Types and Causes of

Unemployment
Unit 10 - Lesson 2
Learning outcomes:
● Define all terms in orange bold in section 10.1 (AO1)
● Explain the causes of unemployment - cyclical, structural, frictional
and seasonal unemployment (AO2)
● Draw diagrams showing: (AO4)
○ A fall in labour demand due to geographical location
○ Unemployment due to minimum wage
○ Cyclical unemployment
● Explain the Natural Rate of Unemployment is the sum of structural,
frictional and seasonal unemployment (AO2)
Four types of Unemployment

We will examine four types of unemployment:

1. Structural unemployment
a. Changes in demand for skilled labor
i. Mismatch in labour skills demanded by employers and
labour skills supplied by workers
b. Changes in Geographical location
c. Labour market rigidities
2. Frictional unemployment
3. Seasonal unemployment
4. Cyclical (demand deficient) unemployment
Structural Unemployment

Structural unemployment occurs when the “structure”/composition of

the economy changes in a local or national economy.
There are three types or causes of structural unemployment:
1. Changes in demand for particular labour skills
2. Changes in geographical location
3. Labour market rigidities
Structural unemployment is considered to be unemployment that
lasts for extended periods of time.
Watch the brief video on INVESTOPEDIA
Structural Unemployment
Changes in demand for certain labour skills

● Demand for labour skills changes over time.

○ May result in technological change
which results in an increase in demand
for a new skill while the demand for other
skills decreases.
■ Examples include the rise of ATMs
and online banking
● Increase in demand for
computer programming skills
and maintenance of ATMs
● Decrease in demand for bank
tellers and brick and mortar
banks.
Structural Unemployment
Changes in demand for certain labour skills (continued)

● Demand for labour skills changes over time.

○ May result in an overall change in the structure of the economy
■ For example as a country develops the importance of the agricultural
sector will begin to decline while the manufacturing sector increases.
● Workers that do not have the skills to work in the manufacturing or
services sectors of the economy may become structurally
unemployed.
○ This type of unemployment was explained in the context of
Income Elasticity of Demand in Unit 3.

These kind of changes in an economy result in a mismatch of labour skills

demanded by employers to labour skills supplied by workers.
Graph Strucutral Unemployment - “Mismatch” of Skills
We can use a supply and demand
diagram to illustrate structural
unemployment caused by a “mismatch”
in labour skills.
When the demand for a product produced
in a declining industry decreases (D - D1)
this will lead to a decrease in the Quantity
Supplied of the product (Qe - Q1)
Since there is less quantity being
produced the demand for labour in that
market also decreases leading to
structural unemployment.
Changes in Geographical Location
Geographical Location (Globalisation)

● When a large firm or industry moves its physical location to another

region.
○ Results in a decrease in demand for labour in the region the firm or
industry has left.
○ Increase in demand for labour in the region the firm or industry
where they relocate.
■ Same result can happen if a firm or industry closes or shuts
down.

If individuals cannot move to economically expanding regions, they may

become structurally unemployed.
Graph - Changes in Geographical Location
We can use a supply and demand diagram
to illustrate structural unemployment
caused by a Geographical location.

When the demand for a product produced in

an industry that relocates decreases
Quantity of the product (Qe - Q1) produced
in that region to decrease.

Since there is less quantity being produced

the demand for labour in that market also
decreases leading to structural
unemployment.
Labour Market Rigidities

Labour Market Rigidities are factors that prevent the market (supply and
demand) from re-allocating resources efficiently in the labour market.
These include:
● Minimum wage
● Labour unions - wage bargaining
● Employment protection laws
● Generous unemployment benefits
Though economists do not fully agree with the effects these have on
unemployment, many would argue that these are causes of higher levels of
unemployment in countries with strong labour protection legislation such as
Europe.
Graph Labour Market Rigidities
We can use a supply and demand diagram to
illustrate structural unemployment caused by the
following Labour Market Rigidities.

● Labour unions - wage bargaining

● Employment protection laws
● Generous unemployment benefits

Labour Market Rigidities lead to an increase

cost of production for firms (S - S1) resulting in a
decrease in Quantity (Qe - Q1)

Due to the decrease in quantity being produced

the firms demand fewer workers resulting in an
increase in structural unemployment.
Graph Labour Market Rigidities

We can use a Minimum Wage diagram to

illustrate structural unemployment caused by
the following Labour Market Rigidities.
Minimum wage is the lowest possible wage a
firm can pay a worker (Pmin). Minimum wage is
set above the market equilibrium preventing the
price mechanism from reallocating resources to
(Pe) creating surplus of labour (unemployment).
● Quantity supplied of labour (Qs) is greater
than the quantity demanded of labour (Qd).
○ This is considered structural
unemployment
Frictional Unemployment

Frictional Unemployment
● Occurs when workers are between jobs.
● This could be the result of:
○ Leave job because they were fired
○ Employer closed their business
○ In search of a better job
○ Waiting to start a new job
Frictional unemployment tends to be short term and does not arise
due to lack of skills in demand.
Watch the brief video on INVSTOPEDIA
Frictional Unemployment

Frictional Unemployment
● A certain amount of frictional unemployment is inevitable in an
economy.
○ In any growing economy, some businesses will close while
some new businesses will open.
○ Some businesses grow faster than others
○ Individuals will look to increase their incomes
This change that occurs naturally in an economy will inevitably
lead to unemployment which we call frictional unemployment.
Frictional Unemployment

Important cause of Frictional Unemployment

● Incomplete (asymmetry) information between employers and
workers seeking jobs.
● This asymmetry of information results in individuals taking longer to
find jobs.
○ Therefore Frictional unemployment is included in the Natural
Rate of Unemployment (NRU) since it occurs naturally.
Governments try to reduce Frictional unemployment by trying to
reduce the time a worker spends between jobs thus decreasing the
asymmetry of information between worker and employer.
Seasonal Unemployment

Seasonal Unemployment
● Occurs when demand for labour in certain industries changes based
on seasonal demand for labour.
○ Examples include farm workers who are hired during peak
harvest season and then do not have a job during the growing
season.
○ Lifeguards and landscapers are mostly in demand during the
summer months.
Seasonal unemployment will always be present in an economy as
the demand for labour from firms and businesses will vary by
season therefore it is included in the Natural Rate of Unemployment.
Natural Rate of Unemployment
The Natural Rate of Unemployment consists of:
● Structural unemployment
● Frictional unemployment
● Seasonal unemployment
When we say an economy is at “full employment”, it means that unemployment
is equal to the Natural Rate of Unemployment (NRU)
A decrease in the Natural Rate of Unemployment (NRU) caused be a
decrease in the structural, frictional and/or seasonal unemployment rate
result in an increase in the potential output of an economy.
Be aware that an increase in potential output due to increases in the quality or
quantity of physical or natural capital does not mean the Natural Rate of
Unemployment has decreased.
Cyclical (demand-deficient) Unemployment
When an economy produces less than its potential output there exists the
natural rate of unemployment plus cyclical (demand-deficient) unemployment.

Cyclical unemployment occurs when an economy is in a recessionary gap.

As Real GDP decreases due to a decrease in Aggregate Demand (AD),

firms lay-off workers and unemployment increases.

Cyclical unemployment arises from insufficient aggregate demand of the

output of an economy and from the Keynesian perspective requires
government intervention to increase the Aggregate Demand (AD) to close
the Recessionary Gap thus eliminating Cyclical unemployment.
Graphing Cyclical Unemployment - Keynesian
A decrease in Aggregate Demand (AD)
caused by a change in consumption
spending, investment spending,
government spending or a change in net
exports (AD - AD1)

Actual output (Yao) is less than potential

output (Ypo)

There exists cyclical unemployment in

the economy due to insufficient
Aggregate Demand.
Graphing Cyclical Unemployment - Monetarist
A decrease in Aggregate Demand (AD)
caused by a change in consumption
spending, investment spending, government
spending or a change in net exports (AD -
AD1)

Actual output (Yao) is less than potential

output (Ypo)

Average Price levels decrease (APL - APL1)

There exists cyclical unemployment in the

economy due to insufficient Aggregate
Demand.