Unemployment and Its Natural Rate (Part 2)

Why Are There Always Some People Unemployed?

The natural (long-run) rate of unemployment persists even in healthy economies due to several underlying factors. Understanding these causes is essential for analyzing labor market dynamics and policy implications.

• Frictional Unemployment: This type of unemployment arises from the time it takes for workers to search for and find jobs that best suit their skills and preferences. It is often short-term and voluntary.

• Structural Unemployment: Occurs when there are mismatches between the skills of workers and the requirements of available jobs, or when the number of jobs in some labor markets is insufficient to provide employment for everyone who wants one. This can be due to technological changes, shifts in consumer demand, or other long-term factors.

• Excess Supply of Labour: When the quantity of labour supplied exceeds the quantity demanded at the prevailing wage, structural unemployment results.

• Above-Equilibrium Wages: Structural unemployment can also result when wages are set above the equilibrium level due to minimum-wage laws, unions, or efficiency wages.

Example: A region where manufacturing jobs decline due to automation may experience structural unemployment as workers need to retrain for new industries.

Unemployment from a Wage Above the Equilibrium Level

When wages are set above the market equilibrium, a surplus of labour (unemployment) occurs. This can be illustrated using a standard supply and demand diagram for the labour market.

• Labour Supply: The total number of workers willing to work at each wage level.

• Labour Demand: The total number of workers firms are willing to hire at each wage level.

• Surplus of Labour: If the wage is set above equilibrium (), the quantity of labour supplied () exceeds the quantity demanded (), resulting in unemployment.

Equation:

Example: If the equilibrium wage is but the minimum wage is set at , more workers will seek jobs than firms are willing to hire, creating unemployment.

Minimum-Wage Laws

Minimum-wage laws set a legal floor for wages, which can impact employment levels, especially among low-skilled workers.

• Price Floor: The minimum wage acts as a price floor in the labour market. If set above the equilibrium wage, it creates a surplus of labour (unemployment).

• Binding Constraint: The law only affects employment if the minimum wage is above the equilibrium wage.

• Targeted Impact: Most workers earn more than the minimum wage, so the law primarily affects low-skilled and inexperienced workers, such as teenagers.

• Empirical Evidence: Studies in Canada show that a 10% increase in the minimum wage reduces teen employment by 1–5%.

Example: Raising the minimum wage from $14 to $15 per hour may reduce employment opportunities for young or inexperienced workers.

Quick Quiz: Minimum Wage Effects

In a competitive labour market, an increase in the minimum wage results in:

• Increase in the quantity of labour supplied

• Decrease in the quantity of labour demanded

Correct Answer: a. increase; decrease

Unions and Collective Bargaining

Unions are organizations that represent workers in negotiations with employers over wages, benefits, and working conditions. Their presence can significantly affect wage levels and employment outcomes.

• Definition: A union is a worker association that bargains with employers.

• Prevalence: Unions are more common in the public sector (71% unionized) than in the private sector (16% unionized) in Canada.

• International Comparison: Unionization rates and collective bargaining coverage vary widely across countries.

The Economics of Unions

• Bargaining Power: Union wages are set through negotiation, not by market equilibrium.

• Cartel Analogy: Unions act as a group of sellers (workers) seeking to exert market power.

• Collective Bargaining: The process by which unions and firms agree on employment terms.

• Strike: The organized withdrawal of labour by a union.

Union Membership in Canada (2005–2015)

Source: Employment and Social Development Canada

Percentage of Workers Covered by Collective Bargaining (Selected Countries, 2019)

Source: OECD, Going for Growth, 2019

Are Unions Good or Bad for the Economy?

• Union Wage Premium: Union workers typically earn 10–20% more than similar non-union workers.

• Employment Effects: Higher union wages can reduce the quantity of labour demanded, causing some unemployment.

• Debate: Economists disagree on the overall impact of unions. Advocates argue unions address market power and improve worker well-being; critics argue unions act as cartels, causing inefficiency and inequality.

• Insider-Outsider Theory: Unions may create a divide between 'insiders' (employed union members) and 'outsiders' (unemployed or non-union workers), potentially increasing unemployment among outsiders.

Example: In a town where the main employer is unionized, union bargaining may secure higher wages but also reduce the number of available jobs.

The Theory of Efficiency Wages

Efficiency wage theory suggests that firms may voluntarily pay wages above the market equilibrium to increase worker productivity, even if it results in some unemployment.

• Definition: Efficiency wages are above-equilibrium wages paid to boost productivity.

• Unemployment Effect: By raising wages above equilibrium, firms create a surplus of labour, leading to unemployment.

Reasons Firms Pay Efficiency Wages

• Worker Health: Higher wages enable workers to afford better nutrition and healthcare, increasing productivity.

• Worker Turnover: Higher wages reduce turnover, saving firms the costs of hiring and training new employees.

• Worker Effort: Well-paid workers are more motivated to work hard and less likely to shirk responsibilities.

• Worker Quality: Higher wages attract a larger and more qualified pool of applicants, improving the firm's workforce.

Example: A technology firm pays above-market wages to attract and retain top talent, reducing turnover and increasing innovation.

Quick Quiz: Efficiency Wages

When a firm pays an efficiency wage, it may:

• Find that its workers quit less frequently (correct answer)

• Other options (incorrect): have trouble attracting enough workers, have to monitor workers more closely, experience declines in worker quality

Additional info: The notes are based on Chapter 9 of "Principles of Macroeconomics" (Ninth Canadian Edition), focusing on the causes and implications of unemployment, including the roles of minimum-wage laws, unions, and efficiency wages.