Slides_unemployment_lecture_3

Slides_unemployment_lecture_3 - Lecture 3: Equilibrium...

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Lecture 3: Equilibrium unemployment theory
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The traditional Keynesian view Unemployment is a short-term phenomenon It is due to nominal price rigidities, which create an imbalance between aggregate supply and aggregate demand Nominal prices eventually adjust downwards as a result of this imbalance Therefore, there is no persistent unemployment
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We need a theory of positive equilibrium unemployment No economy with zero unemployment has ever been observed Two routes to generate unemployment: Built-in real wage rigidity Labor demand < labor supply Built-in frictions: people lose their jobs and it is physically impossible for them to find another one
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The simplest model of real wage rigidity: Labor demand Labor supply Wage floor Unemployment Employment L w/p
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What is wrong with this model? No micro foundation for the wage floor we see that later It is not a macro model: we do not know where labor demand comes from. So we have equilibrium unemployment but we do not know its determinants! The model is not very useful
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Introducing the wage curve: It looks like a labor supply curve But it is not a labor supply curve The labor supply curve gives us how much labor people want to supply at a given wage The wage curve tells us how the unemployment rate affects the wage that wage setters ask in a non competitive framework ) ( t t t u h p w =
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How it works: SR Labor demand LR Labor demand SR Unemployment SR Employment L w/p Wage curve Labor force LR Unemployment
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How are wages set? Wages can be thought of as the sum of three terms: A compensation for the disutility of labor An outside option which determines what the worker would get outsidr the employment relationship (alternative wage = OC of labor) A rent which tells us how much he can grab beyond that
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When is unemployment involuntary? If the employed are better-off than the
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Slides_unemployment_lecture_3 - Lecture 3: Equilibrium...

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