Problem set 3.
Question 1
The natural rate of unemployment. Let N = 100 be the number of million people in the labour force, L = 85 be the number of million employed, and U = 15
be the number of million unemployed. Assume that the size of the labour force is
fixed at N = 100, so people can only move between employment and unemployment, they cannot retire or decide to study for example.
Assume that every month σ = 3.5% of the employed lose their job, and every
month ψ = 48% of the unemployed find a job.
part a
What is the outflow from employment each month? (Or equivalently what is
the inflow to unemployment?)
part b
What is the outflow from unemployment each month? (Or equivalently what
is the inflow to employment?)
part c
Write down the condition under which the number of employed do not change.
Write down the condition under which the number of unemployed do not change.
Are the two conditions different? Explain your answer.
part d
What is the natural rate of unemployment?
part e
Show that the economy tends to this rate of unemployment.
Question 2
Go to the OECD website and collect data on unemployment rates for the US, the
UK, France, Germany, Italy from the 1980s until today. Compare them. Are there
any significant differences? Thinking about the differences in our search framework, what do you think the reasons underlying this phenomenon can be? Do
you think the job finding rate or the job separation rate is more important in this?
Explain your answer.
Question 3
The 1973 oil crisis started in October 1973, when the members of Organization of Arab Petroleum Exporting Countries or the OAPEC (consisting of the Arab
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members of OPEC, plus Egypt, Syria and Tunisia) proclaimed an oil embargo. This
was ”in response to the U.S. decision to re-supply the Israeli military” during the
Yom Kippur war. It lasted until March 1974.
On October 16, 1973, OPEC announced a decision to raise the posted price of oil
by 70%, to $5.11 a barrel. The following day, oil ministers agreed to the embargo, a
cut in production by five percent from September’s output, and to continue to cut
production over time in five percent increments until their economic and political
objectives were met.
Since short term oil demand is inelastic, demand falls little when the price is
raised. Thus, oil prices had to be raised dramatically to reduce demand to the new
lower level of supply. Anticipating this, the market price for oil immediately rose
substantially, from $3 a barrel to $12.
part a
In our model of real business cycles, how would you evaluate this shock?
part b
Thinking about the automobile industry, what effects would such a shock imply? What would happen to capacity utilisation in car factories?
part c
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With a low supply of gas and high prices what type of cars would households
try to buy? What type of cars would factories try to produce after this shock?
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