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Most workers fear unemployment. They rely on their income to maintain a certain standard of living, and the loss of a job will threaten to reduce that standard of living. This creates a range of problems for the worker and their family. Unemployment is harmful to society, as well. Unemployed workers represent wasted production capability. This means that the economy is putting out fewer goods and services than it could be. It also means there is less money being spent by consumers, which has the potential to lead to more unemployment, in a vicious cycle.
Unemployment is obviously a source of income inequality. But even when two people are both gainfully employed, it may be that one of them is earning just enough to scrape by (or maybe not even that), while the other is earning far more than they deserve or need by any commonsense standard. This kind of social imbalance also poses challenges for society, which we will consider at the end of the chapter.
By unemployment, economists mean the condition of not having a job but actively seeking one. There are actually three major types of unemployment.
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Some people who are not working are simply between jobs. They may already have a new job lined up, but if not, they will land one soon. Their skills are in demand, so it’s just a matter of time. This kind of unemployment is called frictional unemployment, because in the real world it is impossible for everyone to smoothly, instantly transition from one job to the next, so that no one is ever unemployed even briefly.
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Other unemployed workers have poorer job prospects, because their skills are less in demand than they used to be. Think of a worker in a dying industry, or a worker whose expertise is on a particular hardware or software system that has fallen out of favor. This type of unemployment is called structural unemployment, because it is caused by structural changes in the economy.
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Finally, some workers may be laid off as the economy slows down. These workers’ skills will be needed again in the future, but for now there is simply not enough demand for their firms to continue to employ them. This type of unemployment is called cyclical unemployment, because it is attributable to changes in output due to the cycles of the economy.
Calculating Unemployment
The Bureau of Labor Statistics (BLS) regularly gathers data every month, from about 60,000 households, to compute a number of macroeconomic statistics. One of these statistics is the unemployment rate.
The first step in computing the unemployment rate is to sort everyone in a country into three categories: employed, unemployed, or out of the labor force. People who are employed are currently working. People who are unemployed are not currently working, but are actively searching for a job and would work if they found one. The employed and the unemployed together make up the labor force. People who are out of the labor force are neither working nor actively seeking work. This includes people who are too young to work and those who have retired from work.
Once people have been placed into the appropriate categories, the total labor force can be calculated as the total number of workers who are either employed or unemployed. The unemployment rate is the ratio of the number of unemployed persons to the total number of people in the labor force. For example, let's say that a survey by the BLS reveals 20 people employed, 5 people unemployed, and 40 people out of the labor force. Then the labor force would number \(20+5 = 25\) people, and the unemployment rate would be \(5/25=20\%\).
Note that the official unemployment rate tends, in two ways, to understate the extent to which people have trouble finding employment. First, the official rate counts people as employed who may be underemployed, that is, who want full-time work but have only found part-time work. And second, the official unemployment rate does not account for marginally attached workers (formerly known as discouraged workers) who would like to work but after weeks of unsuccessful job-hunting have stopped actively seeking employment. These people are considered to be no longer in the labor force and are therefore excluded from the calculation of the unemployment rate.
Full Employment and the Natural Rate of Unemployment
Oddly, the term full employment does not describe an economic situation where everybody is working. Rather, full employment refers to circumstances in which unemployment is as low as it sustainably can be. This condition exists when there is frictional unemployment, and a level of structural unemployment consistent with steady economic growth (which inevitably involves structural changes), but no cyclical unemployment on top of the frictional and structural unemployment.
The natural rate of unemployment is the rate of unemployment that corresponds to full employment. There is no widely accepted numerical value, but historically, an unemployment rate below 4% is unusual in the United States, and on the other hand the U.S. economy has at times gone a decade or more without the rate rising above 6%. Most economists therefore believe that the natural unemployment rate is somewhere in the range of 4 to 6 percent. During temporary slowdowns of the economy, cyclical unemployment causes unemployment to rise above the natural rate. During periods of unsustainably rapid economic growth, unemployment may fall below the natural rate.
