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.)
(a) 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?
(b) Do you think it’s plausible that the legislation would not affect the job finding rate? Briefly explain why or why not.
(c) This question is actually more typical of policy debates in Europe than in the U. S. For example, it’s notoriously difficult for firms to fire workers in many European countries. How might this be a factor in the higher natural rate of unemployment that is often estimated for those countries?

Explanation:

a) To understand the parameters listed in this question let us first look at the formula for the natural rate of unemployment,

U/L = S/ S+F

Where,

U is the number of people unemployed,

L is the number of people in the

labor force.

S is the chance of separation and

f is the rate of job finding.

From the equation we can see that if this legislation reduces the rate of job separation (s) without affecting the rate of job finding (f) then the natural rate of unemployment will most certainly fall because the numerator reduces and even though one part of the denominator reduces as well, the other part stays.

b) The New law will most likely have an effect on the Job finding rate. Firstly looking at it from the point of view of those searching for employment. This law will mean that they will most likely spend longer in a job and so they will be careful which companies to apply to as they do not want a situation where they will feel the regret of their choice over a longer period. And on the other hand as well, employers will take their time looking for employees that they think will be a right fit in the company and so will not accept just anybody in case they aren't a good fit because they wouldn't be able to fire the person easily.

c) From the reasons given in question b, we can see just how much more complicated it is on the labor market with such a law implemented. Employers are scared and therefore more stringent in requirements when hiring people and prospective employees don't apply just anywhere because they don't want a situation where a perceived bad choice cannot be rectified easily. This reduction in f can therefore keep rising and if it gets to a certain level, can even increase the natural rate of unemployment (if f drops below s in the equation, the denominator will become smaller and therefore the rate will rise) as has shown to be the case in many European countries.

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