Contemporary Economic Issues (ECO 408)

Chapter One

Unemployment

Why Unemployment Is a Problem?

Unemployment is a serious personal and social economic
problem for two main reasons.

It results in:

■ Lost incomes and production

■ Lost human capital

1- Lost incomes and production

The loss of a job brings a loss of income and production.

Although Unemployment benefits create a safety net, but they

don’t fully replace lost earnings.

Lost production means:

- lower consumption and
- lower investment in capital,
which lowers the living standard in both the present and the
future.

2- Lost Human Capital

Prolonged unemployment damages a person’s job prospects by
destroying human capital.

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Population Categories:

The following figure shows the population categories used by the

Census Bureau and the relationships among the categories.

The total population divides into two broad groups:

1- The working-age population
2- Others who are too young to work or study at institutions and
are unable to work.

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The working-age population
The Census Bureau divides the working-age population into two
groups:

1- Those in the labor force aged 16 years and over.

2- Those not in the labor force (for example a woman prefers to

care for her family instead of searching for or having a job,
people who are in jail, hospital, or some other form of
institutional care).

The labor force is divided into two groups:

1- The employed
2- The unemployed.

So the labor force is the sum of the employed and the

unemployed.

Labor force = Number of people employed + Number of

people unemployed.

To be counted as employed, a person must have either a

1- Full-time job or
2- A part-time job.

To be counted as unemployed, a person must be available for

work but Without work although he has made specific efforts to
find a job within the previous four weeks.

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The Unemployment Rate
The unemployment rate is the percentage of people in the
economy who are willing and able to work but who cannot find
jobs. It is the percentage of the people in the labor force who are
unemployed. That is,

Unemployment Rate = Number of people unemployed *100

Labor Force

Labor force = Number of people employed + Number of people

unemployed.

For example, if the total unemployed stands at 8 million and the

labor force stands at 160 million, the unemployment rate is:
8 million ÷ 160 million = 0.05 × 100 = 5%

The following figure shows the unemployment rate over the

period 1980 - 2010 in USA. The average unemployment rate
during this period was 6.2 percent.

The unemployment rate fluctuates over the business cycle and

reaches a peak value after a recession ends.

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Types of Unemployment
1- Frictional Unemployment

Frictional unemployment is unemployment caused by people

entering the job market and people quitting a job just long
enough to look for and find another job. Frictional
unemployment is a permanent and healthy phenomenon in a
dynamic, growing economy.

2- Structural Unemployment
is long-term unemployment that occurs because of changes in the
structure of the economy (arises due to change in technology or
change the locations of jobs) and cannot be resolved by macro
policies.

Structural unemployment usually lasts longer than frictional

unemployment because workers must retrain and possibly
relocate to find a job. Structural unemployment is painful,
especially for older workers for whom the best available option
might be to retire early or take a lower-skilled, lower paying job.

3- Cyclical Unemployment
Cyclical unemployment is that which results from fluctuations in
economic activity. It is temporary unemployment that can be
expected to end as the economy recovers and can be resolved by
macro policies.

A worker who is laid off because the economy is in a recession

and who gets rehired some months later when the expansion
begins has experienced cyclical unemployment.

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“Natural” Unemployment
Natural unemployment is the unemployment that arises from
frictions and structural change when there is no cyclical
unemployment.

Natural Unemployment = Frictional Unemployment +

structural Unemployment

Natural Unemployment Rate = Natural unemployment / labor

force *100

Full employment is defined as a situation in which the

unemployment rate equals the natural unemployment rate.

Cyclical Unemployment = Unemployment Rate - Natural

Unemployment Rate

If Unemployment Rate = Natural Unemployment Rate, Cyclical

Unemployment will equal to Zero and in this case the economy
will be at full employment.

Usually 4 to 6 percent of the labor force is searching for jobs,

waiting between jobs, or getting trained for new jobs.

Unemployment rate above the natural rate is considered to be

cyclical, e.g., 7.5% – 6% = 1.5%

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