A classroom unemployment compensation experiment.

• Author: Hazlett, Denise
• Position: Targeting Teaching

1. Introduction

   This experiment can be used in an introductory undergraduate macroeconomics course as a hands-on demonstration of the effects of unemployment compensation. During the course of the experiment, students observe how progressively higher levels of unemployment compensation affect unemployment rates, wages, and the distribution of income between skilled and unskilled workers. Because of its interactive nature, the experiment works best in classes of 16 to 50 students. However, the author and other professors have successfully run it in classes as small as 12 and as large as 90. It requires 45 minutes to run.

   The experiment uses two labor markets: one for skilled labor and one for unskilled labor. The markets operate simultaneously. Students take the roles of workers and employers who negotiate employment contracts in these markets using a double oral auction. See Hazlett (1999) for a general description of how to administer a double oral auction market. The experiment consists of several periods, each of which represents hiring workers for one hour of labor. An employer can hire at most one worker from each market each period. Every period, workers try to earn the highest possible net benefits from working. Likewise, employers try to earn the highest possible net benefits from hiring them.

   Workers calculate their net benefits of working by taking the difference between their wage and their cost of working. Different workers have different costs of working. Their costs reflect the various work-related expenses they face, such as transportation and day care, as well as the opportunity cost of their time. Similarly, employers calculate their net benefits by taking the difference between the revenue they earn from hiring someone and the wage they pay that person. Different employers earn different amounts of revenue.

   Ready-to-use printouts of all the materials for running the experiment are available online by going to http://people.whitman.edu/~hazlett/econ/private, entering "private" as the username and "Modeling!" as the password. You will be prompted twice to enter the password. The materials available online include the instructions, the slips instructors pass out to assign students their roles in the experiment, the record-keeping sheets students use to track their actions, and follow-up discussion questions.

   The experiment consists of two phases. In phase I, the government does not intervene in the labor markets. Phase I lasts about three periods, providing just enough repetition for the two markets to settle at or near their respective equilibria. In phase II, the government announces that it will offer unemployment compensation to any worker who chooses not to work. Some of the unskilled workers would earn smaller net benefits from working than the government offers in unemployment compensation. So they accept the government's offer and stop working. In subsequent periods of phase II, the government offers progressively higher amounts of unemployment compensation, causing more and more of the unskilled workers to join the unemployed. Only the unskilled workers with the lowest costs continue to work. In contrast, none of the skilled workers accept unemployment compensation. High demand for their labor services relative to their cost of working keeps their wages too high for them to be tempted by the government's offer.

   As the rising unemployment compensation induces more and more of the unskilled workers to join the unemployed, the wages for the remaining unskilled workers increase. That is, the supply curve for unskilled labor shifts up and left as it incorporates the opportunity cost of forgoing the government's offer. This decrease in supply causes the wage to rise along the demand curve. The more generous unemployment benefits thus raise the earnings of the unskilled workers, narrowing the distribution of income between skilled and unskilled workers.

   This experiment introduces a discussion of how the relatively low level of unemployment benefits in the United States might in part cause the relatively low unemployment rate and high level of income disparity we see in the United States. The U.S. economy resembles one of the early periods in the experiment, when the government offers low levels of unemployment compensation. Similarly, a western European economy such as Germany's, with its higher unemployment rate and tighter income distribution, resembles one of the later periods of the experiment, when the government offers more generous unemployment compensation. Thus, this experiment can serve as the opening for a discussion of the puzzling contrast between U.S. and western European unemployment rates and income distributions. Of course, there are many possible explanations for this contrast other than the differences in unemployment compensation programs highlighted in this experiment. For instance, alternative explanations include unionization or welfare-state institutions, such as employment protection.

2. Details on the Running of the Experiment

   Phase 1

   Before class begins, the instructor clears two separate areas of the room to serve as the trading floors for the skilled and unskilled labor markets. Employers will move between the two markets, while workers stay in their designated market. As students arrive, the instructor hands each a private information slip that establishes that student's role in the experiment. These slips assign workers their cost of working and employers their revenue from hiring. See Table 1 for examples of these slips. The instructor also passes out record-keeping sheets that the students will use to track their actions and net benefits.

   The instructor then passes out the instructions and reads them aloud, inviting student questions. Once the instructor has announced the beginning of the first period, the employers and workers mingle, calling out wage offers. An employer will call out an offer to hire at a specified wage. Similarly, a worker will call out an offer to work at a specified wage. Either party may accept an offer from the other. After an employer and a worker agree on a wage contract, the worker comes to the front of the room to report the wage and identifications (ID) of the worker and employer. The instructor records this information on the blackboard (or uses a projector) for everyone to see. (Overhead slides or computer projection have the advantage of providing a permanent record of the results for later use.) The finished worker...