Chapter 4: Unemployment

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Categories Of Unemployment
The problem of unemployment is usually
divided into two categories.
• The long-run problem.
o The natural rate of unemployment
• The short-run problem.
◦ The cyclical rate of unemployment
The focus of this chapter is the long-term
unemployment.

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Identifying Unemployment
Unemployment needs to be:
◦ Carefully defined.
◦ Measured.
◦ Explored in terms of how long people are out of work.

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What is Unemployment?
Defining unemployment.
◦ Someone who does not have a job and is willing and
available for work at the going rate.
◦ Unemployment rate is expressed as a percentage of
the labour force.
◦ Labour force is the total number of people in work
plus those who are unemployed.

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How Is Unemployment Measured?
Unemployment may be measured in two ways.
◦ The claimant count.
◦ A monthly survey of households .
Economically inactive people
◦ People who are not in employment or unemployed
due to reasons such as being in full-time education,
being full-time careers and raising families.

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How Is Unemployment Measured?
Each adult is placed into one of three categories:
◦ Employed
◦ Unemployed
◦ Not in the labour force
Labour Force
◦ The labour force is the total number of workers,
including both the employed and the unemployed.

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How Is Unemployment Measured?
The unemployment rate is calculated as the percentage of the
labour force that is unemployed.

Unemployment Number Unemployed

= * 100
rate Labour force

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How Is Unemployment Measured?
The labour force participation rate is the percentage of
the adult population that is in the labour force.

Labour force participation rate

Labour force
= * 100
Adult population

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Causes Of Unemployment
In an ideal labour market.
◦ Wages would adjust so that the quantity of labour
supplied and the quantity of labour demanded would
be equal.
◦ At equilibrium, therefore, there is no unemployment.
◦ Changes in the supply of and demand for labour would
create surpluses and shortages in the labour market
and the adjustment of the wage rate would ensure that
all workers are always fully employed.
Then why Are There Always People Unemployed?
◦ Labour markets do not clear instantly.

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Frictional Unemployment
Frictional unemployment refers to the unemployment
that results from the time that it takes to match workers
with jobs.
◦ It takes time for workers to search for the jobs that
are best suit their tastes and skills.
◦ Search unemployment is inevitable because the
economy is always changing.
◦ Job search means there must always be some
unemployment.

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 Frictional Unemployment
 Voluntary unemployment is where people choose to
remain unemployed rather than take jobs which are
available.
 Involuntary unemployment is where people want work at
going market wage rates but cannot find employment.

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 Structural Unemployment
Structural unemployment occurs because the number of
jobs available in some labour markets is insufficient to
provide a job for everyone who wants one.
◦ Three possible reasons for an above equilibrium wage are
minimum wage laws, unions, and efficiency wages.
 Workers who lose their jobs in one industry may find
that jobs that are available:
◦ Require skills and experience they do not possess =
occupational immobility.
◦ Or are not in the immediate region where they live =
geographic immobility.

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Structural Unemployment
 Technological Change
◦ The losers are those whose knowledge, skills
and experience are now redundant.
◦ As a result they have to seek new employment.
 Structural change in the Economy
◦ Over time structural changes affect the make-
up of economies.
◦ Structural change can be caused by competition
from abroad or by changes in technology and
changes in societal norms and trends.

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Labour Market Imperfection
 Unemployment can be caused by wages
being above the market equilibrium.
 Imperfections in the labour market prevent the
wage rate from adjusting to equate the
demand and supply of labour.
 When the wage is above the equilibrium level.
◦ The quantity of labour supplied exceeds the
quantity of labour demanded.
◦ Workers are unemployed because they are
waiting for jobs to open up.

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Minimum Wage Laws
When the minimum wage is set above the level that
balances supply and demand, it creates
unemployment.
Minimum wages are binding most often for the least
skilled and least experienced members of the labour
force, such as teenagers.

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 The Minimum Wage
A Free Labor Market
Wage
Labor
supply

Equilibrium
wage

Labor
demand
0 Equilibrium Quantity of
employment Labor
 The Minimum Wage
A Labor Market with a
Wage
Minimum Wage
Labor
Labor surplus supply
(unemployment)
Minimum
wage

Labor
demand
0 Quantity Quantity Quantity of
demanded supplied Labor
Unions And Collective Bargaining
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.

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The Economics of Unions
The process by which unions and firms agree on the
terms of employment is called collective bargaining.
• Economists have found that union workers typically
earn significantly more than similar workers who do
not belong to unions.
A strike may be organized if the union and the firm cannot
reach an agreement.
◦ A strike refers to when the union organizes a withdrawal
of labour from the firm.

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Are Unions Good or Bad for the
Economy?
Critics argue that unions cause the allocation of labour to
be inefficient and inequitable.
◦ Wages above the competitive level reduce the quantity
of labour demanded and cause unemployment.
◦ Some workers benefit at the expense of other workers.

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Are Unions Good or Bad for the
Economy?
Advocates of unions contend that unions are a
necessary antidote to the market power of firms that
hire workers.
◦ They claim that unions are important for helping
firms respond efficiently to workers’ concerns.

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The Theory Of Efficiency Wages
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.

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The Theory Of Efficiency Wages
A firm may prefer higher than equilibrium wages for the
following reasons:
◦ Worker Health: Better paid workers eat a better diet
and thus are more productive.
◦ Worker Turnover: A higher paid worker is less likely
to look for another job.
◦ Worker Effort: Higher wages motivate workers to put
forward their best effort.
◦ Worker Quality: Higher wages attract a better pool of
workers to apply for jobs.

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 Demand Deficient Unemployment

1. Say’s law is that ‘supply creates its own demand’ and is a theory that
overproduction in both the short-run and the long-run is not possible.
2. However, Keynes argued that the principal cause of unemployment during
the Great depression was due to insufficient demand in the economy.
3. He rejected the short-run interpretation of Say’s law since those short-run
shocks to the economy can reduce effective demand.
4. Therefore demand could remain well below that sufficient to generate full
employment and for unemployment to persist.

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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.
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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Figure 1 Unemployment Rate Since 1971

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How Long Are the Unemployed
without Work?
Most spells of unemployment for most people are
short.
Most unemployment observed at any given time is
long-term.
◦ Most of the economy’s unemployment problem is
attributable to relatively few workers who are jobless
for long periods of time.
◦ Hysteresis refers to the effect is that the longer
people are without work the less likely they are to be
hired by firms.

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 Job Search
Job search is the process by which workers find appropriate
jobs given their tastes and skills.
◦ It takes time for qualified individuals to be matched with
appropriate jobs.
◦ This unemployment is different from the other types of
unemployment.
◦ It is not caused by a wage rate higher than equilibrium.
◦ It is caused by the time spent searching for the “right” job.

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 Why Some Frictional unemployment
Inevitable
 Frictional unemployment often occurs because of a change in the demand
for labour among different firms.
◦ If workers stop buying a good produced by Firm A and start buying a
good produced by Firm B, some workers at Firm A will likely lose their
jobs.
◦ New jobs will be created at Firm B, but it will take some time to move
the displaced workers from Firm A to Firm B.
◦ The result of this transition is temporary unemployment.
◦ The same type of situation can occur across industries as well.

 The economy is always changing, so frictional unemployment is inevitable.

 Workers in declining industries will find themselves looking for new jobs,
and firms in growing industries will be seeking new workers.

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

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Public Policy and Job Search
Government-run employment agencies give out
information about job vacancies in order to match
workers and jobs more quickly.
Public training programs aim to ease the transition of
workers from declining to growing industries and to
help disadvantaged groups escape poverty.

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Unemployment Insurance
Unemployment insurance is a government programme
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.

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Unemployment Insurance
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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Criticisms of the Natural Rate
Hypothesis
The neoclassical synthesis - markets do not
adjust quickly to imbalances of the supply and
demand for labour because of sticky prices and
sticky wages.
◦ Prices and wages do not move quickly to eliminate
surpluses and shortages in the market. This can
result in high unemployment persisting in the short
run.
◦ Much of Keynesian unemployment was ‘involuntary’
– even at prevailing wage rates, most people who are
unemployed would prefer to be in work.

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Criticisms of the Natural Rate
Hypothesis
The synthesis spawned the idea of the NRU and
has become a mainstay of economics teaching
and philosophy over the last 40 years.
◦ The prevailing view of the NRU came to be that
unemployment would only differ from its natural rate if
expected inflation was different to actual inflation.
Other economists suggest that the NRU can change over time
and there might be different reasons for this.
• One is the idea of hysteresis which effectively means not
returning to the original state, so a recession leaves a
permanent scar on the economy.

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The Costs Of Unemployment
Unemployment comes with costs to:
◦ The individual.
◦ Society and the economy as a whole.

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Costs Of Unemployment To The
Individual
Loss of earnings.
◦ Increased risk of slipping into poverty.
Self-esteem and health problems.
Drug abuse and alcohol abuse and crime.
Family breakdown.
De-skilling.
◦ The individual loses touch with changes in work
practices and technology.

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The Costs Of Unemployment To Society
And The Economy.
The opportunity cost of unemployment.
◦ Lost output.
The tax and benefits effect.
◦ Lower tax revenues, higher welfare payments.

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The Reverse Multiplier Effect
When people experience unemployment they:
◦ Cut back their spending on luxuries
◦ Goods with a relatively high income elasticity of demand are likely to
be affected more significantly.
◦ These businesses cut back orders, lay off workers, take a hit on
profits.
◦ So an increase in unemployment can produce a multiplied impact on
economic activity as a whole.
◦ Knock on effect can be local as those supplying goods and services
have to cut back and lay off workers.
◦ Switch their spending to substitute goods which may be seen as
inferior goods.
◦ So some firms might see demand increase e.g. budget supermarkets.

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