Unemployment is a macroeconomic phenomenon that directly affects
people. When a member of a family is unemployed, the family feels it
in lost income and a reduced standard of living. There is little in
the realm of macroeconomics more feared by the average consumer than
unemployment. Understanding what unemployment really is and how it works is
important both for the economist and for the consumer, as it is often discussed.
The Costs of Unemployment
Because most people rely on their income to maintain their standard of living,
the loss of a job will often directly threaten to reduce that standard of
living. This creates a number of emotional problems for the worker and the
family. In terms of society, unemployment is harmful as well. Unemployed
workers represent wasted production capability. This means that the economy
is putting out less goods and services than it could be producing. It also
means that there is less money being spent by consumers, which has the potential
to lead to more unemployment, beginning a cycle. However, in general, while
unemployment is harmful for individuals, there are some circumstances in which
unemployment is both natural and beneficial for the economy as a whole.
Okun's law
We know that when there is unemployment, the economy is not producing at full
output since there are people who are not working. But, what exactly is the
relationship between unemployment and national output or GDP? How much
would we expect the GDP to increase if unemployment fell 1%? These are useful
and important questions to ask when trying to understand the costs of
unemployment.
An economist named Arthur Okun looked at the relationship between unemployment
and national output over the past 50 years. He noticed a general pattern and
stated an equation to explain it. His equation, Okun's Law,
relates the
percentage change in real GDP to changes in the unemployment rate. In
particular, the equation states:
% change in real GDP = 3% - 2 x (change in unemployment rate)
This equation basically says that real GDP grows at about 3% per year when
unemployment is normal. For every point above normal that unemployment moves,
GDP growth falls by 2%. Similarly, for every point below normal that
unemployment moves, GDP growth rises by 2%. This equation, while not exact,
provides a good estimate of the effects of unemployment upon output.
For example, let's say a country had an unemployment rate of 8% in one year and
6% in the next. Using Okun's law, it would be hypothesized that the percentage
change in the real GDP would be 3% - 2 * (-2%) = 7%. Because 2% fewer people
were unemployed the nation produced 7% more output.
Types of Unemployment
While unemployment is a general term that describes people who wish to
work but cannot find jobs, there are actually a number of specific
types of unemployment. Three particular types of unemployment stand out as most
important, frictional unemployment, structural unemployment, and cyclically
unemployment
- Some people who are not working are simply between jobs. This may be the
result of being hired elsewhere or simply relocating. They are not actively
searching for a job, but instead just waiting to begin their next job. This is
called frictional unemployment because these workers are literally between
jobs.
- Other workers have a mismatch of skills for the job or geographic area that
they want to work. If a welder is displaced by a robot or if a nuclear engineer
is simply no longer needed in a lab, these workers become unemployed. This type
of unemployment is called structural unemployment because the structure of
the job is incompatible with the skills offered by the worker.
- Finally, some workers may be laid off as the economy slows down. These
workers possess the necessary skills, but 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 from 60,000
households to compute a number of macroeconomic figures. One of these
figures is the unemployment rate.
To compute the unemployment rate, the first step is to place people
into one of 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 a job. People who are out of the
labor force are either not currently looking for a job or would not
work if they found a job.
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 people unemployed over 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 be the sum of the employed plus the
unemployed or 20 + 5 = 25 people. The unemployment rate is the ratio
of the unemployed to the total labor force or (5 / 25) = 20%.
Full Employment and the Natural Rate of Unemployment
The term full employment sounds as though it means everybody is working.
And indeed, full employment refers to an economic situation in which
unemployment is very low. However, when the economy is at full employment there
is a still small amount of normal unemployment. This unemployment exists
because people are always changing between jobs creating frictional
unemployment. Similarly, when new workers enter the labor market, they do not
immediately gain jobs. Instead, they must search for jobs, even if only for a
short period of time. This causes there to be some unemployment even when the
economy is theoretically at full employment.
The natural rate of unemployment is the rate of unemployment that
corresponds to full employment. Economists theorize that this is around 6%
unemployment due to frictional unemployment and structural unemployment.
Cyclical unemployment causes a slight variation above and below this natural
rate. In general, the economy is said to be operating at full capacity when
the unemployment rate is at the nature rate of unemployment. Similarly, when
the unemployment rate is below the natural rate of unemployment, the economy is
said to be operating above full capacity. Finally, when the unemployment rate
is above the natural rate of unemployment, the economy is said to be operating
below full capacity.
The Causes of Unemployment
Now that we have covered the types of unemployment and how to calculate the
unemployment rate, let's go over what causes unemployment. There are four basic
causes of unemployment in a healthy, working economy. These reasons for
unemployment are: minimum wage laws, labor unions, efficiency wages, and job
search. In the real world economy all four of these forces work together to
create the unemployment that is reflected in the unemployment rate.
Minimum Wage Laws
In microeconomics, we learned that in an efficient market, the price of a
good changes to equilibrate the quantity demanded and the quantity supplied
(See the SparkNote on Supply and Demand.)
The labor
market, in its natural form, is just like any other market. If there are
unemployed workers who want jobs, the price of labor or the wage will
simply drop until all of the labor force is employed. That is, this would
happen if there were not government intervention into the labor market. In
order to help maintain a certain standard of living among all workers, the
government implements a minimum wage, which artificially inflates the wages
of the workers at the bottom of the wage scale above what the firm would
normally pay at equilibrium. This in turn causes the people above the minimum
wage workers to demand more pay and for the people above them to do the same.
Eventually, the minimum wage causes the wages of all workers to increase above
the market-clearing level. When the wage demanded is greater than
the wage
offered, workers earn more; but in response firms will cut jobs to recoup the
money they are losing, increasing unemployed workers. Raising the minimum wage
therefore also increases unemployment. (The factors playing into this dynamic are
more closely examined in the microeconomics SparkNote on Labor
Markets.)
Labor Unions
A second, and closely related, cause of unemployment, lies with the actions of
labor unions. Labor unions are collectives of workers who rally together
for higher wages, better working conditions, and more benefits. These
unions force firms to spend more money on each worker, some in the form of wage
and some in the form of benefits. Overall, this has an effect similar to the
minimum wage law, where workers are demanding wages greater than the firms are
willing to pay. Again, this raises the wages of workers above the market
clearing level and creates a situation in which there are more people who want
to work at the wage than there are firms who want to hire at the wage. In this
way, labor unions increase the wages and benefits of workers who are employed,
but may simultaneously increase the number of workers who are unemployed.
Efficiency Wages
A third reason for unemployment is based on the theory of efficiency wages.
The basic idea behind efficiency wages is that firms benefit by paying their
workers above the equilibrium wage, since higher wages produce happier,
healthier, and more productive workers, and may even increase worker loyalty.
But, when the firms pay efficiency wages that are above the equilibrium level,
they also create an excess in the labor supply: more people want to work for the
wage than there are positions. Efficiency wages, like the minimum wage and
labor unions, therefore increase the wages for workers who are employed but also
increase overall unemployment.
Job Search
The fourth cause of unemployment, job search, is unrelated to the labor
market. Instead, it is based on ideas similar to the frictional, structural,
and cyclical unemployment discussed earlier. When a person decides that
he wants to work, he cannot simply become employed. Instead he
much find a job. This job search often takes a bit of time. During
the process of looking for the right job, the person is considered as an
unemployed member of the labor force. Simply looking for a job or moving from
one job to the next causes some unemployment.
Unemployment is in reality much more complex than the average consumer
appreciates. For this reason, most people do not understand that some
unemployment in the economy is not a problem. In fact, unemployment of certain
low levels indicate that the economy is functioning neither above nor below its
potential output level, at a sustainable level.
