Worth: Mankiw Economics 5e 160 PART 11 Classical Theory: The Economy in the Long Run this program, unemployed workers can collect a fraction of their wages for a certain period after losing their jobs. Although the precise terms of the pro- gram differ from year to year and from state to state, a typical worker covered by unemployment insurance in the United States receives 50 percent of his or ler former wages for 26 weeks. In many European countries, unemployment Insurance programs are even more generous By softening the economic hardship of unemployment, unemployment insur- ance increases the amount of frictional unemployment and raises the natural rate. The unemployed who receive unemployment-insurance benefits are less pressed offers. Both of these changes in behavior reduce the rate of job finding. In ad a to search for new employment and are more likely to turn down unattractive j tion, because workers know that their incomes are partially protected by unem ployment insurance, they are less likely to seek jobs with stable employment prospects and are less likely to bargain for guarantees of job security. These be havioral changes raise the rate of job separation That unemployment insurance raises the natural rate of unemployment does not necessarily imply that the policy is ill advised. The program has the benefit of reducing workers'uncertainty about their incomes. Moreover, in- ducing workers to reject unattractive job offers may lead to a better matching between workers and jobs. Evaluating the costs and benefits of different sys tems of unemployment insurance is a difficult task that continues to be a topic of much research Economists who study unemployment insurance often propose refor that would reduce the amount of unemployment. One common proposal is to require a firm that lays off a worker to bear the full cost of that worker's un employment benefits. Such a system is called 100 percent experience rated, be- cause the rate that each firm pays into the unemployment-insurance system lly reflects the unemployment experience of its own workers. Most current programs are partially experience rated. Under this system, when a firm lays off a worker, it is charged for only part of the worke ers unen ployment benefits; the remainder comes from the program's general revenue. Because a firm pay only a fraction of the cost of the unemployment it causes, it has an incentive to lay off workers when its demand for labor is temporarily low. By reducing that incentive, the proposed reform may reduce the prevalence of temporary Unemployment Insurance and the Rate of Job Finding Many studies have examined the effect of unemployment insurance on job search. The most persuasive studies use data on the experiences of unemployed ndividuals, rather than economy-wide rates of unemployment. Individual data often yield sharp results that are open to few alternative explanations One study followed the experience of individual workers as they used up heir eligibility for unemployment-insurance benefits. It found that when User JOENA: Job EFF01422: 6264_ch06: Pg 160: 26231#/eps at 100s wed,Feb13,20029:364M
User JOEWA:Job EFF01422:6264_ch06:Pg 160:26231#/eps at 100% *26231* Wed, Feb 13, 2002 9:36 AM this program, unemployed workers can collect a fraction of their wages for a certain period after losing their jobs. Although the precise terms of the program differ from year to year and from state to state, a typical worker covered by unemployment insurance in the United States receives 50 percent of his or her former wages for 26 weeks. In many European countries, unemploymentinsurance programs are even more generous. By softening the economic hardship of unemployment, unemployment insurance increases the amount of frictional unemployment and raises the natural rate. The unemployed who receive unemployment-insurance benefits are less pressed to search for new employment and are more likely to turn down unattractive job offers. Both of these changes in behavior reduce the rate of job finding. In addition, because workers know that their incomes are partially protected by unemployment insurance, they are less likely to seek jobs with stable employment prospects and are less likely to bargain for guarantees of job security.These behavioral changes raise the rate of job separation. That unemployment insurance raises the natural rate of unemployment does not necessarily imply that the policy is ill advised.The program has the benefit of reducing workers’ uncertainty about their incomes. Moreover, inducing workers to reject unattractive job offers may lead to a better matching between workers and jobs. Evaluating the costs and benefits of different systems of unemployment insurance is a difficult task that continues to be a topic of much research. Economists who study unemployment insurance often propose reforms that would reduce the amount of unemployment. One common proposal is to require a firm that lays off a worker to bear the full cost of that worker’s unemployment benefits. Such a system is called 100 percent experience rated, because the rate that each firm pays into the unemployment-insurance system fully reflects the unemployment experience of its own workers. Most current programs are partially experience rated. Under this system, when a firm lays off a worker, it is charged for only part of the worker’s unemployment benefits; the remainder comes from the program’s general revenue. Because a firm pays only a fraction of the cost of the unemployment it causes, it has an incentive to lay off workers when its demand for labor is temporarily low. By reducing that incentive, the proposed reform may reduce the prevalence of temporary layoffs. 160 | PART II Classical Theory: The Economy in the Long Run CASE STUDY Unemployment Insurance and the Rate of Job Finding Many studies have examined the effect of unemployment insurance on job search.The most persuasive studies use data on the experiences of unemployed individuals, rather than economy-wide rates of unemployment. Individual data often yield sharp results that are open to few alternative explanations. One study followed the experience of individual workers as they used up their eligibility for unemployment-insurance benefits. It found that when
Worth: Mankiw Economics 5e CHAPTER 6 Unemployment |161 unemployed workers become ineligible for benefits, they are more likely to find new jobs. In particular, the proba lity of a person finding a new j more than doubles when his or her benefits run out. One possible explanation is that an absence of benefits increases the search effort of unemployed work ers. Another possibility is that workers without benefits are more likely to ac cept job offers that would otherwise be declined because of low wages or poor working conditions Additional evidence on how economic incentives affect job search comes rom an experiment that the state of Illinois ran in 1985. Randomly selected new claimants for unemployment insurance were each offered a $500 bonus if they found employment within 11 weeks. The subsequent experience of this group was compared to that of a control group not offered the incentive. The average duration of unemployment for the group offered the $500 bonus was 17.0 weeks, compared to 18.3 weeks for the control group. Thus, the bonus reduced the aver rage spell of unemployment by 7 percent, suggesting that more effort was devoted to job search. This experiment shows clearly that the incentives provided by the unemployment-insurance system affect the rate of 6-3 Real-Wage Rigidity and Structural Unemployment A second reason for unemployment is wage rigidity--the failure of wages to djust until labor supply equals labor demand. In the equilibrium model of the labor market, as outlined in Chapter 3, the real wage adjusts to equilibrate supply and demand. Yet wages are not always flexible. Sometimes the real wage is stuck bove the market-clearing level Figure 6-3 shows why wage rigidity leads to unemployment. When the real wage is above the level that equilibrates supply and demand, the quantity of labo supplied exceeds the quantity demanded Firms must in some way ration the scarce jobs among workers. Real-wage rigidity reduces the rate of job finding and raises the level of unemployment The unemployment resulting from wage rigidity and job rationing is called structural unemployment. Workers are unemployed not because they are ac- tively searching for the jobs that best suit their individual skills but because, at the going wage, the supply of labor exceeds the demand. These workers are simply waiting for jobs to become available Lawrence F Katz and Bruce D. Meyer, "Unemployment Insurance, Recall Expectations, and Un- employment Outcomes, " Quarterly Journal of Economics 105(November 1990): 973-1002 S Stephen A. Woodbury and Robert G Spiegelman, "Bonuses to Workers and Employers to Re- duce Unemployment: Randomized Trials in Illinois, "American Economic Review 77(September User JOENA: Job EFF01422: 6264_ch06: Pg 161: 26232#/eps at 100s wed,Feb13,20029:364M
User JOEWA:Job EFF01422:6264_ch06:Pg 161:26232#/eps at 100% *26232* Wed, Feb 13, 2002 9:36 AM 6-3 Real-Wage Rigidity and Structural Unemployment A second reason for unemployment is wage rigidity—the failure of wages to adjust until labor supply equals labor demand. In the equilibrium model of the labor market, as outlined in Chapter 3, the real wage adjusts to equilibrate supply and demand.Yet wages are not always flexible. Sometimes the real wage is stuck above the market-clearing level. Figure 6-3 shows why wage rigidity leads to unemployment.When the real wage is above the level that equilibrates supply and demand, the quantity of labor supplied exceeds the quantity demanded. Firms must in some way ration the scarce jobs among workers. Real-wage rigidity reduces the rate of job finding and raises the level of unemployment. The unemployment resulting from wage rigidity and job rationing is called structural unemployment.Workers are unemployed not because they are actively searching for the jobs that best suit their individual skills but because, at the going wage, the supply of labor exceeds the demand.These workers are simply waiting for jobs to become available. CHAPTER 6 Unemployment | 161 unemployed workers become ineligible for benefits, they are more likely to find new jobs. In particular, the probability of a person finding a new job more than doubles when his or her benefits run out. One possible explanation is that an absence of benefits increases the search effort of unemployed workers.Another possibility is that workers without benefits are more likely to accept job offers that would otherwise be declined because of low wages or poor working conditions.2 Additional evidence on how economic incentives affect job search comes from an experiment that the state of Illinois ran in 1985. Randomly selected new claimants for unemployment insurance were each offered a $500 bonus if they found employment within 11 weeks.The subsequent experience of this group was compared to that of a control group not offered the incentive.The average duration of unemployment for the group offered the $500 bonus was 17.0 weeks, compared to 18.3 weeks for the control group. Thus, the bonus reduced the average spell of unemployment by 7 percent, suggesting that more effort was devoted to job search.This experiment shows clearly that the incentives provided by the unemployment-insurance system affect the rate of job finding.3 2 Lawrence F. Katz and Bruce D. Meyer,“Unemployment Insurance, Recall Expectations, and Unemployment Outcomes,’’ Quarterly Journal of Economics 105 (November 1990): 973–1002. 3 Stephen A.Woodbury and Robert G. Spiegelman, “Bonuses to Workers and Employers to Reduce Unemployment: Randomized Trials in Illinois,’’ American Economic Review 77 (September 1987): 513–530
Worth: Mankiw Economics 5e 162 PART 11 Classical Theory: The Economy in the Long Run fiqure 6-3 Real wage Real-Wage Rigidity Leads to Job Supply Rationing If the real wage is level, then the supply of labor Amount of exceeds the demand. the result is unemployment. Amor Demand labor hired Labor Amount of labor To understand wage rigidity and structural unemployment, we must examine why the labor market does not clear. When the real wage exceeds the equilib- rium level and the supply of workers exceeds the demand, we might expect firms to lower the wages they pay. Structural unemployment arises because firms fail to reduce wages despite an excess supply of labor. We now turn to three causes of this wage rigidity: minimum-wage laws, the monopoly power of unions,and efficiency w Minimum-Wage Laws The government causes wage rigidity when it prevents wages from falling to equilibrium levels. Minimum-wage laws set a legal minimum on the wages that firms pay their employees. Since the passage of the Fair Labor Standards Act of 1938, the U.S. federal government has enforced a minimum wage that usually has been between 30 and 50 percent of the average wage in manufacturing. For most workers, this minimum wage is not binding, because they earn well above the minimum. Yet for some workers, especially the unskilled and inexperienced, the minimum wage raises their wage above its equilibrium level. It therefore reduces the quantity of their labor that firms demand. Economists believe that the minimum wage has its greatest impact on teenage unemployment. The equilibrium wages of teenagers tend to be low for two reasons. First, because teenagers are among the least skilled and least experienced members of the labor force, they tend to have low marginal pro- ductivity. Second, teenagers often take some of their"compensation"in the User JOENA: Job EFF01422: 6264_ch06: Pg 162: 26233 #/eps at 100s wed,Feb13,20029:364M
User JOEWA:Job EFF01422:6264_ch06:Pg 162:26233#/eps at 100% *26233* Wed, Feb 13, 2002 9:36 AM To understand wage rigidity and structural unemployment, we must examine why the labor market does not clear.When the real wage exceeds the equilibrium level and the supply of workers exceeds the demand, we might expect firms to lower the wages they pay. Structural unemployment arises because firms fail to reduce wages despite an excess supply of labor. We now turn to three causes of this wage rigidity: minimum-wage laws, the monopoly power of unions, and efficiency wages. Minimum-Wage Laws The government causes wage rigidity when it prevents wages from falling to equilibrium levels. Minimum-wage laws set a legal minimum on the wages that firms pay their employees. Since the passage of the Fair Labor Standards Act of 1938, the U.S. federal government has enforced a minimum wage that usually has been between 30 and 50 percent of the average wage in manufacturing. For most workers, this minimum wage is not binding, because they earn well above the minimum.Yet for some workers, especially the unskilled and inexperienced, the minimum wage raises their wage above its equilibrium level. It therefore reduces the quantity of their labor that firms demand. Economists believe that the minimum wage has its greatest impact on teenage unemployment. The equilibrium wages of teenagers tend to be low for two reasons. First, because teenagers are among the least skilled and least experienced members of the labor force, they tend to have low marginal productivity. Second, teenagers often take some of their “compensation’’ in the 162 | PART II Classical Theory: The Economy in the Long Run figure 6-3 Real wage Labor Supply Demand Amount of unemployment Amount of labor hired Amount of labor willing to work Rigid real wage Real-Wage Rigidity Leads to Job Rationing If the real wage is stuck above the equilibrium level, then the supply of labor exceeds the demand. The result is unemployment