pressure on the firm to... negotiate with it. And essentially what the union is going to be arguing for is this, right? Now, the union would not be, they don't, the unions are not going to represent unskilled labor. The union represents skilled labor. But what they're going to be arguing for is a wage that's higher than the equilibrium wage. And so we're going to get a very similar picture to this. If the wage is higher than the equilibrium. Then firms are going to want to buy less labor. More people are going to want to work at that higher wage, and those more people are going to be people typically outside of the union as well as people within the union. But it's going to create a situation where there's unemployment. Typically, the union negotiation process is going to help the workers in the union at the expense of workers who are not members of the union. So, typically, most economics programs would have a class in labor economics. You could spend a year studying just labor economics, the history of unions. So, the conclusion I would hope that you get from this is not that unions are bad or that they're unnecessary or that we needed to somehow eliminate them, I would say that it would be up to you to just take a look at the history of the labor movement. If firms have what we would call market power over workers, then of course it would be natural for workers to form unions to try to counteract that market power. Turns out that the amount of market power that firms have has probably gone down significantly. compared to what it was in the early 1900s, and consequently union membership has fallen drastically below what it was in the early 1900s. But let's just leave it as this being another cause of there being not enough jobs to go around. The last thing that we're going to think about in terms of causes of structural unemployment would be what economists refer to as efficiency wages. Efficiency wages. So let's talk about what an efficiency wage is. An efficiency wage is the name that economists give it when the firm voluntarily pays more than it has to. So if we think about this picture, here's a picture where we've got the labor market, we've got an equilibrium wage, I've called it the price, but we could think about that as the wage. In these pictures, the firm is being forced to pay a higher wage, or they're negotiating with the union to pay a higher wage than the equilibrium. But it may be the case that the firm chooses on their own to pay a higher wage. And the reason that they might want to do that is because that creates a situation, well, let's use this picture, that creates a situation if the firm were to choose to pay W-bar. voluntarily, not because of some law, but just because it wants to, then it's probably going to want to hire less workers, more people are going to want to work at that wage, but let's think about the benefit to the firm. What that does is that raises the opportunity cost for the worker of losing this job. And so what you tend to see if you're a firm that chooses to pay higher than what you have to, you're typically going to get workers that work harder. It's going to increase productivity. It's going to decrease the amount of turnover that you experience, which is costly for the firm. If you train a worker and then they quit six months later, and you have to incur the cost of training another worker, that's expensive. So if you choose to pay more than what you have to, then you're going to get a higher quality worker. You're going to have workers that work harder. You're going to have less turnover. You're also going to have... More workers that want to work for you than you want to hire, which means you're going to have a stack of applications that you can choose from. You can go through that stack to find the best workers. When my kids were younger and we needed babysitters, I've got three kids, and when they were young, my wife and I chose to pay more than we had to to get somebody to babysit. Actually, significantly more than we had to. And the nice thing about that was that we never had a problem finding a babysitter. We paid well enough that there were times that people would call us up and say, hey, would you guys like to have a night out? Because they wanted to come over and babysit our kids. And they did a good job when they were babysitting. They would clean up and they would do anything that the kids wanted to do. And so that was a situation where we were choosing. Not because somebody made us. We were choosing to pay higher than what we had to because we knew that we were going to get better labor out of the people that were working for us at the time. Lots of people who argue for minimum wages, their argument is that if we don't do this, firms are just always going to pay nothing. Well, that doesn't make any sense. The firm would have to pay the equilibrium wage in the absence of a minimum. So They're not going to be able to pay nothing, and it can be the case that firms are going to have an incentive to voluntarily choose to pay more. That doesn't mean every firm will, but there are some great examples. Quick Trip is a good example of a firm that pays more than what it has to to get workers, and as a consequence, it gets better workers than if they chose to pay the equilibrium, the minimum that they would have to. So, these are some causes of structural unemployment. Remember, this is the bad kind of unemployment where there's not enough jobs to go around. These are some causes of frictional unemployment, a healthy kind of unemployment, even though it's not going to be comfortable for the people who are experiencing it. So, hopefully this video gives you some ideas of the challenges of estimating the unemployment rate, of interpreting what the unemployment rate means, and then an idea of where the unemployment rate comes from that goes into that natural rate of unemployment. So I'll see you in a future video.

We use gross domestic product, GDP. We've talked also about how to measure changes in the cost of living. And remember, our goal with these chapters is to think about different ways of gauging the economic health of an economy. And so another thing that we can look at to gauge the economic health of an economy is the unemployment rate.

And what we'll see is that the unemployment rate is going to measure the number of people in an economy that want to work but aren't working. And the higher the unemployment rate, other things equal. the worse off the economy is because those are people that want to be productive and aren't being productive.

And so, again, all other things equal, the economic pie is going to end up being smaller the higher the unemployment rate is. So, let's think about, first off, thinking about kind of the different type of unemployment that we're going to be thinking about. We can divide unemployment up. into what we're going to call the natural rate of unemployment.

And then we can think about what we're going to call the cyclical rate of unemployment. So let me give you kind of a quick idea of what that looks like. If I were to graph what unemployment looks like over time, if we put time down here and we put percent up here and we graphed the unemployment rate from, say, one year to the next, It's going to fluctuate.

There are going to be times when it's high and times when it's low, and it's going to kind of move around like this. And when the unemployment rate is low, that's good for the economy. When the unemployment rate's high, that's bad for the economy.

But it's going to fluctuate. If we looked at kind of what we could think of as maybe the average rate of unemployment, we could draw a line through that to think about kind of what average unemployment looks like from one year to the next. And so if we did that, we could call this the natural rate of unemployment. You can think about that kind of as the average rate of unemployment that the economy typically experiences.

But from one year to the next, it's going to fluctuate around that. Not necessarily higher than lower. Maybe for several years it's higher and several years it's lower.

What we talk about here would be cyclical unemployment. And we can think about what causes the natural rate of unemployment to be what it is in an economy and then we can also think about what causes unemployment to kind of fluctuate from one year to the next. This is something that we're going to think about a little bit later on in a later video. where we think about what causes the unemployment rate to fluctuate, you know, in a short amount of time, in the short run. In this chapter, we're going to focus more on what determines this natural rate of unemployment, what determines whether or not that's 3% or 6% or 8% in an economy.

In the U.S. economy, the natural rate of unemployment is somewhere in the neighborhood of 4.5% to 5%, somewhere in there. So we want to know what is it that determines that that's four and a half to five percent versus one percent or zero percent. Why is there always typically going to be some unemployment?

So in this chapter we're going to be focusing kind of on that. We'll come back to that cyclical unemployment a little bit later. Let's talk about identifying the unemployed people that are in an economy. So the Bureau of Labor Statistics is the organization that calculates the unemployment rate and then reports it. It's reported monthly by the Bureau of Labor Statistics, and the way they calculate it is they do a survey of about 60,000 households.

A lot of times in a face-to-face class, I'll ask my class, what do you think about that sample size? Do you think that a... A sample of about 60,000 households is a big enough sample to get a good estimate. of the unemployment rate for an economy the size of the U.S. economy, and most students, their knee-jerk reaction is, no, gosh, that's not anywhere close to being big enough. That's a pretty good-sized sample.

That is a big enough sample to get a pretty good estimate of what the unemployment rate is across the economy. We'll talk about some shortcomings, some problems with the unemployment rate. It's not perfect, but... Don't be bothered by that sample size. That's a pretty good size sample.

So what the Bureau of Labor Statistics does is they sample 60,000, survey 60,000 households, and then each adult in that household is placed in one of three categories. The first category is employed. So if you spent part of the previous week... Working at a paid job, you would be recorded by the Bureau of Labor Statistics as being employed.

It doesn't have to be the job you want or the job you think you are going to find someday. If you spent part of the previous week at a paid job, then you are counted as employed. The second category is unemployed.

So you are counted as unemployed if you have a temporary layoff. Or you're looking for a job within the last four weeks. So it could be a temporary layoff or looking within the last four weeks. Looking within last four weeks. If the last time you looked for a job was five weeks ago, then you're not counted as unemployed anymore.

The third category is not in the labor force. So you would be counted as not in the labor force if you are in neither of these categories. So if you're, say, a full-time student or somebody who is running a household, a homemaker, you're not counted in the labor force. Not being in the labor force doesn't mean you're not working. If you're running a household, that means you're going to be working a lot, but you're not officially in the labor force because you're not working at a paid job.

So, that's the three categories that the Bureau of Labor Statistics is going to put you in. And then once we have the numbers for these three categories, then we can calculate some different statistics. So, the first thing we want to think about is the labor force, the size of the labor force. So, the labor force is going to be equal to the number of employed plus the number of unemployed.

So, number of employed. plus number of unemployed. Those two numbers capture all the people who want to work and have a job, plus the people who want to work and don't have a job, and are actively looking for a job. So that's the labor force, number of employed plus the number of unemployed. Once we've got that, we can calculate the unemployment rate.

Unemployment rate, very easy to calculate. You simply take the number of unemployed and divide by the labor force. Unemployed divided by labor force, we multiply it by 100 to turn it into a percent. So that gives us the unemployment rate. That tells us the percent of the labor force that doesn't have a job but is actively looking for a job.

The Bureau of Labor Statistics calculates the unemployment rate for different subgroups of the population. So we could think about the overall unemployment rate across all workers. We could think about the unemployment rate for people in a particular state or a particular region within the country.

We could think about the unemployment rate based upon the race. of people. We could think about the unemployment rate based upon age.

So we could look at the unemployment rate, say, for people 18 to 24. So the Bureau of Labor Statistics calculates a whole bunch of different unemployment rates for subcategories of the population. We can also think about something else that's going to be interesting to consider, and that's the labor force participation rate. Labor force.

Participation rate. And what that, the way that's calculated, is going to be the labor force divided by the adult population. Labor force divided by the adult population, and then we multiply by 100 to turn it into a percent. So that tells us the percent of the total adult population that's actually participating in the labor force. Let's think about a numerical example.

You can see calculating these things is not challenging. As long as you remember what to divide by what, it should be pretty easy. Let's look at an example.

Let's use some numbers from 2009. 2009 was kind of an interesting year in terms of the employment situation in the U.S. So let's think about that. In 2009...

We had 139.9 million people employed. Million employed. There were 14.3 million unemployed. And then let's look at the adult population. The adult population was 235.9 million.

Say adult population. So let's use those numbers to calculate these things that we've defined here. Let's start by thinking about the labor force.

So the labor force is going to be the number of employed plus the number of people unemployed. So it's going to be 139.9 plus 14.3. That gives us a labor force of 154.2 million.

We can calculate the unemployment rate. Unemployment rate. So we have to take the number of people unemployed, 14.3, divide by the labor force, which is 154.2.

We multiply by 100. That gives us an unemployment rate of 9.3% in 2009. We could think about the labor force participation rate. Labor force participation rate. There we're going to be thinking about the labor force divided by the adult population.

That's 154.2 divided by 235.9. We multiply by 100. That gives us a labor force participation rate of 65.4%. So approximately 65% of the adult population was participating in the labor force. Obviously that means approximately 35% of the adult population is not participating in the labor force. Not working, not looking for a job, at least not working at a paid job.

They could be homemakers, they could be students. Could be working real hard, but not at a paid job. So you can see that calculation of these things is not challenging. One of the things that you would tend to see on an economics test is that I might ask you questions about who's in the labor force and who isn't.

So I could say, consider a person who used to work as a carpenter. They don't have a job now, and the last time they applied for a job was seven weeks ago. Is this person? Unemployed, employed, not in the labor force.

Well, if the last time they looked for a job was was seven weeks ago, then they're not in the labor force. They're not unemployed because they're not looking within the last four weeks. So those are the types of questions you might get asked on a test. Of course, there would be questions where you'd have to calculate these.

So you might be given some numbers that look like this and then be asked to calculate. Unemployment rate, labor force participation rate. Remember that anytime you've got a formula, like this formula for the unemployment rate, let's use this one, this formula for the unemployment rate, you've got three things in here.

You've got the rate over here, you've got the number of people unemployed, and you've got the labor force. You could be given any two of these and asked to solve for the third one. So I could give you the unemployment rate and the size of the labor force, and then ask you how many people are unemployed. So just keep that in mind.

This is all relatively straightforward, but you have to kind of consider the ways that questions can be asked. What we want to do now is clear this off and then think about whether or not the unemployment rate, whether or not that really measures what we want it to. We have to think about some challenges with interpreting what this number of 9.3% actually tells us.

So let's clear this off and then we'll take a look at that. All right, let's consider some of the challenges with the unemployment rate. One of the main challenges is interpreting or... deciding which category to put somebody in. So if you think about what we just discussed here, about the fact that the Bureau of Labor Statistics is going to put each adult in the household into one of those three categories, it's really easy to distinguish the difference between somebody who's working and somebody who's not.

So it's not hard to tell when somebody's employed versus when they're not employed. But what is hard to figure out sometimes is whether somebody is unemployed or not in the labor force. And so that creates a challenge when we think about interpreting the unemployment rate. Let's think about some characteristics of just how people choose to work or not. It's very common for people to move in and out of the labor force.

So more than one-third of all unemployed at any particular time are new entrants into the labor force. So those could be young workers looking for a first job. So people maybe getting out of college or getting out of high school that are looking for a first job. It could be older workers who left the labor force and now are coming back. So it's not the case that if somebody leaves the labor force, they're just out of it for the rest of their life.

It's very common for people to leave the labor force for a while and then go back into it. It also turns out that about half of the spells of unemployment end with the person leaving the labor force, not with them finding a job, but leaving the labor force. So that can make it challenging.

Because people move in and out of the labor force so frequently, it can be really hard to understand exactly how to interpret unemployment statistics. It's also the case that some people who report not being in the labor force are actually what we would call a discouraged worker. A discouraged worker is somebody who has become so discouraged with the process of finding a job that they've just given up.

And so that's the kind of person that's challenging to kind of get a grip on and figure out how much of that is taking place in the economy. Because they haven't looked for a job in the last four weeks, but it's somebody who, if offered a job, would probably take it because they want to be working. They've just given up looking.

They're frustrated with the process. So it can be hard to measure how many discouraged workers there are. Actually, if you go back to 2009, let's revisit that. We just used those numbers to calculate some. measures of unemployment, what we saw was that there was about 9.3% unemployment in 2009. 2009, we were in the midst of a recession.

Actually, the recession was probably over by then, technically, because remember, a recession is two consecutive quarters of declining GDP. So the recession was over, but things were still not that good. Things were actually pretty bad and continue to be pretty bad. unemployment-wise for quite a while. There were a lot of discouraged workers.

It can be hard to estimate how many, but if you were to include the number of discouraged workers, it's estimated that the actual unemployment rate, if discouraged workers were included, if discouraged workers were included, It's estimated that the unemployment rate was closer to about 16.3%. So you may have heard somebody say, well, the official unemployment rate, that doesn't really capture the full story. And there's some truth to that because discouraged workers are hard to pin down how many of them there are.

And so it depends on exactly how you estimate the number of them. But. You can see that if we would have included discouraged workers in 2009, the unemployment rate would have been significantly higher than 9.3%.

And so the Bureau of Labor Statistics tries to get a grip on how many unemployed or how many discouraged workers there are, but it's not precise. That's one of the challenges. Let's think about how long the unemployed are typically without work.

So what we want to think about here is whether or not being unemployed is kind of a short-term problem or whether it's a long-term problem for the people who are unemployed. And the reason we want to think about that is that we want to figure out how much help the government needs to give people who are unemployed. If it's typically short-term, then maybe it's not that big of a problem. On the other hand, if it's typically long-term, then maybe it is a problem, and we need to think about how we might help those people find a new job. Let me give you a sentence that will kind of summarize whether unemployment is a long-term problem or a short-term problem.

Let's write this sentence out. The sentence is going to appear contradictory, but let's write it out, and then we'll kind of take a look at it. Turns out...

That most spells of unemployment are short. Most spells are short, but most unemployment is long-term. Let's say it this way.

Most unemployment observed at any given time is long-term. Most spells of unemployment are short, but most unemployment observed at any given time is long-term. If I just said that and then moved on, you'd probably say, well, gosh, that doesn't really seem like it's consistent with itself. But it turns out that it is. We need to think about why this sentence makes sense, and the way to do it is just to think about maybe a nice, simple, numerical example.

Let's suppose that you wanted to get a grip on... the unemployment situation of people in your town. And so let's suppose that every week you went down to the unemployment office and you just observed who was there. And let's suppose that when you did that, you did that every week for a year. So let's suppose that every week you observed four unemployed people.

Every week there were four people that were unemployed. Let's suppose that each week three of those was a new person, so three new people, but then suppose that fourth person, now let's suppose that three the same person. That'll make it, that'll make things work out. So three of them are always the same person. Then there's always one new person.

So, every week you see these three people. They're always there. You get to know them within the first couple weeks by name.

You walk in, there's those three people. But then there's always this fourth person. There's always a new person.

So, now let's think about it. At the end of that year, if you had always seen those three people there for that full year, but then you also all observed a fourth person, a new person every week, let's think about how you would summarize The unemployment situation in your hometown. So you've met a total of 55 unemployed people in that year. 55 unemployed people.

You met these three people every week for 52 weeks, but then you met this new person, 52 other people that you saw each there for one week. That means, let's summarize that, 52 were unemployed for a week, unemployed one week, and three were unemployed a full year. So 52 out of 55 people, that's 95% of the spells of unemployment ended in one week.

95% of the unemployment spells ended in one week. So most spells of unemployment are short. Three of the spells of unemployment lasted a full year, but 95% of them...

ended in a week. But now let's think about the number of weeks of unemployment that you've observed. So let's think about the total amount of unemployment. So if we were to consider it that way, total amount of unemployment, what we've had is three people each unemployed for 52 weeks. Those three people account for 156 weeks of unemployment.

Three people accounted for 156 weeks of unemployment. You've got 52 people that each are accounting for one week. That's another 52 weeks. So there were a total of 208 weeks of unemployment.

208 weeks total. 156 of them were attributable to three people, long-term unemployment. So 156 out of 208, that's 75% of the unemployment, of the unemployment, total weeks of unemployment, that were attributable to three people. In other words, most unemployment observed at any given time is long-term. Those three people were unemployed long-term.

75% of the unemployment. So, what's the kind of takeaway from this? Well, what I would say is that you have to be really careful with how you interpret unemployment statistics. What I always tell my students is that if you're not aware of the way that the story can be... fashioned, then it's going to be easy to fool you with the numbers.

What you find out as you start looking at statistics is that it's very easy to tell the story that you want to tell. So if somebody were to ask me, describe unemployment. Is unemployment a big problem or not a big problem? If I wanted to make it look like it's not a big problem, I could say, well, most bills of unemployment are short. Most people who become unemployed are going to find a job very rapidly.

If on the other hand I wanted to make unemployment sound like a big problem, I could say, well, most unemployment that we observe is long term. Most of the unemployment that we observe is attributable to people who have a really, really difficult time finding a job and the government needs to step in and help them. So you can tell whatever story you want. And I think as a As a consumer of information from other people, it's up to you to be smart about how you might be told a story in an effort to influence your behavior. It's up to you to be smart about how to interpret things like this.

So it's kind of a mixed story. Most spells are short, most unemployment is long term. Let's talk about why there are... always going to be some unemployed people. So I started this video with a little picture over there where we looked at the natural rate of unemployment and then we looked at cyclical unemployment that fluctuated around that.

What we want to think about is why is it that there are always some unemployed people? Why is that natural rate of unemployment not down there by zero? And so what we need to do, let's clear this off and then we'll talk about what some of the causes of unemployment are. So let's think about what goes into that natural rate of unemployment.

And we're going to think about two different types of unemployment. The first one is what we're going to call frictional unemployment. And frictional unemployment you can think about as being the unemployment that results from the matching of workers with jobs. And we'll talk more about that here in just a second. Then there's what we call structural unemployment.

Structural unemployment is a situation where there's just not enough jobs to go around. So let's call this, let's just say matching. This is what happens when somebody says, you know what, I don't like my job, I'm going to quit this job and find a different job. That would be what we would call frictional unemployment. And we'll talk more about that here in a second.

Structural unemployment is where there's not enough jobs. So it's not a matter of just quitting a job and then finding another one. It's that it doesn't matter how long you look, there's not enough jobs to go around. Now both of these are going to be explanations for why that natural rate of unemployment is somewhere, at least in the U.S., around 4.5% to 5%. So we talked about cyclical unemployment, and we talked about the natural rate of unemployment.

These are not two things additional to that. These are two explanations for what causes the natural rate of unemployment to be what it is. So let's start by thinking about... Let's go back just a little bit and think about demand and supply.

So if we were to think about what's going on with, say, a labor market. Let's think about a labor market where we've got, if we had a demand and supply picture, we've got price up there, we've got quantity down there, we've got demand, and we've got supply. We've been thinking about this as if it was the output market, so say the market for gasoline. We've talked a lot about how that market works.

It would also work the same way if this was the market for labor. So if we were thinking about this as being the market for labor, instead of just calling this price, we might call it the wage, because that's the price of labor. And this quantity down here we could think about in terms of the amount of hours of labor purchased, or we could think about it you could think about in terms of number of workers. There's lots of different ways to think about that.

But what we know is from our study of how a market works is that the law of demand and supply tells us that as long as the price is allowed to adjust, it will adjust until quantity demanded is equal to quantity supplied. And so we know that if the price is allowed to adjust, it's going to move to right there and our quantity is going to move to right there. And this is the price at which there's no surplus or shortage.

So what we know is that if the labor market functioned exactly like the markets that we were thinking about in our previous videos, there would be no surplus of labor or shortage of labor, or at least not long term. The price would adjust to eliminate any surplus or shortage, and unemployment is a surplus of labor. So what we need to think about is what's going on?

Why is it that in the labor market this isn't happening, or the various labor markets? Why is it that this is not happening? Why is there always some unemployment?

And so that's where these two things come in. There's always going to be some unemployment. Some of it's going to be coming from frictional unemployment. Some of it's going to be coming from structural unemployment. So let's start by thinking about frictional.

The first cause of frictional unemployment we can think about is job search. So here's a, there are a couple of things that are happening here. The economy is constantly changing. So let's start with that.

The economy is constantly changing. What that means is. Consumer demand for different goods and services is constantly changing. Input prices are changing. What happens is that as the economy changes, some jobs vanish and other jobs open up.

So if we think about what happens in, say, a market, let's think of this as, say, the market for some good or service. This could be, say, the market for potato chips or the market for tennis shoes or it doesn't matter. We've got a demand and we've got a supply. Let's think about the quantity that's bought and sold in the market and then let's think about what happens if consumer demand decreases.

If consumer demand shifts from D1 to the left to D2, then the equilibrium quantity in this market is going to fall from Q1 to Q2. What that means is if firms are now producing a smaller quantity than before, Because less of the good is being bought and sold, firms are not going to need as much labor in this particular industry. And so that means they're going to let some workers go, some jobs are going to vanish. And so if consumer demands decrease in one particular industry or increase in that industry, that can affect the number of jobs in that industry.

And so because our economy is constantly changing, some jobs vanish, other jobs are appearing. And this is just a characteristic of a healthy economy. It can be tempting to say, oh, well, you know, the introduction of the ATM has caused some bank tellers to lose their jobs.

And it can be tempting to say, well, we need to keep that from happening. But you have to think really carefully about whether or not you want to prohibit technological progress to try to protect some jobs. It could be the case that if your job vanishes because of changes in consumer demand, it's not a comfortable situation to be in.

So we're not saying that it's good for the people whose jobs vanish at all, but what's happening here is just something that happens in a healthy economy. We can also think about another aspect of this as people are free to... quit their job. So people, some people, let's say, quit their job to find a better one. You're free to do that if you want.

Better one. Some people quit their job to find a better one. Well, that's part of this matching yourself with the right job for you. We can look at that from the perspective of the employer too. Employers are free to fire a worker and find a better worker.

So if you've got, if you're an employer and you've got a worker that's not doing the job or maybe they're stealing stuff from the job site or maybe they just don't do the job right, you can let them go and find somebody who will do the job right. So there what you're trying to do is match up your job with the right worker for you as an employer. And so because that is constantly happening in the economy, there's always going to be some unemployment.

Another cause of frictional unemployment is unemployment insurance. So what unemployment insurance is, is something that you can apply for from the government. If you don't have a job and you're in the process of looking for a job, the government will give you, typically in the U.S., it's half of your previous salary for half of a year, for 26 weeks. So that gives you kind of a safety net, a little bit of a cushion so that you don't go from earning a certain amount to earning nothing.

It allows you to ease the pain of being without a job. And that can happen if your job vanishes because of changes in the economy, if you get fired. So how generous these benefits are, of course, is going to determine the pain that you feel or the discomfort that you feel from not having a job. And the more generous these benefits are, the less hard people will look for a job.

So we have to be careful with how generous we make them. If, for example, we said that if you don't have a job, we'll give you your full salary for a full year, well, then that starts to feel like a paid year's vacation. And so if people were to be without a job, they're probably not going to look very hard for a job, at least for a while.

So we have to be careful as to how generous those are, but there needs to be some type of safety net for people who find themselves without a job. So in terms of frictional unemployment, it's typically going to be job search. The economy is constantly changing. Some people will quit their job to find a better one or a different one. Some employers will fire workers to find a better worker.

And then the generosity of unemployment in benefits affects how quickly people find another job. Those are all part of frictional unemployment. This we would describe as being a characteristic of a healthy economy.

I would hesitate to describe it as the good kind of unemployment because if you're one of the people unemployed, it doesn't feel good. But this is not a situation where there aren't enough jobs to go around. It's a situation of matching yourself with the right job. Let's talk now about some causes of structural unemployment.

Structural unemployment. is going to be a worse type of unemployment. This is going to be a situation where there are not enough jobs to go around.

So it doesn't matter how hard you look for a job, there simply is not enough to go around. The first cause of structural unemployment would be the minimum wage. So let's think about how the minimum wage works. If we draw a picture of a labor market here, we're going to have the wage.

The type of labor market we're thinking about here would be the market for unskilled labor. Down here we're going to have the quantity of labor. I'm trying to squeeze that in there, quantity of labor.

We've got a demand for labor. We've got a supply of labor. Let's think about who's behind the demand curve and who's behind the supply curve. So if we go to this picture right here, if we were thinking about this as being the demand and supply for some good, like say potato chips, then the buyers of potato chips would be consumers, and the people that are behind the supply curves would be the businesses, the firms.

If we think about the labor market, then the buyers of labor are going to be the firms. And the suppliers of labor are typically going to be the households or the consumers, people like us. So who's behind the supply curve in this picture is the opposite of who's behind the supply curve in that picture, and who's behind the demand curve is opposite.

But the market works like any other type of market. In the absence of any type of restrictions on wage, the wage would go to right there, and the quantity of labor bought and sold would go to right there. But if the government were to establish a wage minimum above the equilibrium, and let's use this symbol to describe that minimum wage, W with a bar below it, in economics we would call that a price floor.

It's a legal minimum on the price. It's a law that says it's illegal to buy and sell the good for anything less than that amount. If we think about what happens if we establish a minimum wage, then that means that the allowable range for prices is going to be anything above that. These wages are allowable. But the market is going to want to push the wage down to that point.

Well, the law won't allow that, so the wage will be at the minimum. Right there is going to be quantity demanded. There's quantity supplied. The number of, the amount of labor that firms want to buy, here's the quantity supplied, the amount of labor that households want to sell, that of course is a surplus.

There's your surplus, that's unemployment. So if you have a minimum wage, that's going to create unemployment in the market for unskilled labor. It can be tempting to think, I've been in discussions with people who say something like, well, okay, I guess I can see that that's going to create some unemployment, but over time that's going to go away. No, actually it's not.

It turns out that typically demand and supply tend to be a little bit flatter over longer time horizons. And you can tell that if the demand curve was flatter and the supply curve was flatter, There's going to be more unemployment over longer time horizons, so it's not just going to go away. There is some disagreement amongst economists as to exactly how much unemployment is created.

You can see that if the demand curve and the supply curve were steeper, the amount of unemployment would be less. And so economists disagree amongst themselves as to how much unemployment is actually created and whether or not it's that big of a deal. But you can see that the unemployment... that the minimum wage is going to create some unemployment.

If the minimum wage were increased, if we had an increase in the minimum wage to this point, then you can see that the amount of unemployment that is created is actually going to go up. It's going to get bigger. So increases in the minimum wage will increase unemployment. And the problem with this is that though it helps some people, it clearly hurts other people.

So it's not all bad for workers. If you're a worker that still gets to keep your job, then you're going to be earning more as long as the businesses don't cut your hours. One way that businesses can adjust to a minimum wage is that they can not necessarily fire people, but buy less labor from them.

So it could be that you don't lose your job, but your hours get cut. And so that's not going to show up as an increase in unemployment, but it's going to show up for you as being able to work less hours. So we have to keep this in mind. This is a situation where there's not enough jobs to go around.

What most economists would say is that if we were to think about why politicians argue for a minimum wage or why anybody would argue for a minimum wage, the argument is typically that we need to help people. Maintain an adequate standard of living. People who are the heads of household, if they're working for the minimum wage, then it can be nearly impossible to raise a family with this. Turns out if you look at who's working for the minimum wage, a majority of people working for the minimum wage are teenagers from middle income families.

It's not heads of households. So most economists would describe it as, at best, as a poorly targeted policy. It's not actually going to be.

targeting the people that you're really interested in helping. And if you were to ask, well, okay, so what's a better policy? If the minimum wage is not a good policy to help workers that we want to help, what's a better alternative?

Well, wage subsidies would be a better alternative. Simply subsidizing the income of people who you want to help, which we do in every industrialized economy. There is some of that that's going on.

That's a better way to help those people rather than establishing some law that restricts price from moving. Remember, we talked about the law of demand and supply that says the price of any good or service will adjust if it's allowed to until quantity demanded equals quantity supplied. Well, this is a situation where we're not allowing price to adjust.

And so quantity demanded and quantity supplied are not going to come together if... price is not allowed to adjust. Those typically are bad policies because you're restricting price. A better policy is to not restrict price and instead target more closely the people that you're trying to help.

So the minimum wage, an example of one of the causes of structural unemployment, probably not a very big cause of the amount of unemployment in the economy, but it is a cause. If we think about another cause, we could think about unions, collective bargaining. So what a union is, is an organization that represents workers in a particular industry.

Collective bargaining is the term that we use to describe the negotiation process between the union and the firm or the management of the firm. If the union's not happy with the way that the collective bargaining process is going, then the union can withhold labor, and we call that a strike. So a strike is just a withdrawal of labor in a way to put pressure on the firm to... negotiate with it.

And essentially what the union is going to be arguing for is this, right? Now, the union would not be, they don't, the unions are not going to represent unskilled labor. The union represents skilled labor.

But what they're going to be arguing for is a wage that's higher than the equilibrium wage. And so we're going to get a very similar picture to this. If the wage is higher than the equilibrium.

Then firms are going to want to buy less labor. More people are going to want to work at that higher wage, and those more people are going to be people typically outside of the union as well as people within the union. But it's going to create a situation where there's unemployment.

Typically, the union negotiation process is going to help the workers in the union at the expense of workers who are not members of the union. So, typically, most economics programs would have a class in labor economics. You could spend a year studying just labor economics, the history of unions.

So, the conclusion I would hope that you get from this is not that unions are bad or that they're unnecessary or that we needed to somehow eliminate them, I would say that it would be up to you to just take a look at the history of the labor movement. If firms have what we would call market power over workers, then of course it would be natural for workers to form unions to try to counteract that market power. Turns out that the amount of market power that firms have has probably gone down significantly. compared to what it was in the early 1900s, and consequently union membership has fallen drastically below what it was in the early 1900s. But let's just leave it as this being another cause of there being not enough jobs to go around.

The last thing that we're going to think about in terms of causes of structural unemployment would be what economists refer to as efficiency wages. Efficiency wages. So let's talk about what an efficiency wage is.

An efficiency wage is the name that economists give it when the firm voluntarily pays more than it has to. So if we think about this picture, here's a picture where we've got the labor market, we've got an equilibrium wage, I've called it the price, but we could think about that as the wage. In these pictures, the firm is being forced to pay a higher wage, or they're negotiating with the union to pay a higher wage than the equilibrium. But it may be the case that the firm chooses on their own to pay a higher wage. And the reason that they might want to do that is because that creates a situation, well, let's use this picture, that creates a situation if the firm were to choose to pay W-bar.

voluntarily, not because of some law, but just because it wants to, then it's probably going to want to hire less workers, more people are going to want to work at that wage, but let's think about the benefit to the firm. What that does is that raises the opportunity cost for the worker of losing this job. And so what you tend to see if you're a firm that chooses to pay higher than what you have to, you're typically going to get workers that work harder. It's going to increase productivity.

It's going to decrease the amount of turnover that you experience, which is costly for the firm. If you train a worker and then they quit six months later, and you have to incur the cost of training another worker, that's expensive. So if you choose to pay more than what you have to, then you're going to get a higher quality worker.

You're going to have workers that work harder. You're going to have less turnover. You're also going to have...

More workers that want to work for you than you want to hire, which means you're going to have a stack of applications that you can choose from. You can go through that stack to find the best workers. When my kids were younger and we needed babysitters, I've got three kids, and when they were young, my wife and I chose to pay more than we had to to get somebody to babysit.

Actually, significantly more than we had to. And the nice thing about that was that we never had a problem finding a babysitter. We paid well enough that there were times that people would call us up and say, hey, would you guys like to have a night out? Because they wanted to come over and babysit our kids. And they did a good job when they were babysitting.

They would clean up and they would do anything that the kids wanted to do. And so that was a situation where we were choosing. Not because somebody made us. We were choosing to pay higher than what we had to because we knew that we were going to get better labor out of the people that were working for us at the time. Lots of people who argue for minimum wages, their argument is that if we don't do this, firms are just always going to pay nothing.

Well, that doesn't make any sense. The firm would have to pay the equilibrium wage in the absence of a minimum. So They're not going to be able to pay nothing, and it can be the case that firms are going to have an incentive to voluntarily choose to pay more.

That doesn't mean every firm will, but there are some great examples. Quick Trip is a good example of a firm that pays more than what it has to to get workers, and as a consequence, it gets better workers than if they chose to pay the equilibrium, the minimum that they would have to. So, these are some causes of structural unemployment. Remember, this is the bad kind of unemployment where there's not enough jobs to go around. These are some causes of frictional unemployment, a healthy kind of unemployment, even though it's not going to be comfortable for the people who are experiencing it.

So, hopefully this video gives you some ideas of the challenges of estimating the unemployment rate, of interpreting what the unemployment rate means, and then an idea of where the unemployment rate comes from that goes into that natural rate of unemployment. So I'll see you in a future video.

Transcript for:Understanding Unemployment and Its Impacts

Transcript for:
Understanding Unemployment and Its Impacts