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IAI Actuarial Core Principles · Business Economics · Business activity, unemployment and inflation

A rise in the generosity and duration of unemployment benefits is most likely to affect the natural rate of unemployment in which way, according to the supply-side view?

It raises the natural rate of unemployment. More generous benefits reduce the cost of remaining unemployed, so people search for longer and hold out for higher wages, increasing frictional and voluntary unemployment independent of the business cycle.

  1. AIt lowers it, because demand for goods rises
  2. BIt raises it, by lengthening job search and raising reservation wagesCorrect
  3. CIt has no effect, because only aggregate demand matters
  4. DIt lowers it, because firms hire more workers
  5. It converts frictional unemployment into cyclical unemployment

Explanation

Higher benefits reduce the cost of staying unemployed, so job seekers search longer and accept only higher wages. This increases frictional and voluntary unemployment and raises the natural rate. Cyclical unemployment is driven by demand, not benefits.

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