Question

2. Unemployment

a. During a recession, labor demand falls and job search will likely produce fewer offers with a given amount of search, as well as lower quality offers. How should this affect the workers reservation wage?

b. How (and why) would an increase in the generosity of unemployment insurance benefits affect workers reservation wages and expected unemployment durations?

c. If a firm pays its workers efficiency wages how will the premium it has to pay its workers to motivate them change as the unemployment rate changes?

Answer 1

^{reservation wage is the lowest amount of wage on which a worker would be willing to work. As recession strikes, the job opportunity reduces and it becomes really difficult for an employer to pay his employ a decent wage. Hence, when recession strikes people's reservation wage reduces as due to lack of work they get ready to work for any wage rate.}

^{2. Increase in generosity of unemployment insurance would have a rising affect on the reservation wage as when unemployed people will have an insurance to fulfill their necessities they won't be willing to work for lesser wage. This may also increase the duration of unemployment as people won't be willing to work of insurance is sufficient enough for them.}

^{3. If unemployment rate is low, the supply of labour would be lesser and employers would have to pay high premiums to keep his employees motivated and the vice versa.}