People who are actually participating in it, by working or looking for work
Labour force: sum of employed and unemployed people
The labour force participation rate is the proportion of people eligible to participate in the labour force
The labour force is defined as the sum of the employed and unemployed
Labour force participation rate (LFPR) or participation rate = Labour force x 100%
Economically Inactive Population
The economically inactive population comprises all persons who are neither âemployedâ nor âunemployedâ during the short reference period used to measure âcurrent activityâ
Therefore, not working and neither looking for work
This population is split into four groups:
Attendant at educational instns; (eg. full time students )
Retired
Engaged in family duties; (housewives)
Other economically inactive (eg. the ill, disabled, prisoners, etc.)
The Unemployed
Officially, a person is unemployed if he /she is a part of the labour force (Economically active population) but doesnât have a job
Unemployment: the situation in which people who are willing & able to work but are unable to find work.
Measuring Unemployment
Unemployment occurs when someone is willing and able to work but does not have a paid job.
The unemployment rate is the percentage of people in the labour force who are unemployed.
Consequently, measuring the unemployment rate requires identifying who is in the labour force.
The unemployment rate is the proportion of the labour force who are willing and able to work, but have not been employed in paid work for at least one hour in the week in which they were surveyed
Natural Rate of Unemployment
Even at the full employment rate, there is still some form of unemployment, known as the natural rate of unemployment.
The natural rate of unemployment is a combination of frictional, structural and unemployment.
Even a healthy economy will have this level of unemployment because workers are always coming and going, looking for better jobs.
This jobless status, until they find that new job, is the natural rate of unemployment.
It occurs at a ânormalâ or ânaturalâ rate of between 1% and 4%.
The Natural Rate of Unemployment for Australia is about 4% (4 to 5)
The Unemployment Rate
The unemployment rate provides an important gauge of spare capacity in the labour market and the economy more generally.
However, other factors also affect unemployment, which complicates its interpretation when informing monetary policy.
Spare Capacity
There will be spare capacity in an economy when aggregate demand for goods and services is less than the economyâs capacity to produce them.
As spare capacity decreases, businesses have difficulty finding enough suitable workers.
As a result, businesses may offer higher wages to attract and retain workers, and they may increase the prices of their products to cover their higher labour costs.
More jobs and higher wages result in greater spending, further increasing aggregate demand and the scope for businesses to increase the prices of their products, ultimately leading to an increase in inflation.
When spare capacity increases, the reverse is true (demand for workers falls; there is downward pressure on wages growth and prices; and inflation falls)
The Non-Accelerating Inflation Rate of Unemployment (NAIRU)
The NAIRU is the lowest unemployment rate that can be sustained without causing wages growth and inflation to rise.
It is a concept that helps us gauge how much âspare capacityâ there is in the economy.
The NAIRU cannot be observed directly.
However, we can infer things about the NAIRU from other variables that can be observed, and which give clues about the level of spare capacity in the economy.
NAIRU and Spare Capacity
A key indicator of spare capacity in the economy is the difference between the NAIRU and the unemployment rate â sometimes known as the âunemployment rate gapâ (and also referred to as the âunemployment gapâ).
Even though we cannot directly observe the NAIRU, if wages growth and inflation are decreasing, there is likely to be spare capacity in the economy; we can conclude that the unemployment rate is above the NAIRU.
On the other hand, if wages growth and inflation are increasing, there is likely to be insufficient capacity in the economy; we can conclude that the unemployment rate is below the NAIRU.
When there is no unemployment rate gap, the NAIRU is equal to the unemployment rate consistent with the economy operating at its full capacity.
The Phillips Curve
In the short run, there is a trade-off between the Reserve Bankâs objectives because unemployment and inflation move in opposite directions in response to changes in interest rates.
By reducing interest rates, the Reserve Bank could lower unemployment if it is willing to accept higher inflation â or, by increasing interest rates, it could reduce inflation at the cost of higher unemployment.
However, it cannot sustainably achieve both unemployment that is below the NAIRU and low and stable inflation at the same time.
The trade-off between unemployment and inflation is highlighted by the short- run Phillips Curve.
Say the economy is at point A: the unemployment rate is equal to the NAIRU and inflation is low and stable.
The Reserve Bank could use monetary policy to stimulate the economy and reduce the unemployment rate below the NAIRU.
As a result, the economy moves from point A to point B in the short run, where the unemployment rate is lower and inflation is higher.
The further the unemployment is below the NAIRU, the faster inflation will accelerate.
In the long run, however, there is no trade-off between unemployment and inflation because households and businesses expect that a lower unemployment rate will cause higher inflation â that is, they have factored this into their âinflation expectationsâ.
Workers now demand increases in wages in anticipation of higher future inflation and as the cost of their labour increases, some businesses will reduce the number of people they employ.
This continues until the unemployment rate equals the NAIRU again, and inflation stabilises at a higher level, as shown by point C.
The unemployment rate will always return to the NAIRU in the long run, and any attempt to lower the unemployment rate to below the NAIRU will increase inflation.
Therefore, the long-run Phillips Curve can be thought of as a straight, vertical line.
The implication of the short- and long-run Phillips Curves is that monetary policy can influence fluctuations in the unemployment rate around the NAIRU in the short run, but it cannot easily change the long-run level of the unemployment rate.
To do this, policymakers must look beyond monetary policy to the government policies that more directly influence the NAIRU.
The GDP Gap (or output gap)
The GDP gap or the output gap is the difference between potential output and actual output.
Potential output is the level of output that can be achieved when the economy operates at full capacity (and the factors of production are thus utilised at non-inflationary levels). Output gaps can either be positive or negative.
Main Types of Unemployment
There are 3 main types of unemployment
Cyclical
Structural
Frictional
Not mutually exclusive
In practice, these cannot be measured directly, and they can often overlap, but they provide a useful way of thinking about unemployment
Frictional Unemployment
Frictional unemployment occurs when people have to move between jobs in the labour market, as well as when people transition into and out of the labour force.
People may not find jobs immediately and need to invest time and effort in searching for the right job.
Businesses also spend time searching for suitable candidates to fill job vacancies.
As a result, people looking for jobs are not matched immediately with vacancies and may experience a period of temporary unemployment.
It occurs naturally, even in a growing, stable economy.
Movement of workers is necessary for a flexible labour market and helps achieve an efficient allocation of labour across the economy.
Frictional unemployment is always present in the economy.
It contributes to the overall employment picture and is part of natural rate of unemployment, which is the minimum unemployment rate in an economy due to economic forces and movement of labor.
The natural rate of unemployment also reflects the number of workers who are involuntarily unemployed, whether due to a lack of skill or replacement by technology.
This type of unemployment is generally shorter term (less than one month).
Frictional unemployment is likely to occur at all points of the business cycle and, like structural unemployment, may not influence wages or inflation.
Summary:
Occurs whenever there are people leaving their jobs in search of better ones voluntarily.
Associated with normal labour turnover.
Exists when the economy is at Full Employment.
Causes:
Imperfect market knowledge
due to ignorance of job opportunities and rates of pay
Aggravated by geographical immobility of labour
takes time for workers to shift to new places where there is demand for labour
Structural Unemployment
Structural unemployment occurs when there is a mismatch between the jobs that are available and the people looking for work.
This mismatch is usually due to jobseekers not having the skills required to do the available jobs, or because the available jobs are a long way from the jobseekers.
It occurs as a result of changes in demand for particular types of labour skills, changes in the geographical location of industries and therefore jobs, and labour market rigidities.
Structural unemployment tends to be longer lasting than other types of unemployment.
This is because it can take a number of years for workers to develop new skills or move to a different region to find a job that matches their skills.
As a result, workers who are unemployed because of structural factors are more likely to face long-term unemployment (for more than 12 months).
In contrast to cyclical unemployment, structural unemployment exists even when economic conditions are good.
Structural unemployment is best addressed through policies that focus on skills (skills upgrade and/or reskilling) and the supply of labour.
Cyclical Unemployment
Cyclical unemployment occurs with changes in economic activity over the business cycle.
It is caused by falling aggregate demand â a fall in its components. (usually C, I, X-M)
During an economic downturn, a fall in aggregate demand (AD) results in a shortfall of demand for goods and services which leads to a decline in available jobs for those who want to work.
Businesses experiencing weaker demand might reduce the amount of people they employ by laying off existing workers, or hiring fewer new workers.
For example, cyclical unemployment is observable when there is a recession.
The downturn in the business trade cycle would be associated with falling growth and hence falling incomes.
This means that aggregate demand would be falling due to one of its components.
A recession due to a fall in consumption expenditure (C) would imply a decrease in spending by households which leads to firms reacting by cutting back on production.
A fall in production would mean firms would have to retrench workers to minimise cost.
This results in cyclical unemployment.
Cyclical unemployment is often described as being medium term in nature (one to 12 months).
Examples can be seen in the unemployment rate rising sharply with the early 1990s recession, declining to low levels by the mid 2000s before rising again around the time of the global financial crisis.
Unemployment (2)
These three types of unemployment are not independent of each other.
For example, a period of high cyclical unemployment might worsen or create structural unemployment.
This could occur when people are unemployed for such a long period that their skills and productivity deteriorate, and they become seen as being less employable, reducing the probability that they will be hired in the future.
Other types include
Seasonal Unemployment
Underemployment
Disguised Unemployment
Seasonal Unemployment
Seasonal unemployment occurs when people are unemployed at particular times of the year when demand for labour is lower than usual.
Seasonal unemployment describes a situation when workers experience unemployment at certain times of the year when the demand has decreased.
Areas of the country with high seasonal unemployment may become unattractive and local workers leave to find more stable jobs elsewhere.
May impact the localised economy.
Underemployment
Underemployment refers to people of working age with part-time jobs when they would rather work full time, or with jobs that do not make full use of their skills and education.
This type of unemployment is due to the inadequacy of the economy to meet the needs of the growing labour force resulting from an increase in population.
The underemployment rate is the proportion of people employed on a part-time basis who would like more work.
It is also an indicator of spare capacity in the economy
Combining information about unemployment and underemployment provides a more complete picture of unused labour supply at any point in time.
Australiaâs unemployment rate has been trending downward in recent years while the underemployment rate has been trending upwards. (This was before Covid-19)
Underemployment exists frequently in developing countries whose large populations create a surplus in the labour force.
Where more people are working than is necessary, the overall productivity of each individual drops.
Underemployment is characterised by low productivity and frequently accompanies informal labour markets and agricultural labour markets, which can absorb substantial quantities of labour.
Effects of Unemployment
Loss of Real output (real GDP)
Loss of income for unemployed workers.
Impact on Government Budget
Loss of tax revenue (both direct and indirect)
Increased expenditure in the form of unemployment benefits
Costs dealing (expenditure) with social problems resulting from unemployment
More unequal distribution of income
Difficulties with the unemployed finding work in the future
Personal and social consequences
Loss of Real output (real GDP)
Fewer people working - the amount of output produced is less than the level the economy is capable of producing.
This is why unemployment implies that an economy may lie somewhere inside its production possibility curve, producing a lower level of output than it is capable of producing. (See PPF)
A fall in output may also represent a reduction in access to goods and services causing a fall in material standard of living
Loss of income for unemployed workers
A loss of income for unemployed workers.
People who are unemployed do not have an income from work.
Even if they receive unemployment benefits, they are likely to be worse off financially than if they had been working.
Impacts material SoL
Impact on Government Budget
Rise in Government spending along with fall in tax revenues may result in higher Govt borrowing and can worsen a Govtâs budget deficit
It also limits the governmentâs ability to spend to achieve positive economic outcomes
Impact on Government Budget - Loss of tax revenue (both direct and indirect)
Since unemployed people do not have income from work, they do not pay income taxes; this results in less tax revenue for the government.
Impact on Government Budget âincreased expenditure in the form of unemployment benefits
If the government pays unemployment benefits to unemployed workers, the greater the unemployment, the larger the unemployment benefits that must be paid
Hence, less tax revenue is left over to pay for important government-provided goods and services such as public goods and merit goods. (Fall in welfare)
Impact on Government Budget â Costs dealing with social problems resulting from unemployment
The social problems that arise from unemployment often require government funds to be used. (Less funds diverted to other areas) (Opportunity cost)
More unequal distribution of income
Some people (the unemployed) become poorer while others (the employed) are able to maintain their income levels.
Since certain disadvantaged population groups (ethnic groups, regional groups, etc.) may be more hard hit by unemployment than others
the effects of increasing income inequalities and resulting poverty tend to be concentrated among population groups who are more disadvantaged to begin with.
If unemployment is high or tends to persist over long periods of time, this may lead to increased social tensions and social unrest.
Difficulties (the unemployed) finding work in the future
When people remain out of work for long periods, they may not find work easily at a later time in the future.
This can happen because the unemployed workers may partly lose their skills due to not working for a long time, or because in the meantime new skills may be required that workers have not been able to keep up with, or because firms have found ways to manage with fewer workers.
This process is known as hysteresis (from a Greek word meaning âdelayâ or âlagging behind somethingâ, in this case the lagging behind of employment).
Hysteresis suggests that high unemployment rates in the present may mean continued high unemployment rates in the future, even when economic conditions become more favourable.
Personal and social consequences â Personal Problems
Being unemployed and unable to secure a job involves a loss of income, increased indebtedness as people must borrow to survive, as well as loss of self-esteem
All these factors cause great psychological stress, sometimes resulting in lower levels of health, family tensions, family breakdown and even suicide.
Personal and social consequences â Greater social problems
High rates of unemployment, particularly when they are unequally distributed, can lead to serious social problems, including increased crime and violence, drug use and homelessness.
