W8 - Unemployment & Economic Growth (Theory)

The Determinants Of Average Labor Productivity

- Popular discussions of this issue often equate worker productivity with the willingness of workers of a given nationality to work hard. + Everything else being equal, a culture that promotes hard work certainly tends to increase worker productivity. + In this section, we will examine six factors that appear to account for the major differences in average labor productivity, both between countries and between generations 1/ Human Capital - Human capital comprises the talents, education, training, and skills of workers. + Workers with a large stock of human capital are more productive than workers with less training + Human capital increases workers' productivity + Premium paid to skilled workers 2/ Physical Capital - Workers' productivity depends not only on their skills and effort, but on the tools they have to work with (physical capital). + More and better capital allows workers to produce more efficiently (increase worker productivity) - Two important points about the effect of additional capital on output: + First, for a given number of workers, adding more capital generally increases both total output and average labor productivity. + Secondly, there are limits to increasing productivity by adding capital because of diminishing returns + This result illustrates a general principle of economics, called diminishing returns to capital. + According to the principle of diminishing returns to capital, if the amount of labor and other inputs employed is held constant, then the greater the amount of capital already in use, the less an additional unit of capital adds to production (a natural consequence of firms' incentive to use each piece of capital as productively as possible) + When a firm has many machines, the most productive uses have already been filled + The increment in capital will necessarily be assigned to a less productive use than the previous increment 3/ Land & Other Natural Resources - Besides capital goods, other inputs to production also help make workers more productive + In general, an abundance of natural resources increases the productivity of the workers who use them 4/ Technology - More productive technologies will help determine its productivity (overall productivity increases when producers concentrate on those activities at which they are relatively most efficient). + Technical change can affect industries beyond the primary application (growth seen in industries that produce these technologies and industries that use them) 5/ Entrepreurship & Management - The productivity of workers depends in part on the people who help decide what to produce and how to produce it + Because of the new products, services, technological processes, and production methods they introduce, entrepreneurs are critical to a dynamic, healthy economy + Although entrepreneurship may be more glamorous, managers—the people who run businesses on a daily basis—also play an important role in determining average labor productivity. 6/ Political & Legal Environment - One of the key contributions government can make is to provide a political and legal environment that encourages people to behave in economically productive ways—to work hard, save and invest wisely + One specific function of government that appears to be crucial to economic success is the establishment of well-defined property rights. + Property rights are well defined when the law provides clear rules for determining who owns what and how those resources can be used. + Maintain political stability + Entrepreneurs and savers are unlikely to invest their resources in a country whose government is unstable

Other Unemployment Issues

- Discouraged workers would like to have a job but they have not looked for work in the past four weeks + Counted as out of the labor force + Willing and ready to work but have give up on job search - Could be counted as unemployed but they are not - Involuntary part-time workers are people who like to work full-time but cannot find a full-time job + Counted as employed + Unemployment rate that includes discouraged workers and involuntary part-time workers would be higher

Are There Limits To Growth?

- The first problem raises the question of whether economic growth can continue indefinitely without depleting natural resources and causing massive damage to the global environment (growth may not be sustainable) + A second problem with the "limits to growth" conclusion is that it overlooks the fact that increased wealth and productivity expand society's capacity to take measures to safeguard the environment. + In more economically developed countries, where the most basic needs are more easily met, extra resources are available to keep the environment clean. + A third problem with the pessimistic view of economic growth is that it ignores the power of the market and other social mechanisms to deal with scarcity. - Can promote sustainable growth through technology and market system + Higher income can pay for better production method to promote environmental quality + Use market's response to deal with scarcity by pushing up the price and reduce consumption + Government action needed in case of externalities

The Costs Of Economic Growth

- Even if we accept for the moment that increased output per person is always desirable, attaining a higher rate of economic growth does impose costs on society + The most straightforward is the cost of creating new capital. + Increasing the capital stock will increase GDP + But, to increase the capital stock, we must divert resources that could otherwise be used to increase the supply of consumer goods (opportunity cost of producing more capital goods is fewer consumer goods). + In short, high rates of investment in new capital require people to tighten their belts, consume less, and save more—a real economic cost. + The cost of research and development (R&D) to improve technology + The cost of education to develop and use new capital + The fact that a higher living standard tomorrow must be purchased at the cost of current sacrifices is an example of the Scarcity Principle. - Some of the measures that policymakers might take to raise its rate of economic growth: 1/Policies To Increase Human Capital - Because skilled and well-educated workers are more productive than unskilled labor, governments in most countries try to increase the human capital of their citizens by paying for education and training programs. + Increases chances of technical innovation 2/ Policies That Promote Saving And Investment - Average labor productivity increases when workers can utilize a sizable and modern capital stock. + To support the creation of new capital, government can encourage high rates of saving and investment in the private sector. + Government periodically offers investment tax credits + Government investment in the infrastructure reduces costs of transporting goods, making markets more efficient 3/ Policies That Support Research And Development - Productivity is enhanced by technological progress, which in turn requires investment in research and development (R&D) and promote innovation. + Because society in general, rather than the individual inventors, may receive much of the benefit from basic research, government may sponsor research for specific projects and industries 4/ The Legal And Political Framework - Although economic growth comes primarily from activities in the private sector, the government plays an essential role in providing the framework within which the private sector can operate productively. + Government policymakers should also consider the potential effects of tax and regulatory policies on activities that increase productivity, such as investment, innovation, and risk taking. 5/ Promoting Economic Growth in Least Developed Countries - To a significant extent, the same factors and policies that promote growth in richer countries apply to the poorest countries as well. + However, to a much greater degree than in richer countries, most poor countries need to improve the legal and political environment that underpins their economies. + Corruption creates uncertainty about property rights and drains financial resources out of the country + Regulation discourages entrepreneurship + Taxes discourage risk-taking + Markets do not function efficiently + Lack of political stability discourages foreign investment

Shifts In The Supply Of Labor

- Any factor that affects the quantity of labor offered at a given real wage will shift the labor supply curve. + At the macroeconomic level, the most important factor affecting the supply of labor is the size of the working-age population + All else being equal, an increase in the working-age population raises the quantity of labor supplied at each real wage, shifting the labor supply curve to the right. + Changes in the percentage of people of working age who seek employment—for example, as a result of social changes that encourage women to work outside the home—can also affect the supply of labor.

The Shifts In The Demand For Labor

- Any factor that raises the value of the marginal product of workers will shift the labor demand curve to the right. + The more productive workers are, or the more valuable the goods and services they produce, the greater the number of workers an employer will want to hire at any given wage. + Two main factors could increase the labor demand: 1/ An increase in the relative price of the company's output - The general conclusion to be drawn is that an increase in the relative price of workers' output increases the demand for labor, shifting the labor demand curve to the right. + A higher relative price for workers' output makes workers more valuable, leading employers to demand more workers at any given real wage 2/ An increase in the productivity of workers - The second factor that affects the demand for labor is worker productivity. + Since an increase in productivity increases the value of a worker's marginal product, it also increases the demand for labor, shifting the labor demand curve to the right. + This can be due to the adoption of new technology. + But sometimes, new technology can reduce the demand for certain workers

The Types Of Unemployment And Their Costs

- Economists have found it useful to think of unemployment as being of three broad types: frictional unemployment, structural unemployment, and cyclical unemployment + Each type of unemployment has different causes and imposes different economic and social costs. + In principle, frictional, structural, and cyclical unemployment add up to the total unemployment rate. 1/ Frictional Unemployment - The function of the labor market is to match available jobs with available workers. + If all jobs and workers were the same, or if the set of jobs and workers were static and unchanging, this matching process would be quick and easy. + Because the labor market is heterogeneous and dynamic, the process of matching jobs with workers often takes time + Short-term unemployment that is associated with the process of matching workers with jobs is called frictional unemployment. - The costs of frictional unemployment are low and may even be negative; that is, frictional unemployment may be economically beneficial. + First, frictional unemployment is short term, so its psychological effects and direct economic losses are minimal. + Second, to the extent that the search process leads to a better match between worker and job, a period of frictional unemployment is actually productive, in the sense that it leads to higher output over the long run. 2/ Structural Unemployment - A second major type of unemployment is structural unemployment, or the long-term and chronic unemployment that exists even when the economy is producing at a normal rate. + Several factors contribute to structural unemployment. + First, a lack of skills, language barriers, or discrimination keeps some workers from finding stable, long-term jobs + Second, economic changes sometimes create a long-term mismatch between the skills some workers have and the available jobs (since their skills are no longer in demand) + Finally, structural unemployment can result from structural features of the labor market that act as barriers to employment. - The costs of structural unemployment are much higher than those of frictional unemployment. + Because structurally unemployed workers do little productive work over long periods, their idleness causes substantial economic losses both to the unemployed workers and to society. + Structurally unemployed workers also lose out on the opportunity to develop new skills on the job, and their existing skills wither from disuse. 3/ Cyclical Unemployment - The third type of unemployment occurs during periods of recession (that is, periods of unusually low production) and is called cyclical unemployment. + Increases in cyclical unemployment, although they are relatively short-lived, are associated with significant declines in real GDP and are therefore quite costly economically.

Why Nations Become Rich: The Crucial Role Of Average Labor Productivity

- Express real GDP per person as the product of two terms: average labor productivity and the share of the population that is working. + This expression for real GDP per person tells us something very basic and intuitive: The quantity of goods and services that each person can consume depends on (1) how much each worker can produce and (2) how many people (as a fraction of the total population) are working. + Furthermore, real GDP per person can grow only to the extent that there is growth in worker productivity and/or the fraction of the population that is employed. + In the long run, increases in output per person arise primarily from increases in average labor productivity. + In simple terms, the more people can produce, the more they can consume. - The labor force participation rate differs from the share of the population with jobs in two ways. + First, rather than counting only people with jobs, it counts also people looking for a job + The second difference between the labor force participation rate and the share of the population with jobs is that the labor force participation rate is the labor force as a share of only the adult population.

Duration of Unemployment

- In assessing the impact of unemployment on jobless people, economists must know how long individual workers have been without work. + Generally, the longer a person has been out of work, the more severe are the economic and psychological costs that person will face. + A period during which an individual is continuously unemployed is called an unemployment spell; it begins when the worker becomes unemployed and ends when the worker either finds a job or leaves the labor force. + The duration of unemployment rises during recessions, reflecting the greater difficulty of finding work during those periods. - Long-term unemployment creates the highest economic, psychological, and social costs, both for the unemployed themselves and for society as a whole + When the economy is not in a recession, most unemployment spells are relatively short. - Short unemployment spells can arise from two very different patterns of labor market experience. + Some people have short unemployment spells that end in their finding a stable long-term job. + For the most part, these workers, whom we will refer to as the short-term unemployed, do not typically bear a high cost of unemployment. + But other workers have short unemployment spells that typically end either in their withdrawal from the labor force or in a short-term or temporary job that soon leaves the worker unemployed again. + In terms of the costs of unemployment, the experience of these workers is similar to that of the long-term unemployed

Unemployment

- In assessing the level of economic activity in a country, economists look at a variety of statistics. + Besides real GDP, one statistic that receives a great deal of attention is the rate of unemployment. + The unemployment rate is a sensitive indicator of conditions in the labor market. + When the unemployment rate is low, jobs are secure and relatively easier to find. + Low unemployment is often associated with improving wages and working conditions as well, as employers compete to attract and retain workers. + In general, a high rate of unemployment indicates that the economy is performing poorly. - Each person in those households who is 16 years or older is placed in one of three categories: 1/ Employed: A person is employed if he or she worked full-time or part-time (even for a few hours) 2/ Unemployed: A person is unemployed if he or she did not work but made some effort to find work in the past four weeks. 3/ Out of the labor force:A person is considered to be out of the labor force if he or she did not work and did not look for work - To find the unemployment rate, we must first calculate the size of the labor force. + The labor force is defined as the total number of employed and unemployed people in the economy. + The unemployment rate is then defined as the number of unemployed people divided by the labor force. + Another useful statistic is the participation rate, or the percentage of the working-age population in the labor force (that is, the percentage that is either employed or looking for work)

Unemployment Benefits and Government Regulations

- In discussing structural unemployment, we mentioned that structural features of the labor market may contribute to long-term and chronic unemployment. + One such structural feature is the availability of unemployment insurance, or government transfer payments to unemployed workers. + Unemployment insurance provides an important social benefit in that it helps the unemployed to maintain a decent standard of living while they are looking for a job. + But because its availability allows the unemployed to search longer or less intensively for a job, it may lengthen the average amount of time the typical unemployed worker is without a job. + Thus, unemployment insurance should last for only a limited time, and its benefits should not be as high as the income a worker receives when working. - Many other government regulations bear on the labor market. + They include health and safety regulations, which establish the safety standards employers must follow, and rules that prohibit racial or gender-based discrimination in hiring. + Many of these regulations are beneficial. + In some cases, however, the costs of complying with regulations may exceed the benefits they provide. + Further, to the extent that regulations increase employer costs and reduce productivity, they depress the demand for labor, lowering real wages and contributing to unemployment.

Effects of Labour Union

- Labor union benefits + Reduced worker exploitation + Increase productivity - Labor union costs + Introduces inefficiency into competitive markets + May keep companies from competing globally + Increase labor supply in non-union sector + Decreases wages for non-union workers

Wages And The Demand For Labor

- Let's start by thinking about what determines the number of workers employers want to hire at any given wage—that is, the demand for labor. + As we will see, the demand for labor depends both on the productivity of labor and the price that the market sets on workers' output. - The marginal product of each worker, the extra production that is gained by adding one more worker + The value of a worker's marginal product is the amount of extra revenue that the worker generates for the firm. + Note that each additional worker adds less to total production than the previous worker did. + The tendency for marginal product to decline as more and more workers are added is called diminishing returns to labor. + The principle of diminishing returns to labor states that if the amount of capital and other inputs in use is held constant, then the greater the quantity of labor already employed, the less each additional worker adds to production. + The economic basis for diminishing returns to labor is the Principle of Increasing Opportunity Cost, also known as the Low-Hanging Fruit Principle. - The lower the wage a firm must pay, the more workers it will hire. + Thus the demand for labor is like the demand for other goods or services in that the quantity demanded rises as the price (in this case, the wage) falls. + Equivalently, we could have expressed the wage and the price of output in real terms—that is, measured relative to the average price of goods and services. + The wage measured relative to the general price level is the real wage, the real wage expresses the wage in terms of its purchasing power. + Because our main interest is in real rather than nominal wages, from this point on we will analyze the demand for labor in terms of the real wage and the relative price of workers' output, rather than in terms of nominal variables.

Structural Barriers to Employment

- Minimum Wage Laws + Setting a minimum wage (Wmin) above equilibrium (W) creates (NB - NA) unemployment + Workers who find a minimum-wage job get a higher wage + Others are unemployed

Economic Growth

- Real GDP of economies tend to increase over time due to improvement in technology and increase in quantity and quality of resources + Economic growth is the percentage change in real GDP + Real GDP per capita or real GDP per person is obtained by dividing the real GDP by the population of the economy + Real GDP per capita reflects the amount of goods and services available to a person in the economy - An indicator of standard of living

Why "Small" Differences In Growth Rates Matter

- The fact that what seem to be small differences in growth rates can have large long-run effects results from what is called the power of compound interest. + Economic growth rates in GDP per capita are similar to compound interest rates. + This analogy suggests that even a relatively modest rate of growth in output per person will produce tremendous increases in average living standard over a long period. + In the long run, the growth rate of an economy matters - Economists employ a useful formula for approximating the number of years it will take for an initial amount to double at various growth or interest rates. + The higher the growth rates, the shorter the time period needed to double the amount + This formula is a good approximation only for small and moderate interest rates.

The Supply Of Labor

- The total number of people who are willing to work (workers and potential wokers) at each real wage is the supply of labor + The greater the willingness to supply labor is, the higher the wage. + For most people, income is one of the principal benefits of working, so the higher the real wage, the more willing they are to sacrifice other possible uses of their time. + The fact that people are more willing to work when the wage they are offered is higher is captured in the upward slope of the supply curve of labor - Reservation wage is the lowest wage a worker would accept for a given job + Opportunity cost of working is your leisure activity + If working conditions are unpleasant or dangerous, a premium for that would be included in the wage

Increasing Wage Inequality: The Effect Of Globalization And Technological Change

- There is an increasing inequality in wages, especially the tendency for the wages of the less-skilled and less-educated to fall further behind those of better-trained workers. + We next discuss two reasons for this increasing inequality: (1) globalization and (2) technological change. 1/ Globalization - This term refers to the fact that to an increasing extent, the markets for many goods and services are becoming international, rather than national or local, in scope. + The main economic benefit of globalization is increased specialization and the efficiency that it brings. + Instead of each country trying to produce everything its citizens consume, each can concentrate on producing those goods and services at which it is relatively most efficient. - The effects of globalization on the labor market are mixed, however, which explains why many politicians oppose free-trade agreements. + Expanded trade means that consumers stop buying certain goods and services from domestic producers and switch to foreign-made products. + Consumers would not make this switch unless the foreign products were better, cheaper, or both, so expanded trade clearly makes them better off. + But the workers and firm owners in the domestic industries that lose business may well suffer from the increase in foreign competition (some domestic sectors shrink). + These changes in the demand for domestic products are translated into changes in the demand for labor + When wages in importing industries fall and wages in exporting industries rise, wage inequality increases + Thus increased trade may lower the wages of those workers in the industrialized country who are already poorly paid and increase the wages of those who are well paid. + Political resistance to free trade grows - The movement of workers between jobs, firms, and industries is called worker mobility. + Worker mobility will tend to reduce labor supply in one industry and increase in another industry, as workers move from the contracting industry to the growing one. + It will also shift workers from a less competitive sector to a more competitive sector. + To this extent, the labor market can adjust the effect of globalization by itself 2/ Technological Change - A second source of increasing wage inequality is ongoing technological change that favors more highly skilled or educated workers. + Increases in worker productivity are in turn a driving force behind wage increases and higher average living standards. + In the long run and on average, technological progress is undoubtedly the worker's friend - This sweeping statement is not true at all times and in all places, however. + Whether a particular technological development is good for a particular worker depends on the effect of that innovation on the worker's value of marginal product and, hence, on his or her wage. + According to some economists, many recent technological advances have taken the form of skill biased technological change—that is, technological change that affects the marginal product of higher-skilled workers differently from that of lower-skilled workers (lack of skills/knowledge to use this technology). + Accordingly, the real wages and employment of skilled workers also rise. + In contrast, because they have been made less productive by the technological change, the demand for unskilled workers shifts leftward + Lower demand for unskilled workers reduces their real wages and employment. - The remedies for the problem of wage inequalities caused by technological change are similar to those for wage inequalities caused by globalization. + First among them is worker mobility. + As the pay differential between skilled and unskilled work increases, unskilled workers will have a stronger incentive to acquire education and skills, to everyone's benefit. + A second remedy is transition aid. + Government policymakers should consider programs that will help workers retrain if they are able, or provide income support if they are not.

Costs of Unemployment

- Unemployment imposes economic, psychological, and social costs on a nation. + From an economic perspective, the main cost of unemployment is the output that is lost because the workforce is not fully utilized. + Much of the burden of the reduced output is borne by the unemployed themselves, whose incomes fall when they are not working and whose skills may deteriorate from lack of use. + However, society at large also bears part of the economic cost of unemployment - The psychological costs of unemployment are felt primarily by unemployed workers and their families (decrease in individual self-esteem). + The unemployed worker's family is likely to feel increased psychological stress, compounded by the economic difficulties created by the loss of income. - The social costs of unemployment are a result of the economic and psychological effects. + Not surprisingly, increases in unemployment tend to be associated with increases in crime, domestic violence, alcoholism, drug abuse, and other social problems. + The costs created by these problems are borne not only by the unemployed but by society in general, as more public resources must be spent to counteract these problems

Supply And Demand In Labor Market

- We have seen how supply and demand analysis can be used to determine equilibrium prices and quantities for individual goods and services. + In the market for labor, the "price" is the wage paid to workers in exchange for their services. + The "quantity" is the amount of labor firms use, which will generally measure by number of workers employed or the number of hours worked. + Firms and other employers demand labor in order to produce goods and services. + Whenever people work for pay, they are supplying labor services at a price equal to the wage they receive. - The labor market is studied by microeconomists as well as macroeconomists, and both use the tools of supply and demand. + However, microeconomists focus on issues such as the determination of wages for specific types of jobs or workers. + We take the macroeconomic approach and examine factors that affect aggregate, or economywide, trends in employment and wages.