Classify unemployment
Distinguish equilibrium and disequilibrium unemployment and separate voluntary from involuntary unemployment.
Employment and Unemployment
This chapter develops the meaning of full employment, separates equilibrium from disequilibrium unemployment, explains the natural rate and labour-market patterns, and evaluates how mobility and policy affect unemployment.
Full employmentEquilibrium unemploymentDisequilibrium unemploymentNatural rateEmployment patternsLabour mobilityUnderemploymentPolicy
What this chapter prepares you to do
Use macro diagrams
Explain how real-wage rigidity, an AD shock or an SRAS shock can leave the economy below full employment.
Interpret labour-market patterns
Analyse participation, sectoral employment, the informal economy, part-time work and hidden unemployment.
Evaluate policy
Match supply-side or demand-side policies to the underlying cause and assess time lags, incentives and inflation risks.
High-grade habit: diagnose the cause before recommending a policy. Demand-side expansion may help demand-deficient unemployment, but it does not directly solve a skills mismatch that causes structural unemployment.
Chapter sections
26.1
Full employment
Full employment exists when people who are economically active, willing and able to work at the going wage rates can find employment. It does not mean that the measured unemployment rate is zero.
Why full employment is not zero unemployment
Even when aggregate output is at its full-employment level, some people will be between jobs, affected by seasonal work, or temporarily have skills that do not match available vacancies. Full employment therefore means that people willing and able to work at going wage rates can find work, not that every worker is employed at every instant.
Why unemployment remains
A dynamic economy always has people moving between jobs, searching for suitable work, facing seasonal changes or temporarily mismatched with vacancies. Some unemployment therefore remains even when the economy is operating at full capacity.
Why the exact rate varies
There is no universal percentage that represents full employment. It depends partly on labour-market flexibility, the speed of job matching, institutions and the structure of the economy.
Policy conflict: pushing unemployment extremely low can create upward pressure on wages and prices. Full employment and price stability may therefore conflict when the economy is close to capacity.
Exam distinction: full employment refers to effective use of labour resources, not a literal situation in which every economically active person has a job at every moment.
26.2
Unemployment
Equilibrium unemployment
Equilibrium unemployment is unemployment present even when the economy overall is in equilibrium. It includes unemployment that can arise from the normal functioning and changing structure of the economy.
Frictional
Workers are between jobs or searching for a better match. It is often temporary and can be voluntary.
Seasonal
Employment varies predictably during the year because demand for some occupations is seasonal.
Structural
The skills or location of workers do not match available jobs as the pattern of economic activity changes.
Technological
New technology changes the skills or number of workers required, leaving some workers unable to match new vacancies.
Disequilibrium unemployment
Disequilibrium unemployment occurs when the economy or a labour market is away from equilibrium. A common mechanism is real-wage inflexibility: wages remain above the level that would clear the labour market.
Unemployment in a labour market
At the free-market equilibrium, wage W* clears the labour market. If the wage is held at W0 above equilibrium, labour supplied Ls exceeds labour demanded Ld; the gap is disequilibrium unemployment.
Adapted from the Cambridge International AS & A Level Economics book by Peter Smith (Second Edition, with Adam Wilby and Mila Zasheva).
Demand-deficient unemployment
If aggregate demand falls, real GDP can drop below the full-employment level. If wages and costs adjust downwards only slowly, unemployment persists. This is demand-deficient unemployment.
Unemployment in the macroeconomy with a negative AD shock
A fall in aggregate demand from AD0 to AD1 reduces real GDP from YFE to Y1. The resulting negative output gap is accompanied by higher unemployment.
Adapted from the Cambridge International AS & A Level Economics book by Peter Smith (Second Edition, with Adam Wilby and Mila Zasheva).
A supply-side shock can also create disequilibrium unemployment. If firms face a sharp increase in costs, SRAS shifts left: real GDP falls below the full-employment level while the price level rises. If wages and costs later adjust downwards, SRAS can move back towards its original position.
Unemployment in the macroeconomy with an SRAS shock
A rise in firms' costs shifts SRAS left from SRAS0 to SRAS1. Real GDP falls from YFE to Y1 while the price level rises, so unemployment and inflation can increase together.
Adapted from the Cambridge International AS & A Level Economics book by Peter Smith (Second Edition, with Adam Wilby and Mila Zasheva).
Classifying unemployment
A worker who voluntarily leaves a job to search for a better one is experiencing frictional, voluntary unemployment. A worker willing to work at the going wage after an AD shock but unable to find a vacancy is experiencing involuntary unemployment. A qualified engineer working as a taxi driver illustrates underemployment, because available human capital is not being fully used.
A negative SRAS shock, such as a major rise in production costs, can also reduce real GDP and employment. If wages are inflexible downwards, the economy may not return quickly to full employment.
Hysteresis and cyclical unemployment
Hysteresis
Unemployment caused by a downturn may continue even after aggregate demand recovers. Long periods out of work can weaken skills, confidence and employability, and employers may be reluctant to hire the long-term unemployed.
Cyclical unemployment
Unemployment rises as real GDP falls below its trend and full-employment level during the recession or slump phase of the business cycle.
Voluntary versus involuntary unemployment
Voluntary unemployment
An individual chooses not to accept a job at the going wage. Examples include leaving one job to search for a better one or choosing benefits over a low-paid job when the financial gain from employment is small.
Involuntary unemployment
An individual is willing and able to work at the going wage but cannot obtain a job. Demand-deficient unemployment is a clear example.
Do not force the categories into one box. Structural unemployment can be equilibrium unemployment from the macroeconomic viewpoint yet involuntary for an individual who wants a job but lacks the required skills.
The natural rate of unemployment
The natural rate of unemployment is the unemployment rate present when the economy is in long-run equilibrium at the full-employment level of real GDP. It mainly reflects frictional, structural and technological influences and can also be affected by regional immobility and incentives.
Structural change / technology
→skills mismatch
→structural unemployment
→higher natural rate
Policies that reduce the natural rate therefore focus on education, training, job matching, mobility and appropriate tax-and-benefit incentives rather than simply increasing aggregate demand.
Policy implication: policies aimed at the natural rate should target the causes of equilibrium unemployment — for example education and retraining for skill mismatch, better job information to reduce frictional unemployment, and carefully designed tax/benefit incentives. General demand expansion does not directly remove these structural causes.
26.3
Patterns and trends in employment and unemployment
Labour force participation
The labour force participation rate is the percentage of the relevant population that is economically active — either employed or unemployed and seeking work.
Labour force participation rate = (economically active population ÷ relevant population) × 100
Participation differs across countries and demographic groups. The textbook emphasises that female participation varies especially widely, reflecting differences in social and cultural attitudes as well as access to employment.
Employment structure
Informal economy
Workers may operate outside formal regulation and employment contracts. This can provide livelihoods where formal jobs are scarce, but workers often lack employment protection and social-security coverage.
Sectoral pattern
Higher-income economies tend to have a larger share of employment in services, while agriculture remains more important in many lower-income economies.
Part-time work
Part-time employment is significant in some economies. It may be voluntary, but some workers are underemployed because they want more hours than employers offer.
Unemployment data need interpretation
Unemployment changes through time and across countries, but simple comparisons can mislead. Different economic structures, informal activity and measurement quality matter. A lower-income country can report a low unemployment rate if people cannot afford to remain openly unemployed and instead work informally or at subsistence level.
Hidden unemployment and underemployment
Disguised unemployment
More people appear to be working than are actually needed to produce the output. This can occur in subsistence agriculture where family members share too little work.
Skill underemployment
A highly trained worker takes a job well below their qualification level, so human capital is not being used fully.
Hours underemployment
A part-time worker would prefer and is available to work more hours but cannot obtain them.
Data-response habit: distinguish the measured unemployment rate from the broader degree of unused labour. Informal work, disguised unemployment and underemployment can make headline unemployment look lower than the true extent of spare labour capacity.
26.4
Mobility of labour
Labour-market flexibility depends partly on whether workers can move to where jobs exist and acquire the skills required by expanding occupations.
Geographic immobility
Workers are unable or unwilling to move between areas even when jobs are available elsewhere.
- Moving, housing and transport costs
- House-price differences or limited rental/public housing
- Family, schooling and social ties
- Poor information about vacancies elsewhere
- Difficulty finding suitable jobs for both partners
- Large rural-to-urban adjustment costs
Occupational immobility
Workers cannot readily move between occupations because their skills, qualifications or information do not match available jobs.
- Retraining costs and time
- Professional entry requirements
- Uncertainty about aptitude and job satisfaction
- Insufficient information about alternative careers
- Underprovision of training by firms
International labour mobility
Wage and employment differences can encourage migration between countries. Immigration can expand labour supply in the destination country and help fill skill shortages. For the country of origin, sustained emigration of skilled workers can create a brain drain.
Textbook example
When wage differentials encourage skilled workers to move abroad, the destination country gains labour supply but the origin country may experience a brain drain. The same movement can therefore improve labour allocation internationally while creating a skills shortage at home.
Why training may be underprovided
A firm may hesitate to pay for general training if another employer can later recruit the trained worker without sharing the training cost. This free-rider problem gives a reason for government support for education and retraining.
Link to elasticity: greater labour immobility makes the supply of labour to an occupation or region less wage-elastic because workers respond less readily to wage differences.
26.5
Policies to reduce unemployment
There is no single unemployment policy. The appropriate response depends on whether unemployment is part of the natural/equilibrium rate or reflects a disequilibrium such as deficient aggregate demand.
Policies for equilibrium unemployment
Reduce structural and technological unemployment
- Education and retraining for new occupations and technologies.
- Targeted support for sectors or regions facing structural decline.
- Infrastructure and housing measures that improve geographic mobility.
- Government support for training where private firms would underprovide it.
Reduce frictional unemployment
- Better vacancy information and job-matching services.
- Improved careers advice and retraining information.
- Tax and benefit systems that preserve incentives to work.
- Labour-market reforms that allow faster adjustment while protecting workers.
Labour-market flexibility and employment contracts
Employment-protection rules can raise firms' costs of reducing employment and may make firms more cautious about hiring. Part-time and zero-hours arrangements can give firms greater flexibility, but they may also reduce workers' income security and bargaining power. Evaluation therefore requires considering both efficiency and worker protection.
Policies for disequilibrium unemployment
When unemployment results from a negative output gap and deficient aggregate demand, expansionary fiscal or monetary policy may raise AD and return the economy toward full employment more quickly.
Evaluation of intervention
Reasons to intervene
- Adjustment back to full employment may be slow.
- Hysteresis can make temporary unemployment more persistent.
- Long unemployment spells create economic and social costs.
Reasons for caution
- The economy may already be adjusting without intervention.
- Policy works with recognition and implementation lags.
- Extra AD can create inflation if spare capacity is small.
- Demand expansion does not solve structural skill mismatches.
Strong evaluation: the effectiveness of unemployment policy depends on the type of unemployment, wage flexibility, labour mobility, the size of the output gap, the speed of spontaneous adjustment and the time lag before policy takes effect.
Chapter 26 revision checklist
□ Define full employment and explain why unemployment need not be zero.
□ Explain the possible conflict between full employment and price stability.
□ Distinguish equilibrium and disequilibrium unemployment.
□ Classify frictional, seasonal, structural and technological unemployment.
□ Explain unemployment caused by a wage above labour-market equilibrium.
□ Explain demand-deficient unemployment using AD/AS.
□ Explain how an adverse SRAS shock can create unemployment.
□ Define real-wage inflexibility and hysteresis.
□ Distinguish voluntary and involuntary unemployment.
□ Define the natural rate of unemployment.
□ Explain policies that can reduce the natural rate.
□ Define and calculate the labour force participation rate.
□ Explain differences in labour participation across groups and countries.
□ Explain the significance of informal and part-time employment.
□ Distinguish measured unemployment from hidden unemployment and underemployment.
□ Explain geographic immobility of labour.
□ Explain occupational immobility and the training free-rider problem.
□ Explain international migration and brain drain.
□ Match supply-side policies to equilibrium unemployment.
□ Evaluate demand-side policies for disequilibrium unemployment.
20 questions. Each answer is marked immediately with a short explanation of why it is correct or incorrect.