Definition: the labor market is in steady state, or long-run equilibrium, if the unemployment rate is constant. The steady-state condition is:
s E = f U
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Why is there unemployment?

If job finding were instantaneous (f = 1), then all spells of unemployment would be brief, and the natural rate would be near zero. There are two reasons why f < 1:
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Sectoral shifts

def: changes in the composition of demand among industries or regions

example: Technological change increases demand for computer repair persons, decreases demand for typewriter repair persons
# of employed people who lose or leave their jobs
# of unemployed people who find jobs
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Solving for the “equilibrium” U rate
f U = s E = s (L –U ) = s L – s U Solve for U/L:
Find the natural rate of unemployment:

U s 0.01 0.05, or 5% L s f 0.01 0.19
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policy implication

A policy that aims to reduce the natural rate of unemployment will succeed only if it lowers s or increases f.
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Exercise

Suppose that some foreign countries begin to subsidize investment by instituting an investment tax credit.
What happens to world investment demand as a function of the world interest rate? What happens to the world interest rate? What happens to investment in our small open economy? What happens to our trade balance? What happens to our real exchange rate?
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Assumptions:
1. L is exogenously fixed.
2. During any given month, s = fraction of employed workers that become separated from their jobs, f = fraction of unemployed workers that find jobs. s = rate of job separations
fall NX does not change if policy affects neither S nor I.
5. Exchange rates
nominal: the price of a country’s currency in
terms of another country’s currency real: the price of a country’s goods in terms of another country’s goods. The real exchange rate equals the nominal rate times the ratio of prices of the two countries.
72.0%
Agriculture Manufacturing Other industry Services
8.5% 17.8% 1.7%
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Public Policy and Job Search
Govt programs affecting unemployment

Govt employment agencies: disseminate info about job openings to better match workers & jobs Public job training programs: help workers displaced from declining industries get skills needed for jobs in growing industries
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Natural Rate of Unemployment

Natural rate of unemployment: the average rate of unemployment around which the economy fluctuates. In a recession, the actual unemployment rate rises above the natural rate.
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Chapter summary
6. How the real exchange rate is determined
NX depends negatively on the real exchange rate, other things equal The real exchange rate adjusts to equate NX with net capital outflow


In a boom, the actual unemployment rate falls below the natural rate.
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U.S. Unemployment, 1958-2002
11 10
Percent of labor force
9 8 7 6 5 4 3 2 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
example: A new international trade agreement causes greater demand for workers in the export sectors and less demand for workers in import-competing sectors.
(f + s) U = s L
so,
U s L s f
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Example:

Each month, 1% of employed workers lose their jobs (s = 0.01)

Each month, 19% of unemployed workers find jobs (f = 0.19)
7. How the nominal exchange rate is
determined
e equals the real exchange rate times the
country’s price level relative to the foreign price level. For a given value of the real exchange rate, the percentage change in the nominal exchange rate equals the difference between the foreign & domestic inflation rates.
a.
b. c.
d. e.
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Chapter 6:
Unemployment
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Chapter objectives
The natural rate of unemployment:


what it means
what causes it
understanding its behavior in the real world
Unemployment rate
Natural rate of unemployment
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A first model of the natural rate
Notation:
L = # of workers in labor force
E = # of employed workers U = # of unemployed U/L = unemployment rate
Y = C + I + G + NX trade balance NX = S - I net capital outflow
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Chapter summary
4. Impact of policies on NX :