[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Thinking Like an Economist
EMPLOYMENT FLUCTUATIONS AND TRADE-OFFS
We measure the cost of cyclical unemployment by the
output that could have been produced if full employment
had been maintained. This represents the opportunity
cost to society of cyclical unemployment. Not all unemployment
represents an opportunity cost, either to the
individual worker or to society. A worker who voluntarily
quits a job to look for another is classified as unemployed,
but she must believe that the value of seeking a new job,
one that either pays better or has other advantages over
her old job, exceeds the temporary loss in wages. Time
spent in job search can thus represent a productive use
of time.
To measure the cost of employment fluctuations,
we need to take into account the trade-offs that individuals
face. For some, the value of time spent in leisure and other
nonmarket activities (taking care of children, for example)
is greater than the real wage that could be earned from
working.
In Chapter 22 we learned that according to Okun’s Law, the unemployment rate
rises above the natural rate of unemployment level (the unemployment rate at full
employment) by 1 percentage point for every 2 percentage points that the output gap
shrinks. Using Okun’s Law, we can translate an 8 percent output gap such as the
United States experienced in the 1982 recession into an added 4 percentage points of
unemployment. Since most estimates at the time placed the natural rate of unemployment
at around 6 percent, the figure provided via Okun’s Law (about 10 percent
unemployment) is consistent with the actual 9.7 percent unemployment rate in 1982.
As a lingering result of the recession in 2001, the unemployment rate averaged
6.0 percent in 2002. Most estimates of the natural rate of unemployment for 2002 put
it in the range of 5 to 5.5 percent. We can use this information, together with Okun’s
Law, to estimate the output cost of 2002’s cyclical unemployment. For the purposes
of this example, we will set the natural rate of unemployment at 5 percent.
Step 1: Cyclical unemployment is the difference between the actual unemployment
rate (6 percent) and the rate estimated to correspond to full
employment (5 percent), or 1 percent.
Step 2: Okun’s Law tells us that the percentage gap between actual output and
full-employment output is about twice the level of cyclical unemployment.
So the lost output was roughly 2 × 1 = 2 percent of real GDP.
Step 3: In 2002, real GDP was $10 trillion. Thus $200 billion (2 percent of $10 trillion)
is the value of the output lost as a result of cyclical unemployment that year.
Why Economies Experience
Fluctuations
It is difficult to reconcile the economic fluctuations we observe, and the associated
changes in unemployment, with the full-employment model. According to the
WHY ECONOMIES EXPERIENCE FLUCTUATIONS ∂ 643