Page 172 - Krugmans Economics for AP Text Book_Neat

push the wage that workers receive above the equilibrium wage. Consequently, there
Efficiency wages are wages that
are more people willing to work at the wage being paid than there are jobs available.
employers set above the equilibrium
Like a binding minimum wage, this leads to structural unemployment.
wage rate as an incentive for better
employee performance. Efficiency Wages Actions by firms may also contribute to structural unemployment.
The natural rate of unemployment is Firms may choose to pay efficiency wages—wages that employers set above the equi-
the unemployment rate that arises from the librium wage rate as an incentive for their workers to deliver better performance.
effects of frictional plus structural Employers may feel the need for such incentives for several reasons. For example,
unemployment. employers often have difficulty observing directly how hard an employee works. They
Cyclical unemployment is the deviation can, however, elicit more work effort by paying above -market wages: employees receiv-
of the actual rate of unemployment from the ing these higher wages are more likely to work harder to ensure that they aren’t fired,
natural rate. which would cause them to lose their higher wages.
When many firms pay efficiency wages, the result is a pool of workers who want jobs but
can’t find them. So the use of efficiency wages by firms leads to structural unemployment.
Side Effects of Public Policy In addition, public policy designed to help workers who
lose their jobs can lead to structural unemployment as an unintended side effect. Most
economically advanced countries provide benefits to laid- off workers as a way to tide
them over until they find a new job. In the United States, these benefits typically re-
place only a small fraction of a worker’s income and expire after 26 weeks. In other
countries, particularly in Europe, benefits are more generous and last longer. The
drawback to this generosity is that it reduces the incentive to quickly find a new job,
and by keeping more people searching for longer, the benefits increase structural and
frictional unemployment. Generous unemployment benefits in some European coun-
tries are widely believed to be one of the main causes of “Eurosclerosis,” the persistent
high unemployment that afflicts a number of European economies.

The Natural Rate of Unemployment

Because some frictional unemployment is inevitable and because many economies also
suffer from structural unemployment, a certain amount of unemployment is normal,
or “natural. ” Actual unemployment fluctuates around this normal level. The natural
rate of unemployment is the normal unemployment rate around which the actual un-
employment rate fluctuates. It is the rate of unemployment that arises from the effects
of frictional plus structural unemployment. Cyclical unemployment is the deviation
of the actual rate of unemployment from the natural rate; that is, it is the difference be-
tween the actual and natural rates of unemployment. As the name suggests, cyclical un-
employment is the share of unemployment that arises from the business cycle. We’ll see
later that public policy cannot keep the unemployment rate persistently below the nat-
ural rate without leading to accelerating inflation.
We can summarize the relationships between the various types of unemployment
as follows:
(13-1) Natural unemployment =
Frictional unemployment + Structural unemployment
(13-2) Actual unemployment =
Natural unemployment + Cyclical unemployment

Perhaps because of its name, people often imagine that the natural rate of unemploy-
ment is a constant that doesn’t change over time and can’t be affected by policy. Nei-
ther proposition is true. Let’s take a moment to stress two facts: the natural rate of
unemployment changes over time, and it can be affected by economic policies.
Changes in the Natural Rate of Unemployment

Private -sector economists and government agencies need estimates of the natural rate
of unemployment both to make forecasts and to conduct policy analyses. Almost all
these estimates show that the U.S. natural rate rises and falls over time. For example,
130 section 3 Measurement of Economic Performance