Unemployment and the Foundations of Aggregate Supply
Foundations of Aggregate Supply • Aggregate supply describes the behavior of the production side of the economy. • The aggregate supply curve or AS curve, is the schedule showing the level of total national output that will be produced at each possible price level, the other things being equal. • Aggregate supply curve in the short-run is upward sloping - one along which higher prices are associated with increases in the production of goods and services. • Long-run aggregate supply curve is vertical, one in which increases in the price level are not associated with an increase in total output supplied.
Determinants of Aggregate Supply• Aggregate supply depends fundamentally upon two distinct set of forces: potential output and input costs.• Potential output is the highest sustainable level of national output.• Input cost is the cost incurred in the production of goods and services.
Variable Impact on Aggregate SupplyPotential OutputInputs Supplies of capital, labor and land are the important inputs. Potential outputs comes when unemployment of labor and other resources is at non-inflationary levels. Growth of inputs increases potential output and aggregate supply.Technology and Innovation, technological improvement, and increasedEfficiency efficiency increase the level of potential output and raise aggregate supply.Production CostsWages Lower wages lead to lower production costs; lower costs mean that quantity supplied will be higher at every price level for a given potential output.Import Prices A decline in foreign prices or an appreciation in the exchange rate reduces import prices. This leads to lower production costs and raises aggregate supply.Other input costs Lower oil prices or less burdensome environmental regulation lowers production costs and thereby raises aggregate supply.
(a) Increase in Potential Output Potential P Output AS AS’Growth inpotential outputwith unchangedproduction costsshifts the AScurve rightwardfrom AS to AS’. QP QP ’ Q
(a) Increase in Potential Output P PotentialWhen production Output AS’costsincrease, say, because of higher ASwages or importcosts, but withunchangedpotentialoutput, the AScurve shiftsupward as from ASto AS’ QP Q
Aggregate Supply in the Short-run and Long-runP P AS Potential Output AS Potential Output QP Q QP Q The short-run AS curve slopes upward Inflexible prices and wages become because many costs are inflexible in the unstuck as time passes, so the long-run AS short-run. curve is vertical and output is determined by potential output.
UnemploymentEmployed- people who perform any paid work, as well as those who have jobs but are absent from work because of illness, strikes, or vacations.Unemployed- includes people who are not employed but are actively looking for work or waiting to return to work. To be counted as unemployed, a person must do more than simply think about work.Not in the Labor Force- includes the adult population keeping the house, retired, too ill to work, or simply not looking for work.Labor Force- includes all those who are either employed or unemployed.
Impact of Unemployment• High unemployment is both an economic and social problem. Unemployment is an economic problem because it represents waste of a valuable resource.• It is a major social problem because it causes enormous suffering as the unemployed workers struggle with reduced incomes.
Lost Output Average GDP loss As percentage of Unemployment ($, billion, 1999 GDP during the rate (%) prices) periodGreat Depression (1930-1939) 18.2 2,420 27.6Oil and Inflation crises (1975-1984) 7.7 1,480 3.0New Economy period (1985-1999) 5.7 240 0.3 Economic Costs from Periods of High Unemployment The two major periods of high unemployment occurred during the Great Depression and during the oil shocks and high inflation. The lost output is calculated as the cumulative difference between potential GDP and actual GDP.
Okun’s Law • For every 2 percent that GDP falls relative to potential GDP, the unemployment rate rises about 1 percentage point. • One important consequence of Okun’s law is that actual GDP must grow as rapidly as potential GDP just to keep the unemployment rate from rising. Okun’s Law Illustrated, (1955-1999)
Economic Interpretation of Unemployment • Three Kinds of Unemployment - Frictional Unemployment- arises because of the incessant movement of people between regions and jobs or through different stages of the life cycle. - Structural Unemployment- signifies a mismatch between the supply and demand for workers. - Cyclical Unemployment- exists when the overall demand for labor is low.
Voluntary and Involuntary Unemployment Wages move to W* to clear S W the labor market. All D unemployment is voluntary. At the competitive, market- clearing equilibrium, firms willingly hire all qualified workers who desire to work at the market wage. The number of unemployed is the line from A to E. Some members of the labor Employed E force would like to work, W* F but only at a higher wage A Voluntary rate and these are the S Unemployment D voluntary unemployed L workers (segment EF). L* Flexible wages
S W DThe graph shows whathappens if wages donot adjust to clear thelabor market. At thetoo high wage at W**, Involuntary Employed UnemploymentJH workers are W** G J Hemployed, but HGworkers are E W*involuntarilyunemployed. S D L L* Inflexible wages
Labor Market Issues • Who are the unemployed • Duration of unemployment • Source of Joblessness • Unemployment by Age
Unemployment rate of different Distribution of total unemployment groups across different groups (% of labor force) (%of total unemployed.)Labor Market Group Recession Boom Recession Boom (1982) (March 2000) (1982) (March 2000)By age: 16-19 23.2 13.3 18.5 20.2 20 and older 8.6 3.3 81.5 80.0By Race: White 8.6 3.6 77.2 77.6 Black and other 17.3 7.3 22.8 22.4By Sex (Adults only): Male 8.8 3.8 58.5 50.5 Female 8.3 4.3 41.5 49.5All Workers 9.7 4.1 100.0 100.0Unemployment by Demographic Group This table shows how unemployment varies across different demographicgroups in boom and recession years. The first set of figures shows the unemploymentrate for each group in 1982 and during the boom period of 2000. the last two columnsshow the percent of the total pool of unemployed that is in each group.
45 40 35 30 25 20 15 10 5 0 <5 10-14 15-26 27-51 52+ Duration of Unemployment, 1999 (weeks)The duration figures show the distribution of length of unemployment. In thefull-employment year 1999, only 14% were unemployed for less than 5weeks. In recessions, duration of unemployment increases.
Recession Unemployment by Reason (percent of the labor force that is unemployed Job Loser 5.7 for different reasons) Boom Reentrant 2.2 Job Loser 1.9New Entrant 1.1 1.4 Reentrant 0.3 New Entrant Job Leaver 0.8 0.6 Job Leaver 1982 1999 Distribution of Unemployment by Reasons, 1982 and 1999 very few were unemployed in 1999 because they left their jobs, and almost 2% were new entrants into the labor force or reentrants. The major change in unemployment from boom to recession, however, Is found in the number of job losers.
Unemployment rate (% of labor force) Age White Black 16-17 14.5 31.0 18-19 10.2 26.2 20-24 6.3 14.6 25-34 3.3 7.6 35-44 2.7 5.3 45-54 2.4 4.0 55-64 2.5 3.9 65 and older 2.9 5.0Unemployment Rates at Different Ages as workers search for jobs and gain training, they settle on aparticular occupation; they tend to stay in the labor force and they find apreferred employer. As a result, the unemployment rates of older people fallto a fraction of those of teenagers.