Economists use rules of thumb to make estimates of the future direction of key aggregates based upon assumptions about the movement in related aggregates. Say, we form the view that over the next year: (a) the average working week will be constant in hours; (b) real GDP growth rate will be 3 per cent; (c) output per unit of labour input (persons) grows at 1.5 per cent; and (d) the labour force maintains a growth rate of 1.5 per cent per annum. We would project that the
Answer: The unemployment rate will be unchanged.
The answer is Option (c) - the unemployment rate will be unchanged.
The assumptions made about the aggregates over the next 12 months were:
The real GDP growth rate doesn't relate to the labour market in any direct way. The late Arthur Okun is famous (among other things) for estimating the relationship that links the percentage deviation in real GDP growth from potential to the percentage change in the unemployment rate - the so-called Okun's Law.
The algebra underlying this law can be manipulated to estimate the evolution of the unemployment rate based on real output forecasts.
From Okun, we can relate the major output and labour-force aggregates to form expectations about changes in the aggregate unemployment rate based on output growth rates. A series of accounting identities underpins Okun's Law and helps us, in part, to understand why unemployment rates have risen.
Take the following output accounting statement:
(1) Y = LP*(1-UR)LH
where Y is real GDP, LP is labour productivity in persons (that is, real output per unit of labour), H is the average number of hours worked per period, UR is the aggregate unemployment rate, and L is the labour-force. So (1-UR) is the employment rate, by definition.
Equation (1) just tells us the obvious - that total output produced in a period is equal to total labour input [(1-UR)LH] times the amount of output each unit of labour input produces (LP).
Using some simple calculus you can convert Equation (1) into an approximate dynamic equation expressing percentage growth rates, which in turn, provides a simple benchmark to estimate, for given labour-force and labour productivity growth rates, the increase in output required to achieve a desired unemployment rate.
Accordingly, with small letters indicating percentage growth rates and assuming that the average number of hours worked per period is more or less constant, we get:
(2) y = lp + (1 - ur) + lf
Re-arranging Equation (2) to express it in a way that allows us to achieve our aim (re-arranging just means taking and adding things to both sides of the equation):
(3) ur = 1 + lp + lf - y
Equation (3) provides the approximate rule of thumb - if the unemployment rate is to remain constant, the rate of real output growth must equal the rate of growth in the labour-force plus the growth rate in labour productivity.
It is an approximate relationship because cyclical movements in labour productivity (changes in hoarding) and the labour-force participation rates can modify the relationships in the short-run. But it provides reasonable estimates of what happens when real output changes.
The sum of labour force and productivity growth rates is referred to as the required real GDP growth rate - required to keep the unemployment rate constant.
Remember that labour productivity growth (real GDP per person employed) reduces the need for labour for a given real GDP growth rate while labour force growth adds workers that have to be accommodated for by the real GDP growth (for a given productivity growth rate).
So in the example, the required real GDP growth rate is 3 per cent per annum and so the actual real GDP growth is also equal to this required real GDP growth rate. In other words, the unemployment rate will remain unchanged.
Unemployment would still be rising but the rate of unemployment will be constant.
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