Unemployment ● Causes of Unemployment ● The Phillips Curve ● Natural Rate of Unemployment ● Okun's Law
Unemployment Unemployment is a central problem in modern societies. Employed are people who perform any paid work, those who have jobs but are absent from work because of illness or vacations. Unemployed (U) are people who are not employed but are actively looking for work or waiting to return to work.
Labour Force Labour force (L) is the number of employed plus the number of unemployed. People without jobs who are not looking for work are outside the labour force. L = E + U
The Unemployment rate The unemployment rate (u) is the number of unemployed divided by the total labour force: L = E + U
Two Methods to Calculate Unemployment Labour Force Sample Surveys are the most preferred method of unemployment rate calculation since they give the most comprehensive results and enables calculation of unemployment by different group categories such as race and gender. This method is the most internationally comparable. Centre of Labour reports the unemployment rate, based on registered unemployed. Labour offices only include unemployed persons who enter employment offices.
Three Categories of Unemployment Frictional unemployment Structural unemployment Cyclical unemployment
Frictional Unemployment Frictional (turnover) unemployment includes people unemployed for a relatively short period of time while searching for employment. Frictional unemployment arises because neither labour market information nor mobility is perfect.
Structural Unemployment Structural unemployment is long-term unemployment resulting from a lack of workers skills or a mismatch between worker skill and job requirements. The reasons for structural unemployment can be: Changes in demand conditions or technology that have eliminated certain types of jobs. Changes in world trade patterns that have transferred certain types of production to other countries.
Cyclical Unemployment Cyclical unemployment exists when the overall demand for labour is law. It occurs when employment falls as a result of an imbalance between AS and AD. When the economy moves into an expansion period, cyclical unemployment gradually declines.
Short-Term Unemployment And Long-Term Unemployment Short-term unemployment is lasting for several weeks. It is typical in economies with flexible labour markets. Long-term unemployment in European Union statistics is defined as unemployment lasting for longer than one year. It is an important indicator of social exclusion.
The Causes of Unemployment Although no universally accepted theory has emerged, many analyses share the common observation that unemployment arises because wages are not flexible enough to clear markets. A labour market characterized by perfectly flexible wages will not contain involuntary unemployment.
Flexible Wages E DLDL SLSL L W Voluntary unemployed Wages move up or down to clear the labour market. There is never any involuntary unemployment workers are voluntary in the sense that they do not want to work at the going market wage rate. W
Inflexible Wages Wages and salaries adjust to reflect shortages or surpluses in a particular market only over an extended period of time. The theory of sticky wages and involuntary unemployment holds that slow adjustment of wages produces surpluses and shortages in individual labour markets. Inflexibility arises because of costs involved in administering the compensation system (union contracts, non-union settings, minimum wage).
Inflexible Wages E DLDL SLSL L W If wages do not adjust to clear the labour market, at too high wages W 1 there are involuntary unemployed people. W1W1
The Natural Rate of Unemployment The natural rate of unemployment is that rate at which upward and downward forces on price and wage inflation are in balance. At the natural rate, inflation is stable, with no tendency to show either accelerating or declining inflation. When cyclical unemployment is zero and the economy is operating at the stable output level, the actual unemployment rate equals the natural rate.
The Natural Rate of Unemployment The factors that affect the natural rate of unemployment: Demographic factors – the age and sex composition of the labour force is an important determinant of the natural rate of unemployment. Government policy: The expansion of unemployment insurance can increase the natural rate. Tax policy that increases the cost of investing or the cost of production has negative effects on the unemployment rate. Increasing of structural unemployment.
The Natural Rate of Unemployment How to reduce the natural unemployment rate: Improve labour market services Bolster government training programs Remove government obstacles
The Phillips Curve The Phillips curve shows the inverse relationship between inflation and unemployment. It illustrates the trade off theory of inflation. According to this view, a nation can buy a lower level of unemployment if it is willing to pay the price of a higher rate of inflation.
The Phillips Curve Phillips Curve PW Unemployment Rate (%) Inflation Rate (%) Annual Wage Rise (%) 0 2 The wage scale is higher than the inflation scale by the assumed 2 % rate of growth of average labour productivity.
The Vertical Long-Run Phillips Curve The tradeoffs between inflation and unemployment remains stable as long as the inertial inflation rate remains unchanged. When the inertial inflation rate changes, the short-run Phillips curve will shift.
The Vertical Long-Run Phillips Curve A B C D Long-run Phillips curve Unemployment rate Inflation rate i1i1 i2i2 U1U1 U2U2
The Vertical Long-Run Phillips Curve The economy starts at point A at the natural rate of unemployment. The economy then expands, with unemployment falling below the natural rate at point B. As output exceeds its potential, wages and prices begin to accelerate. With higher rate of wage and price inflation, firms and workers begin to expect higher inflation. The rate of inflation thus increases → the short -run Phillips curve shifts upward. The new short-run Phillips curve reflects the higher expected rate of inflation. In the final period, as the economy slows the contraction in economic activity brings output back to its potential, and the unemployment rate returns to the natural rate.
The Vertical Long-Run Phillips Curve According to the natural rate theory, the only level of unemployment consistent with a stable inflation rate is the natural rate of unemployment. The long-run Phillips curve must, in this theory, be drawn as a vertical line, rising straight up at the natural unemployment rate, as shown by the vertical line.
Impact of Unemployment Economic impact: when unemployment is high, much output is lost, incomes decline. Okun's law states that for every1 percent that unemployment rate rises GDP falls by 2 percentage relative to potential GDP. It describes the association between short-run movements in real GDP and changes in unemployment. Social impact: unemployment leads to a deterioration of both physical and psychological health.