AS Economics Notes
4.5 UNEMPLOYMENT
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Definition
Unemployment
refers to people of working age who are actively looking for a job but who are not employed.
result in wastage of scarce resources by not fully utilizing them.
Underemployment
Occurs when individuals have part-time jobs or jobs that don't fully utilize their skills and education.
Involves waste of resources used for training and education when individuals are unable to work in their desired profession.
Measures of Unemployment
Labour force
The total number of employed individuals and unemployed individuals actively seeking work.
Labour force excludes children, retired persons, adult students, individuals unable to work due to illness or disability, and those who choose not to work.
Unemployment measurement
Number: Total count of unemployed persons actively seeking work.
Percentage: Unemployment rate calculated as the number of unemployed divided by the labour force, multiplied by 100.
Example Question :
Suppose there is a population of 45.5 million people, of whom 20 million are in the labour force, 1.5 million work part time though they would rather work full time, 0.5 million are discouraged workers, and 1.2 million are looking for work but cannot find any. What is the unemployment rate?
Unemployment rate : 1.2 / 20 * 100 = 6%
Challenges in measuring unemployment accurately
Hidden unemployment is not accounted for:
Discouraged workers who have stopped actively seeking employment are excluded from the official statistics.
Part-time workers are counted as fully employed, disregarding their underemployment.
Highly skilled individuals working in low-skilled jobs are considered fully employed.
Retraining program participants and early retirees are not included in the unemployment figures.
Overestimation of unemployment can occur:
People engaged in the underground economy, unreported and unregulated activities, are not included in the official statistics.
Limitations of national unemployment rate:
Unemployment varies across different population groups.
Regional differences: Areas with declining industries may have higher unemployment rates compared to other regions.
Gender disparities: Women may experience higher unemployment rates than men.
Ethnic groups: Discrimination and lower education levels can lead to higher unemployment rates for certain ethnic groups.
Age disparities: Youth unemployment tends to be higher, while older individuals may face challenges in finding employment.
Occupation and education: Less skilled individuals often have higher unemployment rates, though highly educated groups may also experience higher rates in some countries.
Consequences of Unemployment
Economic consequences of unemployment:
Loss of real output (real GDP) due to underutilization of available labor.
Decreased income for unemployed individuals, even with unemployment benefits.
Reduction in tax revenue for the government as unemployed individuals do not contribute income taxes.
Increased costs for the government in providing unemployment benefits and addressing social problems associated with unemployment.
More unequal distribution of income, leading to increased poverty and social tensions.
Reduced future employability of long-term unemployed individuals due to skill deterioration and changing job market demands (hysteresis effect).
Personal and social consequences of unemployment:
Personal problems such as financial strain, increased debt, and loss of self-esteem.
Negative impact on mental health, family relationships, and overall well-being.
Social problems arising from high and unevenly distributed unemployment rates, including crime, violence, drug abuse, and homelessness.
Causes of Unemployment
Full employment occurs when an economy produces real GDP equal to its potential GDP.
Full employment does not mean zero unemployment; it includes the presence of the natural rate of unemployment.
The natural rate of unemployment consists of three types of unemployment: structural, frictional, and seasonal.
Structural Unemployment :
Changes in Demand
lower demand particular types of labor skills due to technological advancements and shifts in industries.
The decline of certain industries and the growth of others can lead to job losses for workers without the necessary skills for new industries.
Mismatches between the labor skills demanded by employers and the skills possessed by workers result in structural unemployment.
Relocation of firms or industries to different regions or foreign countries can cause a fall in labor demand in one region and an increase in another, leading to structural unemployment.
Labour Market Rigidities - impede the functioning of supply and demand forces in the labor market Examples include :
Minimum wage legislation, which sets wages above the equilibrium level and can result in unemployment.
Labour union activities and wage bargaining that lead to higher wages than the equilibrium, causing unemployment.
Employment protection laws that make it costly for firms to terminate workers, making them more hesitant to hire.
Generous unemployment benefits, which make remaining unemployed more attractive and reduce work incentives.
Structural unemployment, including all types, is a significant and long-term form of unemployment.
Some level of structural unemployment is natural in a growing economy.
Frictional Unemployment:
Occurs when workers are in transition between jobs.
Reasons for frictional unemployment include:
Being fired from a job
Employer going out of business
Seeking a better job
Waiting to start a new job
Frictional unemployment is typically short term and not due to a lack of in-demand skills.
It is considered less serious than structural unemployment.
In a growing and changing economy, with expanding and contracting industries and firms, and workers aiming for income and professional advancement, some level of frictional unemployment is inevitable.
Incomplete information between employers and workers regarding job vacancies and required qualifications is a significant cause of frictional unemployment.
Matching the right applicants with the right job openings takes time, leading to frictional unemployment.
This type of unemployment is part of the natural rate of unemployment.
Seasonal unemployment :
Occurs when the demand for labor in certain industries fluctuates seasonally - industries experience variations in labor demand based on seasonal needs.
Workers may be hired during peak seasons and laid off during off-peak periods.
It is considered a form of natural unemployment as some degree of seasonal variation is inevitable in any economy.
Cyclical Unemployment:
Occurs during economic downturns or recessions, when the economy is in a recessionary gap.
It is associated with declining or low aggregate demand (AD) and is also known as demand-deficient unemployment - firms laying off workers as real GDP decreases due to a fall in AD. (refer figure 4.1)
Cyclical unemployment decreases as the economy recovers and aggregate demand increases.
Government policies are used to address cyclical unemployment by boosting aggregate demand and reducing the recessionary gap.
Figure 4.1 Cyclical demand
In the model, the economy initially operates at full employment (Yf) with zero cyclical unemployment.
A decrease in aggregate demand (AD1 to AD2) leads to a recessionary gap, causing a decline in real output (Y1) and the emergence of cyclical unemployment.
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