2. The unemployment system in the United States operates through state governmen

Question

2.         The unemployment system in the United States operates through state governments and allows laid off workers who were ‘permanently’ attached to the labor force to collect unemployment benefits. These benefits are related to the previous earnings level (with the replacement rate being about 50% of an unemployed worker’s previous earnings) and usually last for about 26 weeks.    

Unemployment benefits are financed by taxes paid by employers. The tax rate paid is based on economic conditions, the industry in which the employer is operating, and the employer’s layoff experience (experience rating). However, unemployment benefits paid to laid-off employees are not perfectly related to the amount paid in unemployment insurance taxes by an employer. Rather, experience rating is imperfect: the marginal cost of laying off a worker to an employer is typically less than the amount paid to that worker in unemployment benefits.

Suppose the government were to increase the typical duration of receipt of unemployment benefits from 26 to 39 weeks in an effort to give the unemployed more time to find a job.

a) How would this change affect the unemployment rate? Identify which, if any, of the three types of unemployment that will change.

Instead, suppose the unemployment insurance tax code is changed such that employers are required to pay an unemployment insurance tax rate that is exactly equal to the amount of unemployment benefits collected by laid-off employees.

b) How would this change affect the unemployment rate? Identify which, if any, of the three types of unemployment that will change.

Explanation / Answer

1 unemployment will increase because people are not in immediate need of finding job. Frictional unemployment will rise

2 unemployment will fall because firms will not easily layoff workers. Cyclic unemployment will fall because firms retain workers even if their is depression

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