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Frictional Unemployment

25 April, 2016 - 09:12

Frictional unemployment occurs because it takes time for people seeking jobs and employers seeking workers to find each other. If the amount of time could be reduced, frictional unemployment would fall. The economy’s natural rate of unemployment would drop, and its potential output would rise. This section presents a model of frictional unemployment and examines some issues in reducing the frictional unemployment rate.

A period of frictional unemployment ends with the individual getting a job. The process through which the job is obtained suggests some important clues to the nature of frictional unemployment.

By definition, a person who is unemployed is seeking work. At the outset of a job search, we presume that the individual has a particular wage in mind as he or she considers various job possibilities. The lowest wage that an unemployed worker would accept, if it were offered, is called the reservation wage. This is the wage an individual would accept; any offer below it would be rejected. Once a firm offers the reservation wage, the individual will take it and the job search will be terminated. Many people may hold out for more than just a wage—they may be seeking a certain set of working conditions, opportunities for advancement, or a job in a particular area. In practice, then, an unemployed worker might be willing to accept a variety of combinations of wages and other job characteristics. We shall simplify our analysis by lumping all these other characteristics into a single reservation wage.

A worker’s reservation wage is likely to change as his or her search continues. One might initiate a job search with high expectations and thus have a high reservation wage. As the job search continues, however, this reservation wage might be adjusted downward as the worker obtains better information about what is likely to be available in the market and as the financial difficulties associated with unemployment mount. We can thus draw a reservation wage curve (Figure 31.12), that suggests a negative relationship between the reservation wage and the duration of a person’s job search. Similarly, as a job search continues, the worker will accumulate better offers. The “best-offer-received” curve shows what its name implies; it is the best offer the individual has received so far in the job search. The upward slope of the curve suggests that, as a worker’s search continues, the best offer received will rise.

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Figure 31.12 A Model of a Job Search

An individual begins a job search at time t0 with a reservation wage W0. As long as the reservation wage exceeds the best offer received, the individual will continue searching. A job is accepted, and the search is terminated, at time tc, at which the reservation and “best-offer-received” curves intersect at wage Wc.

The search begins at time t0, with the unemployed worker seeking wage W0. Because the worker’s reservation wage exceeds the best offer received, the worker continues the search. The worker reduces his or her reservation wage and accumulates better offers until the two curves intersect at time tc. The worker accepts wage Wc, and the job search is terminated.

The job search model in Figure 31.12does not determine an equilibrium duration of job search or an equilibrium initial wage. The reservation wage and best-offer-received curves will be unique to each individual’s experience. We can, however, use the model to reach some conclusions about factors that affect frictional unemployment.

First, the duration of search will be shorter when more job market information is available. Suppose, for example, that the only way to determine what jobs and wages are available is to visit each firm separately. Such a situation would require a lengthy period of search before a given offer was received. Alternatively, suppose there are agencies that make such information readily available and that link unemployed workers to firms seeking to hire workers. In that second situation, the time required to obtain a given offer would be reduced, and the best-offer-received curves for individual workers would shift to the left. The lower the cost for obtaining job market information, the lower the average duration of unemployment. Government and private agencies that provide job information and placement services help to reduce information costs to unemployed workers and firms. They tend to lower frictional unemployment by shifting the best-offer-received curves for individual workers to the left, as shown in Panel (a) of Figure 31.13. Workers obtain higher-paying jobs when they do find work; the wage at which searches are terminated rises to W2.

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Figure 31.13 Public Policy and Frictional Unemployment

Public policy can influence the time required for job-seeking workers and worker-seeking firms to find each other. Programs that provide labor-market information tend to shift the best-offer-received (BOR) curves of individual workers to the left, reducing the duration of job search and reducing unemployment, as in Panel (a). Note that the wage these workers obtain also rises to W2. Unemployment compensation tends to increase the period over which a worker will hold out for a particular wage, shifting the reservation wage (RW) curve to the right, as in Panel (b). Unemployment compensation thus boosts the unemployment rate and increases the wage workers obtain when they find employment.

Unemployment compensation, which was introduced in the United States during the Great Depression to help workers who had lost jobs through unemployment, also affects frictional unemployment. Because unemployment compensation reduces the financial burden of being unemployed, it is likely to increase the amount of time people will wait for a given wage. It thus shifts the reservation wage curve to the right, raises the average duration of unemployment, and increases the wage at which searches end, as shown in Panel (b). An increase in the average duration of unemployment implies a higher unemployment rate. Unemployment compensation thus has a paradoxical effect—it tends to increase the problem against which it protects.