EC 212 INTERMEDIATE

MACROECONOMICS
Chapter Three
Unemployment
 Composition of Population in terms of
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Economic Status

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 Flows in the Labour Market
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DEFINITIONS
An individual is either
 EMPLOYED
 UNEMPLOYED
 OR NOT PART OF THE LABOUR FORCE
• The labour force is defined as the sum of the employed and unemployed,
and the unemployment rate is defined as the percentage of the labour
force that is unemployed.
• A person is considered employed if he or she spent most of the previous
week working at a paid job.
• A person is unemployed if he or she is on temporary lay off, is looking for a
job, or is waiting for the start date of a new job.
• A Person who fits neither of the first two categories, such as a full-time
student, homemaker, or retiree, is not in the labor force.

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Categories of Unemployment
• The economy always has some unemployment and that amount changes
from year to year.
• The normal rate of unemployment around which the unemployment rate
fluctuates is called the natural rate of unemployment, and the deviation of
unemployment from its natural rate is called cyclical unemployment.

 The problem of unemployment is usually divided into two categories.

 The long-run problem and the short-run problem:
• THE NATURAL RATE OF UNEMPLOYMENT
• THE CYCLICAL RATE OF UNEMPLOYMENT

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Natural Rate of Unemployment
 The natural rate of unemployment is unemployment that does not go away
on its own even in the long run.
 It is the amount of unemployment that the economy normally experiences.
 It is the average or long-run rate of unemployment around which the
economy fluctuates.
 In a recession, the actual unemployment rate rises above the natural rate.
 In a boom, the actual unemployment rate falls below the natural rate.

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Cyclical Unemployment
 Cyclical unemployment refers to the year-to-year fluctuations in
unemployment around its natural rate.
 It is associated with short-term ups and downs of the business cycle.

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 HOW IS UNEMPLOYMENT MEASURED?
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 The unemployment rate is the statistic that measures the percentage of

those people wanting to work who do not have jobs.

Unemployment Rate
Number unemployed
Unemployment rate = x 100
Labor force

Labor Force Participation Rate

Labor force
Labor force participation rate = x 100
Adult population

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 Labor Force
Labor Force
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 The labor force is the total number of workers, including both the employed
and the unemployed.

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Problems of Unemployment Statistics
 It is difficult to distinguish between a person who is unemployed and a
person who is not in the labor force.
 Discouraged workers, people who would like to work but have given up
looking for jobs after an unsuccessful search, don’t show up in
unemployment statistics.
 Developing countries are generally not close to the full employment level.
 Here, unemployment does not occur due to periodic demand shortfall.
These countries, like Zambia, suffer from disguised unemployment.

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 DOES THE UNEMPLOYMENT RATE MEASURE WHAT
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WE WANT IT TO?
 Measuring the amount of unemployment in the economy might seem
straight forward. In fact, it is not.
 Where as it is easy to distinguish between a person with a full-time job and
a person who is not working a tall, it is much harder to distinguish between
a person who is unemployed and a person who is not in the labor force.
 Movements into and out of the labor force are, in fact, very common. More
than one-third of the unemployed are recent entrants into the labor force.
 These entrants include young workers looking for their first jobs, such as
recent college graduates.
 They also include, in greater numbers, older workers who had previously left
the labor force but have now returned to look for work.

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 DOES THE UNEMPLOYMENT RATE MEASURE
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WHAT WE WANT IT TO?
 Moreover, not all unemployment ends with the job seeker finding a job.
 Almost half of all spells of unemployment end when the unemployed
person leaves the labor force.
 Because people move into and out of the labor force so often, statistics on
unemployment are difficult to interpret.
 On the one hand, some of those who report being unemployed may not, in
fact, be trying hard to find a job.
 On the other hand, some of those who report being out of the labor force
may, in fact, want to work.
 These individuals may have tried to find a job but have given up after an
unsuccessful search.
 According to most estimates, adding discouraged workers would increase
the measured unemployment rate by about one-half of one percentage
point.

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HOW LONG ARE THE UNEMPLOYED WITHOUT WORK
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 In judging how serious the problem of unemployment is, one question to consider is
whether unemployment is typically a short-term or long-term condition.
 If unemployment is short-term, one might conclude that it is not a big problem.
 Workers may require a few weeks between jobs to find the openings that best suit
their tastes and skills.
 Yet if unemployment is long-term, one might conclude that it is a serious problem.
 Workers unemployed for many months are more likely to suffer economic and
psychological hardship.

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 WHY ARE THERE ALWAYS SOME PEOPLE
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UNEMPLOYED?
 The first explanation is that it takes time for workers to search for the jobs
that are best suited for them.
 The unemployment that results from the process of matching workers and
jobs is some times called frictional unemployment, and it is often thought to
explain relatively short spells of unemployment.
 The number of jobs available in some labor markets maybe insufficient to
give a job to every one who wants one.
 This occurs when the quantity of labor supplied exceeds the quantity
demanded.
 Unemployment of this sort is some times called structural unemployment,
and it is often thought to explain longer spells of unemployment.

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 WHY ARE THERE ALWAYS SOME PEOPLE
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UNEMPLOYED?
 Frictional unemployment refers to the unemployment that results from the
time that it takes to match workers with jobs. In other words, it takes time for
workers to search for the jobs that are best suit their tastes and skills.
 Structural unemployment is the unemployment that results because the
number of jobs available in some labor markets is insufficient to provide a
job for every one who wants one.

Public Policy
 Government programs can affect the time it takes unemployed workers to
find new jobs.
 These programs include the following:
- Government-run employment agencies
- Public training programs
- Unemployment insurance

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 WHY ARE THERE ALWAYS SOME PEOPLE
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UNEMPLOYED?
1) Government-run Employment Agencies
 Government run employment agencies give out information about job vacancies in order
to match workers and jobs more quickly.
2) Public Training Programs
 Public training programs aim to ease the transition of workers from declining to growing
industries and to help disadvantaged groups escape poverty.
3) Unemployment Insurance
 Unemployment insurance is a government program that partially protects workers’ incomes
when they become unemployed.
 Offers workers partial protection against job losses.
 Offers partial payment of former wages for a limited time to those who are laid off.
 Unemployment insurance increases the amount of search unemployment.
 It reduces the search efforts of the unemployed.
 It may improve the chances of workers being matched with the right jobs.

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 Types of Unemployment
17 1) Seasonal
 Regular seasonal changes in employment / labour demand
 Affects certain industries more than others
•Catering and leisure
•Construction
•Retailing
•Tourism
•Agriculture
2) Frictional
 Transitional unemployment due to people moving between jobs: Includes
people experiencing short spells of unemployment.
 Includes new and returning entrants into the labour market.
 Imperfect information about available job opportunities can lengthen the
period of someone’s job search.

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 Types of Unemployment
18 3) Structural Unemployment
 Structural Unemployment Arises from the mismatch of skills and job opportunities
as the pattern of labour demand in the economy changes.
 Occupational immobility of labour.
 Often involves long-term unemployment.
 Prevalent in regions where industries go into long-term decline.
 Good examples include industries such as mining, engineering and textiles.
• Structural unemployment occurs when the quantity of labor supplied exceeds
the quantity demanded.
• Structural unemployment is often thought to explain longer spells of
unemployment.
Why is there Structural Unemployment?
 Minimum-wage laws
 Unions
 Efficiency wages

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 Minimum Wage Law
19  When the minimum wage is set above the level that balances supply and
demand, it creates unemployment.

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 Union
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 A union is a worker association that bargains with employers over
wages and working conditions.
 A union is a type of cartel attempting to exert its market power.
 The process by which unions and firms agree on the terms of
employment is called collective bargaining.
 A strike will be organized if the union and the firm cannot reach an
agreement.
 A strike refers to when the union organizes a withdrawal of labor
from the firm.
 A strike makes some workers better off and other workers worse off.
 Workers in unions (insiders) reap the benefits of collective
bargaining, while workers not in the union (outsiders) bear some of
the costs.

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 Union
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Union Worker’s Wage
 By acting as a cartel with ability to strike or other wise impose high
costs on employers, unions usually achieve above- equilibrium
wages for their members.
Union: Good or Bad?
 Critics argue that unions cause the allocation of labor to be
inefficient and inequitable.
 Wages above the competitive level reduce the quantity of labor
demanded and cause unemployment.
 Some workers benefit at the expense of other workers.

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 Theory of Efficiency Wages
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 Efficiency wages are above- equilibrium wages paid by
firms in order to increase worker productivity.
 The theory of efficiency wages states that firms operate
more efficiently if wages are above the equilibrium level.
A firm may prefer higher than equilibrium wages for the
following reasons:
1. Worker Health: Better paid workers eat a better diet
and thus are more productive.
2. Worker Turnover: A higher paid worker is less likely to
look for another job.
3. Worker Effort: Higher wages motivate workers to put
forward their best effort.
4. Worker Quality: Higher wages attract a better pool of
workers to apply for jobs.
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 4) Cyclical unemployment
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Cyclical (Keynesian)
 There is a cyclical relationship between demand, output,
employment and unemployment.
 Caused by a fall in aggregate demand leading to a loss of real
national output and employment
 A slowdown can lead to businesses laying off workers because they
lack confidence that demand will recover
 Keynes argued that an economy can become stuck with a low rate
of AD and an economy operating persistently below its potential
Real Wage Unemployment
 Created when real wages are maintained above their market
clearing level leading to an excess supply of labour at the prevailing
wage rate.
 Some economists believe that unemployment can be created if the
national minimum wage is set too high.
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 Unemployment, GDP, and Okun’s Law
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 What relationship should we expect to find between
unemployment and real GDP?
 Because employed workers help to produce goods and services
and unemployed workers do not, increases in the unemployment
rate should be associated with decreases in real GDP.
 This negative relationship between unemployment and GDP is
called Okun’s law, after Arthur Okun, the economist who first studied
it.

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 EFFECTS OF UNEMPLOYMENT: Economic
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and Social Costs of Unemployment
 The private costs for the unemployed
–Loss of income
–Fall in real living standards
–Increased health risks
•Stress
•Reduction in quality of diet
•Social exclusion because of loss of work and income
–Loss of marketable skills (human capital) and motivation
•The longer the duration of unemployment, the lower the chances of finding
fresh employment -the unemployed become less attractive to potential
employers

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 EFFECTS OF UNEMPLOYMENT: Economic
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and Social Costs of Unemployment
•Economic Consequences for Businesses
–Negative consequences
•Fall in demand for goods and services
•Fall in demand for businesses further down the supply chain
•Consider the negative multiplier effects from the closure of a major employer in a town
or city
–Some positive consequences
•Bigger pool of surplus labour is available –but still a problem if there is plenty of structural
unemployment
•Less pressure to pay higher wages
•Less risk of industrial / strike action –fear of job losses –leading to reduced trade union
power

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 EFFECTS OF UNEMPLOYMENT: Economic
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and Social Costs of Unemployment
Consequences for the Government (Fiscal Policy)
 Increased spending on unemployment benefits and other income –related
state welfare payments
 Fall in revenue from income tax and taxes on consumer spending
 Fall in profits –reduction in revenue from corporation tax
 May lead to rise in government borrowing (i.e. a budget deficit)
Consequences for the economy as a whole
 Lost output (real GDP) from people being out of work –the economy will be
operating well within its production frontier
 Unemployment seen as an inefficient way of allocating resources - labour
market failure?
 Some of the long-term unemployed may leave the labour force
permanently –fall in potential GDP
 Increase in the inequality –rise in relative poverty
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Policies to reduce or
Cure unemployment

Demand and supply side approaches

Demand side Policies to Reduce Unemployment
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 These are mainly measures to boost total labour demand (reduce cyclical
unemployment)
 Lower interest rates (a monetary policy stimulus)
 A lower exchange rate (helps exporters)
 Lower direct taxes (fiscal stimulus to spending power)
 Government spending on major capital projects (e.g. improving the
transport infrastructure)
 Employment subsidies –designed to reduce the cost to a business of
employing additional workers
 Incentives to encourage flows of foreign investment in our respective
countries(economies)

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 Supply-side policies to reduce Unemployment
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 These are measures to improve labour supply (reduce frictional and
structural unemployment)
 Increased spending on education & training including an emphasis on
“lifetime-learning”)
 Improved flows of information on job vacancies.
 Changes to tax and benefits to improve incentives.
 Measures designed to make the labour market more flexible so that workers
have the skills and education that gives them improved employment
options.

Mr C. Chongo
 Consequences of falling unemployment
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The circular flow and the multiplier:
 Incomes flowing into households will grow
 Falling unemployment adds to demand and creates a positive multiplier effect on
incomes, demand and output.
The balance of payments:
 When incomes and spending are growing, there is an increase in the demand for
imports. Unless this is matched by a rise in export sales, the trade balance in goods and
services will worsen.
Government finances:
 With more people in work paying income tax and value added tax, the government
can expect a large rise in tax revenues and a reduction in social security benefits.
Inflationary effects
 Falling unemployment can also create a rise in inflationary pressure –particularly when
the economy moves close to operating at full capacity.
 However this is not really a risk when the economy is coming out of recession, since
aggregate supply is likely to be highly elastic because of a high level of spare capacity.
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