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Economics Unit 4: Unemployment (Chapter 13)

Unemployment may be defined as the number of people of working age who do not have jobs
but are seeking work at the existing wage rate.
Measuring Unemployment
The unemployment figure is measured in two ways:
Claimant Account- This measures all those whom claim Job seekers allowance. However the
claimant account excludes people who do no not meet the criteria but they do still seek jobs.

Labour Force Survey- This measure of unemployment includes all those who have looked for
work in the past month and are able to start in the next two weeks. It tends to exceed the
claimant count in numbers by about 500,000.

Equilibrium Unemployment Unemployment can come in many forms. When a worker is simply
moving between jobs, it is deemed ‘’Frictional Unemployment’’.
Real Wage rate ASL When there is a change of taste in the economy, leading to whole
industries no longer being in demand, it is known as ‘’Structural
ALF unemployment’’. These two particular types of unemployment
comprise what is known as Equilibrium unemployment. This is
W1
when AD for labour equals AS for labour.
In this graph, ALF shows the Aggregate labour force of the nation
ADL whilst ASL is the aggregate labour supply willing to work at the
wage rate of W1. The equilibrium unemployment is thus equal to
Q2 Q1 Employment
the difference between those willing to work and the actual amount
of labour.

Causes and types of unemployment

1.) Frictional Unemployment
This is a form of voluntary unemployment and is caused by people moving in between jobs
pr searching for jobs. Incomplete or inaccurate information may also lead to frictional
unemployment.
Geographical Unemployment
This is when the labour force is unable move locations to where there are more jobs due to
family/personal reasons.
Unemployment Trap
People may also choose to be unemployed if they believe that they are better off that way.
The Replacement Ratio
This is a formula and shows the relationship between disposable income in being employed
and disposable income of being unemployed and relying on state benefits. The formula is:

Replacement ratio= disposable income out of work

disposable income in work
A
high level of state benefits acts as a disincentive to work. If the answer is one then it means
the worker would receive the same amount of money if they were on benefits. If the answer
were above one then the worker would receive more money if they were on state benefits. On
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the other hand, if the ratio equalled less than one then it means being employed would give
them more money than being unemployed.

2.) Casual and seasonal unemployment

Definitions:
Casual Unemployment- This is when workers are made redundant on a short-term basis.
Seasonal Unemployment- This is casual unemployment resulting from fluctuations in
aggregate demand through out the year. An example would be the a waiter being dismissed at
the end of the summer as demand falls once the summer is over.

3.) Structural Unemployment

This form of unemployment occurs when there is a long run decline in demand for labour
relative to its supply. In other words, demand is falling yet there supply remains high for
labour in this industry. Structural unemployment arises from a change in the structure of the
economy. In the UK, the structure of the economy has changed as there has been a long run
decline in demand for labour in the primary and secondary sectors, where as the tertiary has
new job opportunities. Workers in the declining sectors do not have the required skills to
work in the tertiary sector thus they face occupational immobility. An example of a structural
change would be the decline in the coal-mining industry.

Technological unemployment
Definition: This is unemployment caused by the introduction of labour-saving technology.
In other words, it means that machines are replacing the demand for labour. Machines
operating machines is known as automations where as workers operating machines is known
as mechanisation.

4.) Cyclical Unemployment

Cyclical unemployment occurs during the recession phase of the economic cycle where
demand is low. The fall is aggregate demand would lead to an increase in the output gap or
the gap between potential GDP and actual GDP. Furthermore demand from labour comes
from the demand to increase output (derived demand) thus if demand for output falls then the
demand for labour will also fall.

Voluntary and Involuntary unemployment

Voluntary unemployment occurs when a worker is not willing to accept the wage rate offered
for example a frictionally unemployed worker. Involuntary unemployment is when a worker
is willing to work for the wage rate offered but is not offered a job. Thus cyclical
unemployment (during a recession) is classed as involuntary unemployment.

Classical Unemployment
Classical or real wage unemployment arises when real
Real Wage
wages are above the market clearing level, creating excess
Rate
in the supply in labour. For example the graph below shows
W2
the market-clearing price of W1. However if the real wage
W1 rate is set above this then firms wish to employ less yet
there is excess supply of labour. There is excess supply of
QD Q1 QS Employment
QS-QD.
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Consequences of Unemployment
Economic Consequences
Unemployment represents a loss of scarce resources whilst also showing that the economy is
working below it potential. Increased unemployment is likely to make consumers save their
money rather than spend. In doing so consumer demand will fall. Redundancies waste the
money spent on education and training. Government spending will increase, as the
government will not have to pay more money to those unemployed. This is furthered by the
loss of tax revenue from income tax.

The longer a person remains out of the work, the more their confidence and motivation will
fall. They will have fewer incentives to keep searching for work, which can be caused by
structural unemployment and an increase in the natural rate of unemployment (when AD/AS
for labour is in equilibrium yet there is still unemployment). The hysteresis is a term used to
describe the effect on the economy. It refers to the tendency for one variable that has been
changed not to return to its previous state fir example unemployment can lead to further
unemployment.

Social Costs of Unemployment

Ares with persistently high rates of unemployment see falling incomes and widening
inequalities of the distribution of income. These areas can also face higher divorce rates,
higher crime and lower life expectancy. Thus unemployment can lead to more negative
externalities.

Benefits from Unemployment

It is generally agreed that the cost of unemployment outweighs the benefits of unemployment
however some firms may find rising unemployment helpful when attempting to lower to
wages as the worker will have less bargaining power. This may also relive inflationary
pressure on non-renewable resources if un employment leas to slower growth of consumption
and production.

Government Policies to reduce unemployment.

The causes ant types of unemployment can be categorised into demand side and supply side.
Cyclical, or demand deficient unemployment can be treated using demand side polices whilst
the remaining types of unemployment are off a supply side nature and thus need to be treated
using supply side policies.

1) Demand Side Policies

Demand side polices are used to increase AD and thus increase income and
employment. Fiscal policy could be used during a recession in order to reflate the
economy. It could achieve this by increasing its own expenditure or reducing income
tax thus people will have more disposable income. It could loosen the monetary
policy meaning more people could borrow on credit. If there is areas of the country
affected more by unemployment than another then it could stimulation economic
activity in those regions by paying firms to move to these areas.
2) Supply-Side policies
The policies that are directed at reducing occupational immobility and structural
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unemployment, seek to provide those unemployed with the skills they need to find
work and also improve the incentives for those unemployed to find work. Improve
education and training would help reduce occupational immobility and make them
more likely to secure jobs. Geographical immobility could be reduce if there was
more information on jobsites about the area with the job opportunities such as
accommodation.

Supply Side economists believe that by reducing welfare benefits the people are faces
with more incentive to find employment.

Phillips Curve
This curve shows the economic trade off between inflation and unemployment. The curve
suggests that falling unemployment might cause inflation to rise whilst reduced inflation
might be at the expense of higher unemployment.
Inflation %
The curve shows that a particular level of
unemployment could be traded off against a certain
level inflation. Inflation and unemployment have a
negative correlation meaning that the LOWER
unemployment leads to higher inflation and
HIGHER unemployment leads to lower inflation.
0
Unemployment %

The

During the 1970’s stagflation set in. Stagflation is the co-existence of high unemployment
and high inflation. This undermined the Phillips curve as many economists argued that the
relationship no longer existed. Some economised believed that the relationship still
existed just that the curve had shifted to the right meaning more unemployment could
exist with higher inflation.

Monetarist economists such as Milton Friedman believe that in the short run, the Phillips
curve existed however in the long run the curve was vertical meaning there was no trade
off between unemployment and inflation.

Friedman argued that for each expected level of expected (when people suspect inflation
may rise) inflation there would be more than one Phillips curve. When people think
inflation may rise, they would expect higher wages in order to anticipate the higher
general price. Friedman assumed there would be no money illusion. The EAPC curve
would look like the one below:

Expectations augmented Phillips Curve (EAPC)

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The economy starts at point U level of unemployment and 0% inflation. The government wants to
lower the level of unemployment by booting AD. In the short run, boosting AD has worked at the
economy is now at point V with lower unemployment and 5% inflation. From point V to point U
there was a movement along the curve. When AS has been boosted, there was an adjustment
period. In this time, there would be shortages in the economy. By this happening prices begin to
rise. Labour would therefore seek wages increases by the equivalent amount the inflation rate has
risen by. Firms are likely to grant these in wage increases due to the power of trade unions
however they may have to let go of some about to deal with the increase prices. In doing so, AS
shifts to the left (falls). The economy now has the same amount of unemployment as it started
with but now with higher inflation.

If firms insist on trying to reduce unemployment again, then the economy will do the same thing
again (W to X to Y) but this time with higher inflation. Trying to reduce the unemployment rate
below U will be purely inflationary and for this reason, U is known as the natural unemployment
rate.

http://www.bized.co.uk/virtual/bank/economics/mpol/inflation/causes/theories4.htm
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The NAIRU
Definition: This is the Non-Accelerating inflation rate of unemployment, that is the level of
unemployment at which there is no tendency for the inflation rate to accelerate.

This is the equivalent to the equilibrium unemployment rate and consists of frictional and
structural unemployment. If unemployment falls below this level due to the government trying
to stimulate AD, then it will lead to increases in the inflation rate. On the other hand if
unemployment goes above the NAIRU then wage rate and inflation will fall as there is higher
unemployment. It has been estimated that during the 90’s the NAIRU was 10% but in recent
years it has fallen to 5%.

The Natural Rate of Unemployment

The rate of unemployment represents frictional unemployment. The natural rate and the NAIRU
are considered to be interchangeable or identical. The natural rate implies there will always be
unemployment in an economy thus the NAIRU is used more commonly today.

The Long Run Phillips Curve

The vertical curve in the EAPC above, is the long run Phillips curve. It can shift in over long
periods of time due to supply side improvements. Labour market reforms can successfully
reduce frictional and structural unemployment. This may lead to a reduction in the natural rate
of unemployment.

What happened to the inflation/unemployment trade off in the UK?

Between the 1990’s and 2007, the UK has relatively stable inflation (ranging from 0.8 to 2.6%)
and unemployment fell from double digits to 4.6%. There are numerous factors for this:
-UK market flexibility: A flexible labour market means that labour can move more easily into
jobs (less occupational immobility). Furthermore firms find it easier to higher labour as they
have more choice.
-Immigration: A rise in the am ount of people
immigrating to the UK have relieved labour shortages and there fore have lessened wage rate
inflationary pressures.
-Setting credible inflation targets: Inflation targeting have helped reduce inflation
expectations in doing so people so not expect higher wages as much.
-Low inflation in the Global economy: Cost and price inflation have been falling in the global
economy previous to 2007. Rapid competition has reduced the prices of many goods and
services.
-Technological change and innovation: This has improved the efficiency of both British and
the international economy, raising labour productivity and cutting production costs.