Question

7. Answer all parts (a) – (c) of this question.

1. [10 marks] Outline a basic model of the natural rate of unemployment. Suppose that the government wants to introduce the following policy: on top of unemployment benefits the unemployed receive a bonus for finding new jobs; the amount of the bonus declines with the duration of search. In the context of the model you have outlined explain the main effects of the proposed policy.
2. [8 marks] Explain the difference between frictional and structural unemployment. In the context of search theory explain why a certain amount of frictional unemployment is probably necessary in a well-functioning economy.  

[7 marks] Some economists argue that efficiency wages theory provides a useful explanation why economy’s wages are sticky. Critically assess that statement.  

Answer 1

Explain the difference between frictional and structural unemployment. In the context of search theory explain why a certain amount of frictional unemployment is probably necessary in a well-functioning economy.  

                         Frictional and structural unemployment are two different types of unemployment that occur in an economy. Frictional unemployment is not a direct result of economic factors and occurs when workers search for jobs. Conversely, structural unemployment is caused by shifts in the economy that make it difficult for workers to find employment.1

KEY TAKEAWAYS

• Frictional unemployment involves people transitioning between jobs; it has nothing to do with the economic cycle and is voluntary.
• Structural unemployment is a direct result of shifts in the economy, including changes in technology or declines in an industry.
• Frictional unemployment is typically a temporary phenomenon, while structural unemployment can last for years.
• Structural unemployment is very concerning to economists, while frictional unemployment is considered inevitable and not factored into the unemployment rate.

Frictional Unemployment

Frictional unemployment is the result of workers searching for new employment or transitioning from their old jobs to new ones. It can also be referred to as “natural unemployment,” because it is not directly related to factors that lead to an underperforming economy.2

Frictional unemployment is voluntary and a direct result of temporary transitions in employment. This includes new people who are entering the workforce, anyone who moves to find work in a different city, and people who quit their jobs to find other work. Workers may also choose to remain unemployed rather than take the first job they are offered. Thus, frictional unemployment is usually present in an economic system, because some people are always searching for new jobs.3

Recent college graduates who are looking for work may not expect to find a job within a year of graduating due to their lack of experience. However, offers may come in for jobs that are not in their chosen field. When they reject those offers for that reason, they are frictionally unemployed. Employers can also cause frictional unemployment. For instance, employers may feel as though there are not enough qualified candidates for certain positions and thus not try to fill them.

Many economists remain unconcerned about frictional unemployment, as there is no way to stop it from happening. They realize that frictional unemployment is temporary and does not put a strain on government resources such as social assistance and unemployment benefits. It is actually a good sign for the economy, as it demonstrates that people are looking for higher-paying, better-quality jobs. Because frictional unemployment is not directly related to the economy, economists tend to factor it out when calculating the unemployment rate

Structural Unemployment

Structural unemployment is a type of long-term unemployment caused by shifts in the economy. It occurs when there is an oversupply of jobs and people who are willing to work them, but those people are not qualified to do so.1

One of the reasons behind structural unemployment is technological advances, which can cause some types of skilled laborers to become obsolete. Assume a data analyst at an investment bank has been working in the field for more than 20 years but has never kept up with technological advances and never learned to program. The analyst’s job is easily programmable, and those programs can analyze big data faster. As the worker is not qualified for other data-analyst jobs, which require extensive programming skills, he or she experiences structural unemployment.

Structural unemployment can also be caused by a decline in an industry. Assume the prices of crude oil have been on the decline over the past year. Therefore, shale oil drilling companies have also been on the decline, losing money on their total investments due to the weakened oil industry. To combat operating at a loss, the shale oil drilling companies must lay off many of their workers. The skilled workers in the drilling field do not have the skills to perform other jobs in emerging industries and markets. Consequently, the decline in this industry can lead to structural unemployment.

Because structural unemployment is a direct result of the economic cycle, economists and analysts take it very seriously. If not addressed, this type of unemployment can last for years, even decades, increasing a nation’s unemployment rate.