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Unemployment Notes

Economics Notes > Macroeconomic Principles Notes

This is an extract of our Unemployment document, which we sell as part of our Macroeconomic Principles Notes collection written by the top tier of LSE students.

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Unemployment Topics

* Labour market measurement and patterns in the OECD

* The efficiency wage model

* A search model of unemployment


Labour Market Measurement and Patterns in the OECD

* Working-age-population: P=L+NL

* Labour force: L=E+U

* Participation rate: L/P

* Unemployment rate: u=U/L

* Aren't employed but actively searching for work

* Employment rate: E/P

* Working part-time or full-time Diagram showing different parts of the labour market

Key Points

* Labour market measurement

* Sticky wages

* Efficiency wage model

* Why does effort increase with real wage

* Wage optimization

* Graphical wage optimization

* What does equilibrium wage depend on?

* Effects of G increase on labour

* Effects of TFP increase on labour

* Search model of unemployment

* Dynamics of unemployment rate

* Steady state unemployment rate

* Dynamics of unemployment rate with new entrants

* Steady state unemployment rate with new entrants

* Value of being employed

* Value of being unemployed


* Reservation wage

* Effects of unemployment benefit increase

* Effects of income tax increase

* Job finding rate

* Wage offer

* Graphs demonstrating US and international labour market

* Explanation for unemployment in a competitive model
* Given market wage rate = w*

* Labour supply is higher than labour demand

* Therefore positive unemployment Graph demonstrating positive unemployment

* Effects of unemployment benefit increase on job finding rate

* Effects of increase in job finding rate Definitions

* Reservation Wage = The lowest wage offer that an unemployed worker is willing to accept

* Sticky Wages = Where employers refuse to cut wages so have to cut labour instead Formulae







* However, because the market wage is flexible it should fall to w** and clear the labour market

* This will mean there is no unemployment

* The theory prior to 1950's was that unemployment was due to sticky wages

* Sticky Wages = Where employers refuse to cut wages so have to cut labour instead

* The labour market was not clearing






The Efficiency Wage Model

* Worker effort | with real wage rate

* Due to adverse selection and moral hazard

* Produces a stickiness in real wage

* Why Adverse Selection?

* Higher wages attract better workers

* Firm doesn't know which workers are good and which will apply

* So higher wages to attract better applicants

* Higher wages retain better workers

* Better workers get headhunted

* Higher wage stops them quitting and saves firm search/training costs

* Why Moral Hazard?

* Higher wages increase value that workers attach to their job

* Workers will be more careful not to be lazy, be found out or fired

* The efficiency wage model lets us represent the idea that higher wages make workers more keen to do well

* Assume that worker effort is a function of wage Graph showing effort of the worker as a function of wage

Course Notes Page 36

* Change in unemployment = Inflow - Outflow

* Effective units of labour:

* Employment rate: E/P

* Job finding rate =

* Labour force: L=E+U

* Maximize:

* Participation rate: L/P

* Production function:

* Unemployment rate: u=U/L

* Value of being employed at wage w =

* We suppose

* Working-age-population: P=L+NL

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