Wk2A1 Unemployment and the Economy

What is Unemployment?

In a market economy, unemployment means that there is an excess supply of labor in the economy. Households supply more labor than is demanded by firms. For unemployed households, market access to goods is cut off. These households cannot sell their labor and earn the money required to buy food, houses, clothes, and other essentials.

The unemployment rate is the most commonly used measure of unemployment. It is the percentage of workers in the labor force who do not have jobs.

The labor force includes people 16 years of age and older who are employed or are actively seeking a job. Therefore, children, elderly people, the severely disabled, people who exclusively earn income in profits, rent, or interest are not included in the labor force.

The definition of unemployment does not include discouraged workers. These individuals without jobs have not actively sought a job in six months. They have given up searching for a job because they believe that there are no jobs for them. Therefore, they are not counted as part of the labor force.

Part-time workers are considered employed and are not considered in the unemployment rate, even though they may be actively seeking full-time employment.

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There are three types of unemployment that are based on the different reasons that individuals are without work even though they are seeking jobs.

Frictional unemployment is when workers are moving from one job to another during a brief transitional period. Frictional unemployment is voluntary unemployment.

Structural unemployment is when workers have skills that do not match any available jobs. Structural employment is involuntary unemployment. Because the problem is long term in nature, short-term changes in growth do not significantly affect the percentage of the workforce that is structurally unemployed.

Cyclical unemployment is when workers lose jobs because of an economic recession. Firms in the aggregate are unable to sell enough goods to justify the employment of these workers. Cyclical unemployment is involuntary unemployment. During an expansion, these workers make short-term growth possible.

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There are few things in economics that could be called a sure thing, but the business cycle is one of them! The business cycle refers to the variations in the level of economic activity over time. In other words, we can expect the level of economic activity to increase and decrease over time.

We cannot predict, however, with any degree of certainty, the magnitude of these variations. One of the major purposes of both fiscal and monetary policies is to “smooth out” these ups and downs so that the effects or costs of theses cycles are minimized.

The business cycle can be divided into four “phases.” Each phase has its own characteristics in terms of the costs and benefits. Below, each of these phases is described.

• Recession: The economy is in a decline in terms of lower levels of employment; tendency for inflation is minimal.

• Trough: The economy has bottomed out, level of unemployment has been has stabilized, economic activity is at its lowest level.

• Recovery: The levels of employment are increasing, inflationary tendencies increasing; other measures of economic activity are also increasing.

• Peak: The economy has “topped out,” there is prosperity, very high employment levels, maximized economic activity.

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Frictional unemployment, being voluntary unemployment, is not a policy problem. Roughly, an unemployment rate of two to four percent represents frictional unemployment. Therefore, an unemployment rate of two to four percent or less is generally considered full employment. The term full employment is used to imply no involuntary unemployment in the economy.

Structural unemployment involves policies directed toward the long-term growth factors that prevent individuals from gaining employment.

The government can act to help provide the structurally unemployed with greater subsidies of human capital—the set of skills that an employee acquires through general education, vocational education, or on-the-job training and experience, which increases that employee’s value in the marketplace. This includes government financing of job-training programs and subsidizing of child care and formal education.

According to John Maynard Keynes, cyclical unemployment is the object of a short-run macroeconomic policy and comes from recessions. Therefore, if the government can shorten recessions or even prevent them from occurring, the unemployment rate in the short run will decrease significantly.

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