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Ch.11 Search Theory of Unemployment

Ch.11 Search Theory of Unemployment. In reality, workers have imperfect information. Therefore, they search for more favourable wage rate. It is called search market.

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Ch.11 Search Theory of Unemployment

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  1. Ch.11 Search Theory of Unemployment • In reality, workers have imperfect information. Therefore, they search for more favourable wage rate. It is called search market. • Because of the imperfect information about equilibrium wage rate  a range of wages in labour market. (i.e. different wages for equally productive workers)  wage differential because lags in the transmission of market information (lack of perfect information).

  2. Search Theory of Unemployment • If one takes up a job, he will give up the opportunity for finding the same job at higher wage rate. In order to search this job, he will have search cost in terms of extra time, effort and wage forgone. Therefore, he must weight with gain from extra search against its cost.

  3. Search Theory of Unemployment • Time spending on search increases •  lower probability of a worker searching the same job at higher wage rate. Therefore, the marginal benefit from search will decrease.

  4. Search Theory of Unemployment • Time spending on search increases •  to sacrifice increasingly large amount of income earned. Therefore, marginal cost from search will increase. • diagram

  5. Search Theory of Unemployment • MB > MC  continue to search a new job until MB = MC • Search unemployment = frictional unemployment

  6. Remarks: • When job market information increases, • - opportunity of finding a better job will decrease. If you have perfect information, you need not search the job. • - the marginal benefit from searching a new job will decrease. • diagram

  7. Remarks: • The MB curve will shift to the left. • The no. of the search will decrease from S1 to S2. • The unemployment rate will decrease.

  8. Natural Rate of Unemployment • Definition (91C9a): • The rate of unemployment at which upward and downward forces on prices and wages are in balance. It represents the lowest level of unemployment that can be sustained without causing accelerating inflation. The natural rate of unemployment is greater than zero because of the imperfect information.

  9. Why the natural rate of unemployment exists ? (93B2) • 1) Part of the unemployment is frictional. It occurs because it takes time to find a new job. • 2) When there are structural changes in the economy, structural unemployment will exist.

  10. Why the natural rate of unemployment exists ? (93B2) • 3) Search unemployment always exists when the labour market information is imperfect.

  11. Remarks: • Frictional / search unemployment : when a man cannot find a job for a long period of time  there is structural unemployment

  12. Why will the natural rate of unemployment increase? (91C9) • 1) Increasing the structural changes in industries will cause the structural unemployment. Therefore, the natural rate of unemployment (NRU) will increase.

  13. Why will the natural rate of unemployment increase? (91C9) • 2) Demographic changes: • For example, the labour force is increasing because more teenagers, minorities or women participate in economic activities but most of them cannot find the jobs because the jobs available are not enough. So the NRU will increase.

  14. Why will the natural rate of unemployment increase? (91C9) • 3) Inappropriate government policy • a) the government provides too generous unemployment benefits. This will reduce the workers’ willingness to work. So NRU will increase. • b) The government imposes the minimum wage law. This will increase the NRU.

  15. Why will the natural rate of unemployment increase? (91C9) • 4) Institutional rigidities • For example, restrictions set by the trade union will reduce the flexibility of wages and prices during the recession. This will increase the NRU.

  16. Measures to reduce NRU (91C9) • NRU can be lowered by the reform of labour market and wage and price setting mechanism. The measures are as follows: • 1) To improve the labour information services about job vacancies will reduce NRU.

  17. Measures to reduce NRU (91C9) • 2) To provide job training programmes to help unemployed workers will reduce NRU. • 3) To reform the government policies in order to reduce the workers’ disincentive to work, such as reducing the social benefits for unemployed will reduce the NRU.

  18. Measures to reduce NRU (91C9) • 4) To remove the minimum wage law will reduce the NRU. • 5) To encourage the workers to move from depressed industries to the developing industries, such as providing the retraining programmes will reduce the NRU.

  19. Measures to reduce NRU (91C9) • 6) To reduce the institutional rigidities by discouraging the restrictive practice by the trade unions will increase the labour mobility. So this can reduce the NRU.

  20. Remarks about search theory • 1) Unemployment may not be wasteful ? (86 B6) • a) unemployment is not necessarily wasteful if unemployed workers are only those who are engaged in the search process for alternatives. They should search until marginal benefit from search = marginal cost from search. That is a wealth maximizing behaviour.

  21. Remarks about search theory • b) The structural changes in the economy will cause a reallocation of labour and other resources. The unemployment will help to reallocate the resources in more efficient way. It will be beneficial to the whole economy.

  22. Remarks about search theory • c) The NRU is economically unavoidable because the information about the job market is imperfect. Therefore, we cannot say something that is unavoidable is wasteful.

  23. 2) The NRU is changeable (by search theory) • a) Information about the job opportunities to the workers • - better information about the job market  the chance of finding the same job with higher wage rate will be reduced  the MB curve will shift to the left  the no. of search will decrease  the period for searching a new job will be shorter. Therefore, the NRU will decrease. • diagram

  24. 2) The NRU is changeable (by search theory) • b) Government policy : if the government increases the unemployment benefit  the MC of search will be reduced  the MC curve shifts to the right  the no. of search will increase  the NRU will increase. • diagram

  25. 2) The NRU is changeable (by search theory) • c) if providing a government central provident funds  workers are more likely to change jobs because they will not lose parts of provident fund  the MC of searching will be reduced  the frequency of changing the job will increase  the NRU will increase. • Diagram.

  26. 3) To measure the unemployment rate (by search theory) • a) Search flow (in %) • - no. of layoff or quits and new entrants in the labour force within a period of time divided by the labour force. • b) Search duration (in %) • - no. of weeks or months (on average) it takes for an unemployed person to find a job divided by the no. of weeks or months in a year.

  27. 3) To measure the unemployment rate (by search theory) • c) unemployment rate • = Search flow X search duration

  28. An example: • Labour force = 100 million • No. of people changing jobs or searching jobs in a year = 25 million • It takes an average of 10.4 weeks to find a job.

  29. Suggested Answers; • Search flow • = (25 millions/100 millions)X100% • = 25% • Search duration • = (10.4 weeks / 52 weeks)X100% • =20%

  30. Suggested Answers; • Unemployment rate • = 25% X 20% • = 5 % • Search flow is affected by the fluctuation in demand in the economy. Search duration is affected by information cost and search cost.

  31. Remarks: • 1) information cost increases •  search duration increases  u/e rate will increase • 2) Search cost increases  search duration will decrease  u/e rate will decrease

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