5 Bathtub model of unemployment and transition dynamics Consider the bathtub model of unemployment discussed in class, described by two equations. Labor force I is divided into employed and unemployed people I = Et + Ut and the inflow into unemployment is AU++1 = 5Et fut (1) Question 5.1 What do the parameters s and f capture? Question 5.2 Consider a government policy that severely limits the ability of firms to fire workers for instance, by instituting that the firm has to pay very high severance payments to the fired worker. Which parameter of the model changes? Show that, other things equal, this decreases the steady state level of unemployment in our bathtub model. Question 5.3 Is this a plausible result? What happens if, if response to this policy, firms become more reluctant to hire new workers because they are worried that they will not be able to fire the worker if he turns out to be unproductive or economic conditions worsen? Which parameter would then change and what impact this would have on the steady state level of unemployment? Question 5.4 What do your answers to the preceding two questions imply about the usefulness of the parameters 5 and f for conducting policy experiments? Question 5.5 Suggest some government policies that may decrease the parameter 5 with- out decreasing the parameter f. Question 5.6 Notice that you can rewrite equation (1) as U4+1 U4 = 5Et FU4 = 5 (L Ut) FU/ (2) and thus Ut+1 = (1 5 F) U+ + 5L (3) Assume that the economy starts in the steady state and the parameter s decreases. What happens to the steady state level of unemployment? By analyzing the equation above, sketch the transition path (in a graph with time on the horizontal axis) for the transition from the old to the new steady state. In the problem set, I will ask you to conduct this experiment numerically, using Excel