Unemployment and

Inflation

1. UNEMPLOYMENT

Macroeconomic Problems:
Unemployment

Unemployment
It is helpful to divide the problem of
unemployment into two categories-the
long-run/term problem and the shortrun problem.
The economys natural rate of
unemployment refers to the amount of
unemployment that the economy
normally experiences in the long run.
(Mankiw, 1997)

Macroeconomic Problems:
Unemployment

Cyclical unemployment refers to the year-to-year

fluctuations in unemployment around its natural rate, and it
is closely associated with the short-run ups and downs of
economic activity. The deviation of unemployment from its
natural rate. (Mankiw, 1997)
Long-Run
In using the word natural, it is not implied that this rate of
unemployment is desirable or inevitable. It just means that
this rate does not go away on its own even in the long term.
We will try to answer three questions. How is the economys
rate of unemployment measured? What problems arise in
interpreting the unemployment data? What explains the
long run natural rate of unemployment?

Macroeconomic Problems:
Unemployment
What does the term unemployment mean and
how is it measured?
In each country, there is an authority/body
charged with the responsibility of carrying out
regular surveys to come up with data on
unemployment and on other aspects of labour
market, such as types of employment, length of
the average workweek, duration of
unemployment, etc.
In the US, the Bureau of Labor Statistics (BLS),
from its survey, places each adult (16 years of
age and older) into;
employed
unemployed
not in the labour force.

Macroeconomic Problems:
Unemployment

Generally,
Employed
An adult who works in the formal sector for wage, either for
an employer or in his/her own or family business for certain
number of hours per week. Someone who has a job but is
temporarily absent (on holiday) with or without pay.
Unemployed
An adult who is looking for a wage job or is temporarily laid
off.
Not in the Labour Force
A person who fits into neither of the above two categories
such as a student (over 16/18 years of age whatever the
age requirement), a retiree, etc, is not in the labour force.

Macroeconomic Problems:
Unemployment

In the case of PNG, we may not use the term unemployed

on the villagers who have their own land and resources to
feed themselves. As such they may be considered to be
outside of the labour force. The unemployed are those who
are in urban centres and are not in formal employment,
including those who are trained but are not formally
employed. This may be debatable.
The Department of Labour is the authority to report on
labour matters (employment figures, categories of
employement, etc). Bank of Papua New Guinea carries out
its own employment survey and publishes an employment
index in the Quarterly Economic Bulletin
Labour force is the total number of workers, including both
the employed and unemployed.

Macroeconomic Problems:
Unemployment
Labour force = Number of employed +
Number of unemployed
Unemployment rate is the percentage of
the labour force that is unemployed.
Unemployment rate = (Number of
unemployed/Labour force) x 100
Labour-force participation rate
- The percentage/portion of the total adult
population of the country that is in the
labour force.

Macroeconomic Problems:
Unemployment

Unemployment rate = (500,000/1,500,000)*100 = 33.33%

Labour Force Participation Rate =
(1,500,000/5,000,000)*100 = 30%

Macroeconomic Problems:
Unemployment

Is unemployment measured correctly?

It is easy to distinguish between a person employed on a
job on a full time basis and a person who is not working at
all in town.
But it is very hard to distinguish between a person who is
unemployed (and is in the labour force) and a person who is
not in the labour force. Movements into and out of the
labour force are very common. Young workers entering the
labour force, old workers moving in and out, moving
between villages and towns. That makes the measure of
labour force unstable/unreliable and therefore the
calculation of unemployment rate has some implied
questions and should be treated with caution.
There is no easy fix. In the end, it is best to view the
reported unemployment rate as a useful but imperfect
measure of joblessness. (Mankiw, p294, 1997)

Macroeconomic Problems:
Unemployment
Factors Contributing to Long-run
Unemployment
In the ideal labour market, (theory)
tells us that wages would adjust to
equate the quantity of labour
supplied and the quantity of labour
demanded. This adjustment would
ensure that there is full employment.
Unfortunately, reality does not
resemble this ideal.

Macroeconomic Problems:
Unemployment
(a)Minimum Wages Laws

Macroeconomic Problems:
Unemployment
WE balances the supply of labour equals demand
for labour.
Wminimum leads to the supply of labour being
greater than the quantity of labour demanded
compared to the quantity of labour demanded at
equilibrium. There is a surplus of labour. More
workers are willing to work than firms are willing
to employ. Thus, the number of workers in excess
of the demand for workers are unemployed.
It is important to note that minimum wages may
not be a predominant reason for unemployment
because many workers have wages well above
the minimum wage. Minimum wage applies to the
youth and the least skilled and the least
experienced. It is only among this group that the

Macroeconomic Problems:
Unemployment
(b) Unions and Collective Bargaining
A union is a worker association that
bargains with employers over wages and
working conditions for its members who
are workers/employees. The process by
which unions and firms agree on the terms
of employment is called collective
bargaining.
Unions ask for higher wages, better
benefits and better working conditions
than the firm would offer in the absence of
a union.

Macroeconomic Problems:
Unemployment
If there is disagreement union go on
strike. The employer/s in fear of a strike
and loss of production and profit is/are
likely to agree to pay higher wages and
offer better working conditions to the
employees.
At higher wages above the equilibrium
level, the quantity of labour supplied
increases and quantity of labour
demanded reduces, resulting in
unemployment. Some workers may be laid
off and become unemployed (outsiders)
and loose out on the new conditions while
those who remain (insiders) enjoy the new
conditions.

Macroeconomic Problems:
Unemployment
(c) The Theory of Efficiency Wages

Firms operate more efficiently if wages are above the

equilibrium level. Therefore, it may be profitable for firms to
keep wages high even in the presence of an excess supply
of labor.
Unemployment that arises from efficiency wages is similar
to the unemployment that arises from minimum-wage laws
and unions. In all three cases unemployment is the result of
wages being above the level that balances supply and
demand of labour. But there is an important difference. The
first two factors prevent firms from lowering wages in the
presence of a surplus of workers while in the third case,
that constraint on not being able to lower wages is
unnecessary because firms are better off keeping wages
above the equilibrium wage level.
Paying better wage is good for the firm because it raises
the efficiency of the worker.

Macroeconomic Problems:
Unemployment
(d) Job Search
Job search is the process of matching workers
with appropriate jobs. More relevant for countries
like the USA and Australia.
If all workers and all jobs were the same in the
sense that all workers were equally well suited for
all jobs, job search would not be a problem and
there will be less unemployment problem.
The reality is workers differ in their skills and
tastes, jobs differ in their attributes, and
information about job candidates and job
vacancies is disseminated slowly among the
many firms and households in the economy.

Macroeconomic Problems:
Unemployment
Unemployment in this case is different from the
first three situations. In the first three cases,
wages are above the equilibrium level and there
is unemployment because workers are waiting
for jobs to become available. In the fourth case,
unemployment is not due to failure of wages to
balance labour supply and demand, it is due to
workers searching for the jobs that suits them.
In the context of PNG, we may think of poor
infrastructure development (roads, education,
health) as a factor contributing to the long-term
unemployment problem in the rural areas. If there
is improved infrastructure, monetization will
increase, enabling more of our rural population to
participate in the market economy (sell produces)

Macroeconomic Problems:
Unemployment
In urban centers, long-run unemployment may be
due to the small size of the market and lack of
competition. If more firms are able to open up
businesses, that will increase the market size and
competition and more workers will be employed.
Another factor could be lack of government
initiatives and good planning to create programs
for the youth.
Again this is debatable, and as students of
economics you should think critically but
scientifically.
The cost of unemployment is of course economic
and psychological hardships. Costs of
unemployment are neither distributed across the
population evenly nor is it easily quantifiable.