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Unemployment

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Unemployment

The escalator doesn’t work, and you’d think they'd still be used as stairs, but in this economic depression, even the stairs are unemployed.

- Jarod Kintz

In April 2020, the rate of unemployment in the US reached 14.8%, the highest rate since the data collection started in 1948. In July 2021, the rate of unemployment continued to be higher than the year before: it was 5.4%, while in February 2020 it had been 3.5%.1 Let’s learn about unemployment, its causes, and its economic consequences.

Unemployment is a situation when an individual is actively looking for employment but is not able to find work.

Unemployment can be voluntary or involuntary. Involuntary unemployment is, as we explained above, when a person wants to work at the going wage rate, but can’t find available jobs as there is no demand for their labour. In such circumstances, unemployment originates due to a deficit of aggregate demand.

Voluntary unemployment, on the other hand, is when an individual without jobs isn’t willing to be employed at the going wage rate, usually opting to receive state benefits instead of working.

Causes of unemployment

Unemployment could result from many factors. The most common causes of unemployment are:

Geographical immobility of labour

Factors like family relations and local friendships demotivate people from moving to other parts of the country to find a job. The uncertainty of actually finding a job in the new place, as well as the costs of moving and the difficulties of finding new housing, make people stay where they are.

Occupational immobility of labour

Many jobs require various skills or have prerequisites like certain specific qualifications, which makes it harder for people to get these jobs. Labour is also occupationally immobile due to biases regarding age, gender, and race in the labour market.

Imperfect information in the market

Imperfect information makes it difficult for the unemployed to find a good job match for their skillset due to the general lack of information about the jobs on the market. Imperfect information is likely to worsen frictional unemployment as well. This is because if the workers have insufficient information about the companies, the workplace, or the compensation, they take longer to move between jobs as they will need more time to evaluate their options.

Learn more about this topic with our explanation on the Types of Unemployment.

Technological unemployment

This arises from the successful development of labour-saving technology in different industries. In comparison to mechanization (where the workers operate the machines) which generally increases the demand for labour and increases employment, automation (where machines are operated by machines) lowers the demand for labour even when the industry output is increasing.

Competition

Globalisation is the main source behind the increasing competition. Developing countries usually have cheaper labour, therefore several companies relocate to these countries for manufacturing their products. Consequently, workers who were formerly working in manufacturing become unemployed.

All these factors relate to different types of unemployment. There are four main types of unemployment: structural unemployment, frictional unemployment, cyclical unemployment, and seasonal unemployment.

To learn more about the different types of unemployment, check our explanation on the Types of Unemployment.

Unemployment example

Unemployment example unemployment graph StudySmarterFigure 2. The unemployment rate in the UK, Statista, StudySmarter Original

Figure 2 above shows the unemployment rate in the UK using data from Statista from 1999 to 2020. We can see that the unemployment rate started to increase again due to the pandemic. Some signs of how severely the UK economy will be influenced by Covid-19, are the monthly jobless claims, which grew by 850,000 between March and April 2020, along with the striking 18.3% fall in the monthly gross domestic product in April 2020. Over 4.7 million jobs were still on the job retention scheme in the UK by the end of January 2021.

The natural rate of unemployment

Frictional and structural unemployment comprise equilibrium unemployment, which is also known as the natural level of unemployment and occurs even with the real wage at its market-clearing level. Stated as a rate of unemployment, instead of level, this is the natural rate of unemployment (NRU).

Unemployment The natural rate of unemployment StudySmarterFigure 3. Natural Rate of Unemployment, StudySmarter Original

Figure 3 shows the natural level of unemployment. It is illustrated by the distance E1 minus EFE (E1 specifies the number of workers who want to work at full employment real-wage rate, WFE, and EFE is the full level of employment). The natural level of unemployment happens when the aggregate labour market is in equilibrium, with aggregate demand for labour equal to the aggregate supply of labour (ADL= ASL). The figure shows that X is the equilibrium employment, with the equilibrium wage rate at WFE.

Full employment happens when the EFE labour is hired. The gap between ASL and the curve ASLN depicts the natural rate of unemployment (which is comprised of both frictional and structural unemployment) in an economy at the full employment wage rate WFE, i.e., the number of people wanting to work at this wage rate, but who due to structural and frictional reasons are jobless.

Frictional unemployment occurs when individuals voluntarily choose to leave their job in search of a new one or when new workers enter the job market.

Structural unemployment is a type of unemployment that lasts for long periods and is deepened by external factors such as technology, competition, or government policy.

The natural rate of unemployment is the rate of unemployment that occurs when the labour market is in equilibrium. It is comprised of both frictional and structural unemployment.

To learn more about why unemployment occurs when the labour market is in equilibrium check our explanation on the Natural rate of unemployment.

The consequences of unemployment on economic output

When workers are not employed, it means that all the productive resources of the economy are not utilised to produce output­. If utilised fully, however, it could increase the living standards and economic welfare of the entire population.

Unemployment lowers the international competitiveness of the economy. Increasing unemployment can decrease the incentives for companies to invest in the latest technologies that would result in increased export competitiveness.

The under-investment, linked with high unemployment, also arises from a decreased desire to invest in capital-intensive technology when there are a lot of jobless workers not only available but also inexpensive to hire. In such situations, companies focus on labour-intensive and old-fashioned technologies, specifically when high unemployment comes with a static economy and low profits.

The vicious circle of unemployment

Long-term unemployment worsens because companies prefer not to hire people who have been inactive for too long. They tend to avoid hiring workers who were economically inactive for many years, as they assume that individuals with current job experience are a less risky and more employable choice.

To learn more about the social costs of unemployment check out our explanation on the Measures of unemployment.

Regardless of the cons of high unemployment for the economy, several free-market economists argue that a particular amount of unemployment is required for the better functioning of the economy. According to the Phillips Curve relationship, higher unemployment in the economy correlates with lower inflation. That's why there needs to be some unemployment 'slack' in order to keep the economy from overheating.

Unemployment is also a contributing factor in the increasing income differences among the better paid and lower-paid workers. Certain free-market economists believe that this is a good thing, and propose that differences in pay are required in order to promote incentives, which can develop supply-side conditions in which the economy can flourish.

Government policies to lower unemployment

For a government’s intervention to decrease unemployment to be successful, first, it has to correctly identify the primary causes of unemployment to choose a suitable policy.

For instance, if a government wrongly diagnoses unemployment in terms of deficit demand when the actual cause is structural, a fiscal or monetary policy expansion to accelerate aggregate demand will be unsuitable. Certainly, reflation of demand in situations like these would possibly create additional demand, which increases the price levels with no persisting beneficial impact on employment.

To learn more about direct and indirect aggregate demand manipulation check our explanations on Fiscal Policy and Monetary Policy.

Some government policies include:

Enhancing geographical mobility

Geographical mobility can be enhanced by making it simpler for families to move. For instance, by providing subsidies for removal costs. Nonetheless, the increasing difference in the UK’s house prices between the south and the north is actually lowering the geographical mobility of labour.

Therefore, government spending on leased social housing in parts where there are constant labour shortages would probably be an efficient way of enhancing the geographical mobility of labour.

Enhancing the occupational mobility of labour

The government can try to increase the occupational mobility of labour by offering retraining policies and introducing laws to prohibit professionals and trade unions’ constricting practices that make it hard for workers to move between jobs.

Government retraining schemes are generally less efficient than the ones run by private companies. However, employers usually choose to evade spending on training their employees and instead hire newly trained workers from companies who do invest in training their employees. As a consequence of this market failure, very few workers get trained.

Supply-side policies

Governments use supply-side policies that try to enhance the competitiveness and effectiveness of the market to lower frictional and structural unemployment. For example, de-industrialisation resulted in high scale structural unemployment in areas of decline like coal fields and regions formerly governed by heavy industry. The supply-side improvements in the 1980s and 1990s established conditions in which service industries developed to swap manufacturing. Thus, more workers were able to move from deteriorating industries to growing ones.

To learn more about the current policies that the government can take to combat long-term unemployment, check our explanation on Supply-side policies.

Does the official unemployment rate reflect the true level of unemployment in the United Kingdom?

It is worth noting that the official unemployment rate figure only registers those unemployed workers that have come forward to declare themselves as unemployed. According to the rules of unemployment reporting in the UK, unemployed individuals need to prove that they are ‘actively searching for work’ but are unable to find one.

Therefore, the official figure does not include economically inactive population like people who retire early, students, those employed in family enterprises, or those taking care of the household.

Although it is arguable whether the economically inactive population needs to be included in the unemployment figure or not, most countries around the world still consider the unemployed only those who are ‘actively seeking employment’ but are unable to find it.

To learn more about how unemployment is currently measured in the UK check our explanation on the Measures of Unemployment.

Unemployment - Key takeaways

  • Involuntary unemployment is when an individual wants to work at the going wage rate, but there is no availability of jobs as there is no demand for their labour.
  • Voluntary unemployment is when an individual without jobs is not willing to be employed at the going wage rate, usually opting to receive state benefits instead of working.
  • The types of unemployment are frictional, structural, seasonal, and cyclical.
  • The causes of frictional unemployment are geographical immobility of labour, occupational immobility of labour, and imperfect information.
  • The causes of structural unemployment are technological changes and competition.
  • The natural level of unemployment occurs with the real wage at its market-clearing level.
  • The consequences of unemployment are lower international competition, reduced productivity, and under-investment in technology.
  • The government policies to reduce geographical mobility are to subsidize moving costs, for occupational mobility, to offer retraining policies, and retaining schemes and supply-side policies for lowering frictional and structural unemployment.

Sources

1. Congressional Research Service, Unemployment rates during the Covid-19 pandemic, 2021 https://sgp.fas.org/crs/misc/R46554.pdf.

2. Statista. Unemployment rate in the United Kingdom (UK) from 1999 to 2020.

Frequently Asked Questions about Unemployment

Unemployment is a situation when an individual is actively looking for employment but is not able to find work.

The problem of unemployment brings about the issue of poverty. The government endures additional borrowing as unemployment causes a cut in production and hence, less consumption of products/services.

Frictional, structural, seasonal, cyclical, real-wage, and technological unemployment.

Some of the causes include global recession, mismatching of labour demand and supply, poor education and training, the role of trade unions, etc.

Final Unemployment Quiz

Question

Define unemployment.

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Answer

Unemployment is when an individual is actively looking for employment but is not able to find work.

Show question

Question

What is involuntary unemployment?

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Answer

Involuntary unemployment is a situation in which the unemployed individual wants to work at the going wage rate. However, there is no availability of jobs as there is no demand for their labour. 

Show question

Question

What is voluntary unemployment?

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Answer

Voluntary unemployment is when an individual without jobs is not willing to be employed at the going wage rate, usually opting to receive state benefits instead of working.

Show question

Question

What are the main causes of unemployment?

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Answer

  • Geographical immobility of labour
  • Occupational immobility of labour
  • Imperfect information
  • Technological unemployment
  • Competition

Show question

Question

What is the natural rate of unemployment?

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Answer

Frictional and structural unemployment comprise what is known as equilibrium unemployment, which is also referred to as the natural level of unemployment, which occurs even with the real wage at its market-clearing level.

Show question

Question

What are some government policies that could decrease unemployment?

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Answer

  • Enhancing geographical mobility
  • Enhancing the occupational mobility of labour
  • Supply-side policies

Show question

Question

Explain supply-side policies in the context of unemployment.

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Answer

These are policies that try to enhance the competitiveness and effectiveness of the market and are  applied to lower frictional and structural unemployment. 

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Question

How does geographical immobility cause unemployment?

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Answer

Unemployed people decide to not move to other places where there might be better employment opportunities for reasons like preferring to stay near their families, uncertainty of actually finding a job, and the housing and moving prices. 

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Question

How does occupational immobility of labour cause unemployment?

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Answer

Occupational immobility of labour arises from adversities in training for jobs that need various skills, the impact of limiting practices like a prerequisite that new workers must hold needless qualifications, and biases regarding age, gender, and race in the labour market.

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Question

How does imperfect information cause unemployment?

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Answer

People may not know about the jobs available. 

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Question

Explain technological unemployment.

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Answer

Technological unemployment arises from the successful development of labour-saving technology. In comparison to mechanization (where the workers operate the machines) which generally increases the demand for labour, automation (where machines are operated by machines) lowers the demand for labour even when the industry output is increasing.

Show question

Question

Explain how competition causes unemployment.

Show answer

Answer

Developing countries usually have cheaper labour, therefore several companies relocate to these countries for manufacturing their products. Consequently, workers who were formerly working in manufacturing become unemployed. 


Show question

Question

How does unemployment lower the international competitiveness of an economy?

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Answer

Increasing unemployment can decrease the incentives for companies to invest in the latest technologies that would result in increased export competitiveness.

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Question

Why is some rate of unemployment desirable in an economy?

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Answer

Several free-market economists argue that a particular amount of unemployment is required for the better functioning of the economy. To be specific, by giving downward pressure on wage rates, unemployment can lower inflation. Unemployment is also a contributing factor in the increasing income differences among the better paid and low-paid workers. 

Show question

Question

What does the following diagram depict?


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Answer

the natural level of unemployment

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Question

The natural level of unemployment happens when the aggregate labour market is in equilibrium. This means ___________ 

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aggregate demand for labour equal to the aggregate supply of labour 

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In the following diagram, E1 represents ___________  


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number of workers who want to work at full employment real-wage rate 

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The distance E1 minus EFE is the ___________   


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natural level of unemployment 

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 ___________  occurs when individuals voluntarily choose to leave their job in search of a new one or when new workers enter the job market.


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Frictional unemployment 

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The natural rate of unemployment comprises both frictional and structural unemployment.


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True

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When workers are not employed, it means that all the ___________  of the economy are not utilised to produce output­.

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productive resources 

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There are four main types of unemployment: structural unemployment, ___________ , cyclical unemployment, and  ___________ .

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frictional unemployment, seasonal unemployment 

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Technology can lower the demand for labour.


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True

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Unemployment is a situation when an individual is ___________ but is not able to find work.


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actively looking for employment 

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Unemployment is always involuntary. 


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True

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___________  is when an individual without jobs isn’t willing to be employed at the going wage rate.

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Voluntary unemployment 

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Factors like family relations and local friendships that demotivate people from moving to other parts of the country to find a job refer to what cause of unemployment?


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Geographical immobility of labour 

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Competition arising from globalisation is not a main cause of unemployment. 

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Answer

True

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