Question

Suppose that Congress passes legislation making it more difficult for firms to fire workers. One example might be a law requiring severance pay for fired workers. The goal of this legislation is to reduce the rate of job separation without affecting the rate of job finding. Use this information to answer the following three questions. (Assume the size of the labor force remains constant.) If this legislation reduces the rate of job separation (s) without affecting the rate of job finding (f), how would the natural rate of unemployment change

Answer 1

If the new law reduces the rate of job separation without affecting the rate of job finding, then, the natural rate of unemployment will fall.

This is because of the formula

U / L = s / (s + f)

Where U is unemployment, L is labor force, s is rate of separation, and f is rate of job finding.

The reason why the rate of natural unemployment will fall is because if employees are harder to fire, companies will be more careful when hiring workers, since the cost of firing a worker is now higher.