Monday, April 15, 2013

Full employment is an extra constraint

There's another way to think about what I just wrote in the last post. General equilibrium is a lot of objective functions and a lot of budget constraints (including those relevant for the labor market) that have been maximized, so there are a lot of marginal benefits equated to each other and to the vector of prices in the economy.

That's general equilibrium.

That's Say's vision or Malthus's vision plus monetary accommodation to get back to Say's vision.

Full employment is an extra constraint.

Full employment isn't the result of an optimization problem, because unemployment and labor surplus are not the same things. We profess to care about unemployment as the CPS measures it: wanting a job, not having a job, being ready to start a job, and looking for a job. I trust that when people confess to care about this they actually do care about this (I actually do care about this, after all). But this is not necessarily a labor surplus.

So think of a full employment condition as an extra constraint on general equilibrium. Something like:

L = aN, where "a" is pretty stable, between zero and one. We might be tempted to think it is a little lower than the labor force participation rate, but if discouraged workers are prominent it may be higher than the labor force participation rate.

If you care about full employment, you need to add this constraint into general equilibrium - and that creates a problem. We have two options, assuming serendipity is not on our side:

1. Throw something else out of equilibrium to meet this constraint, or
2. Shift some of the other objective functions and budget constraints in order to meet this constraint and be in equilibrium


  1. My impression has always been that the rules on unemployment are structured to measure the labor surplus. That's why you are no longer considered unemployed if you turn down job offers or stop looking: you are considered to not want to work at the current price level. It's a very imperfect measure to be sure, but that's what it tries to measure.

    1. You can turn down a job and still be considered unemployed. You might not be eligible for unemployment insurance, but I'd have to review that. And yes, if you stop looking you're not considered unemployed but that makes sense because you're not supplying your labor in that market anymore - you're not even on the supply curve.

      We might want to think about treatment of discouraged workers though. In other words, are these people maybe supplying their labor but rationally setting job search efforts at zero until conditions change?

      This is the sequence of questions that defines unemployment in the U.S.:

      1. Does anyone in this household have a business or a farm?
      2. LAST WEEK, did you do ANY work for (either) pay (or profit)?
      If the answer to question 1 is "yes" and the answer to question 2 is "no," the next question is:
      3. LAST WEEK, did you do any unpaid work in the family business or farm?
      For those who reply "no" to both questions 2 and 3, the next key questions used to determine employment status are:
      4. LAST WEEK, (in addition to the business,) did you have a job, either full or part time? Include any job from which you were temporarily absent.
      5. LAST WEEK, were you on layoff from a job?
      6. What was the main reason you were absent from work LAST WEEK?
      For those who respond "yes" to question 5 about being on layoff, the following questions are asked:
      7. Has your employer given you a date to return to work?
      and, if "no,"
      8. Have you been given any indication that you will be recalled to work within the next 6 months?
      If the responses to either question 7 or 8 indicate that the person expects to be recalled from layoff, he or she is counted as unemployed. For those who were reported as having no job or business from which they were absent or on layoff, the next question is:
      9. Have you been doing anything to find work during the last 4 weeks?
      For those who say "yes," the next question is:
      10. What are all of the things you have done to find work during the last 4 weeks?
      If an active method of looking for work, such as those listed at the beginning of this section, is mentioned, the following question is asked:
      11. LAST WEEK, could you have started a job if one had been offered?
      If there is no reason, except temporary illness, that the person could not take a job, he or she is considered to be not only looking but also available for work and is counted as unemployed.

  2. Interesting idea. :)

    But FWIW, the impression that I have gotten from several economics blogs is that full employment is an assumption of general equilibrium, at least in the classical sense. At the same time, "full employment" seems to be an ambiguous term. It does not mean that everybody who wants a job has one. Nor, AFAICT, is there an operational definition.

    I would be interested in your thoughts about that. Thanks. :)

    1. In the journey to "even rotation" when all dynamic forces have settled, we have the situation where all prices are flexible over the long-run and all goods are reproducible. In that kind of General-equilibrium full employment is all assumption. The more common kind of GE doesn't assume that though, it assumes something weaker. I've never read a clear explanation of what the kind of GE does assume.

  3. I'm not sure about all this "Malthus" and "Say" discussion. I find it difficult to understand the old debates.

    I put the problem like this.... If you sell goods and services there are three things you can do:
    * 1. Earn money and keep the money. This money holding causes the problems we're all familiar with.
    * 2. Earn money and spend it on output.
    * 3. Earn money and spend it on existing assets*. This also causes problems because it doesn't lead directly to increased demand for output, it only leads to increased demand in the long-term.

    A lot of what people are talking about in very elaborate terms is just the difference between 2 and 3 above. Buying stocks, for example, is spending money on existing assets. The poster that Brad DeLong dragged from the comments was essentially pointing out this issue. Whether he's drawing the right conclusions is a much more complicated question.

    * Output and existing asset aren't complete substitutes. Existing assets, like the Ford Motor Company, may not be freely reproducible and a rise in their price in the short term may not lead spur people to make more of them, because that short-term price doesn't equate with a long term price that exists when the job is finished.


All anonymous comments will be deleted. Consistent pseudonyms are fine.