What is unemployment?

Since the late 1970s, full employment has not meant that everyone is
employed. It now means the number of people wishing to work at the
agreed wage rate is equal to the number of workers employers want to
hire at that rate. If there are still people who want to work at the existing
wage rate and are willing and available to work, this is described as
unemployment.

Unemployment

Unemployment is where people are able and willing to work but do not
have a job.

Employment rate

The employment rate is the percentage of the labour force in work.

Unemployment rate

The unemployment rate is the percentage of the labour force that is out
of work.

Underemployment

Underemployment refers to those people who only manage to get a few

hours paid work per week - they want full-time employment, but can
only find part-time employment.
Costs of unemployment

Perhaps the main cost of unemployment is a personal one to those who

are unemployed. However, if they suffer then the whole economy
suffers. Individuals may become dispirited by unemployment. They may
lose their self-esteem and confidence. This may affect their motivation
to work. The longer they are unemployed the more they may lose their
skills and this has to be bad for the economy as well. On top of that,
these problems (and financial ones) often lead to the unemployed being
less healthy, and then the health service picks up the bill. The whole
economy suffers from people being unemployed.

As well as these microeconomic effects, there will also be macro effects.

These will include:

 Loss of output to the economy - the unemployed could be

producing goods and services and if they are not, then GDP is
lower than it could be.
 Loss of tax revenue - unemployed people are not earning and they
therefore are not paying tax. The government has lost out.
 Increase in government expenditure - the government has to pay
out benefits to support the unemployed.
 Loss of profits - with higher employment firms are likely to do
better and make higher profits. If they make less profit because of
unemployment, they may have less funds to invest.
The true impact of unemployment will depend on two factors. These are:

 Its rate
 Its duration

Normally, the longer one is unemployed the more difficult it is to find

work. Similarly, a large number of unemployed people cause more
problems than a small number.

Unemployment has consequences for those who feature in it. Some may
seek a career change, whilst others will look towards the golf course!
However, for the majority, there will be a fall in disposable income as
benefits seldom pay as much as salaried employment. Living standards
will fall and some might be forced to extend credit and loan-financed
purchases. The longer they remain unemployed, the less training and
development they are receiving and the more unemployable they
therefore become.

For businesses, unemployment means lower demand for some products

and employee morale may suffer. Productivity could fall, as workers
fear that they are next for the unemployment pile. However, a larger
pool of unemployed will exist, so some employers might find hiring new
labour easier (and perhaps cheaper?).

The economy might also suffer as output falls (and therefore tax
revenue falls) and government expenditure on benefits will increase.
Opportunity cost decisions will have to be made. The distribution of
income will become more uneven, but unemployment might cause
downward pressure on wage levels, as workers fear pricing them out of a
job.

When unemployment exists, it means lost output, as the economy will

be working below full potential and tax revenues will be lower.
Because of unemployment more state benefits have to be paid and that
involves a further economic opportunity cost. We have also noted the
potential for social difficulties.

Types of unemployment

Unemployment is often categorized into various types. This can be very

helpful when formulating policy as different causes of unemployment
require different solutions. The most common classifications are:

 Frictional - this is when a time lag exists between someone

losing/changing job and starting another. Such unemployment may
be the result of occupational or geographical immobility or a lack
of knowledge regarding available job opportunities.
 Casual (people out of work in between short periods of
employment) and seasonal unemployment (e.g. unemployment in
many tourist areas) are examples of frictional unemployment.
  Structural - arises when a structural decline takes place in certain
industries, which are no longer capable of competing in their
markets. They are facing a combination of changing demand, new
products, and new techniques of production and new more efficient
competitors from overseas markets. This increase in international
competition, or globalization, has meant that many developed
economies have suffered structural unemployment. Technological
unemployment is a form of structural unemployment. It is the
result of more capital intensive techniques of production being
used within an economy.
 Cyclical or demand deficient unemployment - this is when the
cyclical nature of the macro economy is moving downwards and so
labour is not required in such large amounts. It is associated with
levels of aggregate demand below full employment.

Equilibrium and disequilibrium unemployment

If the wage rate rises above the equilibrium then some unemployment
will arise. This would be known as real wage or classical
unemployment. This is shown in Figure 1 below as disequilibrium
unemployment. If the labour market is free to return to equilibrium,
then the disequilibrium wage rate will not last for long. The excess
supply of labour and wage rates will fall. But if wages are sticky
(downwards) then this may not be possible. Even at full employment
some unemployment will arise, as markets are always in a state of
change.

Figure 1 Disequilibrium unemployment

However, it is possible for there to be unemployment at the equilibrium

wage as well. Even though the demand for labour may match the supply
of labour in equilibrium, there may still be people who are unemployed.
This may be because they are stuck in an unemployment trap where they
are earning more on benefits than they could in work, or it may be
because the industry they were working for has been shrinking and their
skills are not required anymore and are of no use in other areas. This
type of unemployment is called equilibrium unemployment and is shown
in Figure 2 below, and is essentially frictional and structured
unemployment.

Figure 2 Equilibrium unemployment

In the diagram above, the X represents the aggregate supply of labour at

the going wage and the Y represents the potential aggregate supply of
labour. XY therefore represents the equilibrium unemployment,
consisting of those who are frictionally and structurally unemployed.

Policies to reduce unemployment

If unemployment is cyclical or demand-deficient, then the best policy to

get rid of it will be to boost the level of aggregate demand. Sounds easy,
but how do we actually do it? Well we could use expansionary monetary
policy or fiscal policy. This could mean:
  Cutting interest rates - this should encourage consumption and
investment and therefore boost aggregate demand
 Increasing government expenditure - government spending is a
crucial component of aggregate demand and so increasing
spending, perhaps on education, health or roads, will help boost
aggregate demand and reduce unemployment.
 Cutting taxes - we could cut either direct or indirect taxes. Both
these would encourage consumption and more consumption should
mean more people needed to make the goods and services.A
reduction in profits tax might also encourage investment.

These expansionary fiscal or monetary policies should increase

aggregate demand and therefore shift the aggregate demand curve to the
right as in figure 1 below.

Figure 1 Expansionary fiscal/monetary policy

But it may not be this simple. As we already know, policy conflicts can
arise, especially the possible adverse effects on inflation of higher
aggregate demand. So, a mixture of monetary policy, fiscal policy and
supply-side policies would normally be used. Hopefully, the supply-side
policies would boost the capacity of the economy and enable higher
aggregate demand, but without the associated inflationary pressures.

In the long run, if there is no shortage of aggregate demand, the cause of

the unemployment is likely to lie with supply-side problems such as
geographic and occupational immobility of labour, lack of appropriate
skills and training or a lack of information. This type of unemployment
can be tackled by application of appropriate supply-side policies, as
previously identified in Section 3.4.