Question

In our simple model there are two labor force statuses, unemployed and employed. Suppose the job finding rate is 0.5, the probability of going from unemployed to employed in a month, and the job separation rate is 0.05, the probability of going from employed to unemployed in a month. (a) What is the steady state unemployment rate, if finding rate and separation rate do not change. (b) Suppose the unemployment rate is 6% this month, what will it be next month?

Answer 1

a) given: f= 0.5, s=0.05

Let steady state unemployment rate be u

Then, u= s/(s+f)

u = 0.05/(0.55)

u = 0.09 or steady state unemployment rate is 9%.

b) steady state equilibrium implies that economy eventually reaches that level. If unemployment rate is 6% this year, economy is not in long run equilibrium. Therefore, it will lead to macroeconomic adjustments such that unemployment rate is 9% next year.