2.3 Unemployment

Question 1

What is the definition of unemployment?

Answer 1

Unemployment refers to those of working age who are willing and able to work but cannot find a job despite an active search.

Question 2

What is the problem with the Labour Force Survey (LFS) measure of unemployment regarding the hidden unemployed?

Answer 2

The hidden unemployed are individuals who have been looking for a job for a long period of time and have become discouraged from constant rejections. They will be missed by official unemployment statistics because such workers drop out of the labour force and stop looking for jobs, causing the official unemployment rate to be lower than it should be.

Question 3

What is the problem with the LFS measure of unemployment regarding the economically inactive?

Answer 3

The economically inactive are individuals who are not actively searching for work for a variety of reasons, such as adult carers for sick relatives, the early retired and those living off their spouse’s income. These people will not be included in the unemployment rate, despite them being of a working age and clearly an unemployed productive resource in the economy.

Question 4

What is the problem with the LFS measure of unemployment regarding the under-employed?

Answer 4

The LFS does not account for those who want to work full-time but are actually working less than this. For example, those who are working part-time or those who are on zero-hours contracts that would prefer to be working full-time would be classed as fully employed according to unemployment figures, when in truth they are partially unemployed.

Question 5

What is the problem with the LFS measure of unemployment regarding disparities?

Answer 5

Official unemployment figures give no indication of potential disparities in age, gender, race and geography. Large disparities signal potential government intervention to deal with important issues in the economy that official unemployment figures can mask.

Question 6

Evaluation: What is the problem with the LFS measure of unemployment regarding cost?

Answer 6

The administration costs of issuing the LFS are extremely high, this means that the survey can never fully cover all households in the economy. As a consequence, the survey will only be a sample of the population, which will always carry a sampling error in attempting to generalise the sample unemployment rate to the whole economy.

Question 7

What is Cyclical Unemployment?

Answer 7

Cyclical unemployment, also known as demand-deficient or Keynesian unemployment, occurs when the economy is in a recession phase of the economic cycle, and aggregate demand (AD) in the economy shifts to the left from AD1 to AD2. As consumption is a component of AD, C+I+G+(X-M), this decreases AD leading to a reduction in growth, a recession from Y1 to Y2 and reduced inflationary pressure from P1 to P2. Consequently, cyclical unemployment spikes because labour is a derived demand, derived from the demand for goods and services, therefore as the demand for goods and services falls in the economy, firms respond by reducing their production, reducing the size of their workforce increasing cyclical unemployment. Furthermore to maintain profitability in a recession when revenues are falling, firms will reduce costs of production by reducing the size of their workforces, increasing cyclical unemployment.

Question 8

What is the cause of Real Wage Unemployment?

Answer 8

Real wage unemployment, also known as classical unemployment, occurs when wages are above the equilibrium wage in the labour market. This could happen because of higher than equilibrium minimum wages set by the government in order to protect the living standards of the poor in society. It could also be due to dominant trade unions that bargain on behalf of their members for higher than equilibrium wages. The consequence of this market distortion is that the number of workers willing to supply their labour is higher than the number of employers willing to hire workers creating excess supply of labour (real-wage unemployment). Furthermore pre-existing workers lose their jobs as minimum wages increase costs of production for businesses. Businesses react by reducing the size of their workforces in order to reduce costs and maintain profitability increasing unemployment.

Question 9

How does Real Wage Unemployment affect the labour market?

Answer 9

The consequence of this market distortion is that the number of workers willing to supply their labour is higher than the number of employers willing to hire workers creating excess supply of labour (real-wage unemployment). Furthermore, pre-existing workers lose their jobs as minimum wages increase costs of production for businesses. Businesses react by reducing the size of their workforces in order to reduce costs and maintain profitability, increasing unemployment.

Question 10

Evaluation: What are some criticisms of the Classical Unemployment theory?

Answer 10

Classical unemployment theory assumes that wages are flexible and will eventually fall to the equilibrium wage. However, in practice, wages may be sticky due to factors such as long-term labour contracts, minimum wage laws, and efficiency wage theory. Additionally, the assumption that unemployment is voluntary has been criticized, as it ignores the possibility of structural and frictional unemployment, where workers may not be able to find jobs even if they are willing to work.

Question 11

What is the natural rate of unemployment?

Answer 11

The natural rate of unemployment refers to the level of unemployment that exists when the labour market is in equilibrium, where the actual supply of labour equals the demand for labour. At the wage rate W1, Q1 workers are willing to take jobs yet only Qfe workers actually do, with the difference between them, a-b, representing the natural rate of unemployment consisting of frictional, seasonal and structural unemployment.

Question 12

1. What is frictional unemployment?

Answer 12

Frictional unemployment occurs when individuals are willing to work at wage rate W1 but prefer to wait instead of accepting the job as they believe that something better will come up in the future.

Question 13

2. What is seasonal unemployment?

Answer 13

Seasonal unemployment arises when individuals are willing to work at the wage rate W1, but the job is seasonal, and they cannot work in the off-season.

Question 14

3. What is structural unemployment?

Answer 14

Structural unemployment is the immobility of labor due to a long-term change in the structure of an industry. This could be because of occupational immobility or geographical immobility of labor.

Question 15

4. What is occupational immobility of labor?

Answer 15

Occupational immobility of labor refers to a mismatch between the skills of workers and the vacancies that exist in the economy, where workers can’t transfer from one job to another due to a lack of appropriate skills.

Question 16

5. What is geographical immobility of labor?

Answer 16

Geographical immobility of labor is where workers may be willing to work at the given wage rate in the labor market but are unwilling to move to the locations where these jobs exist. This could be because of family ties, poor infrastructure, differences in living costs, and/or recreational reasons.

Question 17

1. What is the first cause of structural unemployment?

A country losing its comparative advantage in production in an industry

Answer 17

The changing nature of a given industry, which makes skills redundant, can lead to structural unemployment. For example, a country may lose its comparative advantage in production in a given industry, such as the UK losing its textile industry to foreign competition. This results in occupational and geographical immobility of labor as workers cannot substitute to other jobs in the economy.

Question 18

2. What is the second cause of structural unemployment?

Technological Advancements

Answer 18

Technological advancements in the economy have changed the nature of a given industry and made human capital redundant in some areas, leading to structural unemployment. For example, robotics in the automotive industry, self-checkouts in supermarkets, digital banking, and machinery in agriculture have replaced many jobs previously undertaken by humans. Workers without the necessary skills to fill other job vacancies are structurally unemployed and occupationally immobile.

Question 19

3. What is the third cause of structural unemployment?

Education

Answer 19

Education can also lead to structural unemployment. In developing countries, education opportunities may not exist for the poor, particularly those in rural areas. Even if education does exist, the quality may be weak, and citizens will not be equipped with the skills needed to access jobs in the economy. In developed countries, the education system may not be changing quickly enough to meet the changing nature of skills required in the economy. This results in occupational immobility of labor as workers are not equipped with the necessary skills to fill job vacancies.

Question 20

1. According to free market proponents, what is a driver of the natural rate of unemployment?

Over-generous benefits system and high rates of income tax

Answer 20

Free market proponents argue that excessive government intervention in the form of an over-generous benefits system and high rates of income tax encourages frictional, structural, and seasonal unemployment. A generous welfare state and high income taxation distort incentives in the labor market away from work and towards remaining unemployed. As a consequence, individuals can afford to take as much time as they need to find a suitable job and remaining out of work when seasons change, prolonging frictional and seasonal unemployment. Workers lack the incentive to take jobs in areas they do not favor or to become trained and attain necessary skills to get into work prolonging structural unemployment.

Question 21

2. According to free market proponents, how can excessive labor market regulation contribute to the natural rate of unemployment?

Answer 21

Free market proponents argue that excessive labor market regulation can increase and maintain a high level of structural unemployment. Strict hiring and firing laws and high minimum wages limit incentives for firms to take risks when employing workers who don’t have the requisite skills necessary for the job before employment. If such laws were lax, firms may decide to employ workers lacking skills at low wages in the hope to train them up, boost productivity, and thus increase revenue for the company. If training is not successful, the worker can be fired quickly or continue to work at low wages. These incentives do not exist with high minimum wages and strict hiring and firing laws, making it harder for the structurally unemployed to find work, with the natural rate of unemployment remaining stubbornly high.

Question 22

3. What is the argument made by proponents of government regarding the under-provision of transport and affordable housing infrastructure?

Answer 22

Proponents of government argue that the under-provision of transport and affordable, high-quality housing infrastructure in the free market is a driver of geographical immobility and thus the natural rate of unemployment. Transport infrastructure like roads and bridges are public goods, whilst many others are merit goods like buses, trains, and trams where no provision or inadequate provision would be the result left to free market forces. Housing infrastructure of poor quality in areas of job vacancies or prices so high to exclude much of the population creates difficulty for those who are geographically immobile and therefore structurally unemployed or those who are frictionally unemployed, making it much harder to get into work given their limited search areas. More government intervention is necessary, funded through borrowing if need be, to appropriately provide housing and transport infrastructure to reduce the natural rate.

Question 23

4. What is the argument made by proponents of government regarding the under-provision of in-work training schemes?

Answer 23

Proponents of government argue that an under-provision of adequate in-work training schemes is a big contributor to the natural rate of unemployment by creating and maintaining structural unemployment. In-work training schemes would be under-provided due to private firms ignoring existing and significant positive externalities of production. A high and firm-specific skill set is required from prospective employees either derived from work experience in a very similar firm or from high-quality education if they are to be employed. Those who lack such skills will be structurally unemployed with real difficulty in attaining the job-specific skills such firms desire. Government intervention in the form of in-work training subsidies is needed for more of them to exist and thus encourage firms to take on workers who do not currently have the right skills but also to provide transferable skills for those who ever find themselves to be unemployed.

Question 24

1. What is the cost of unemployment to the economy in terms of lost output?

Answer 24

With high levels of unemployment, the economy will underutilize its factors of production, and thus, produce less than potential output, operating inside the PPF. As a consequence, less production will be taking place, implying that growth rates in the economy will be lower than they should be. With fewer goods and services being produced, consumers will have a smaller range of goods and services to buy, reducing their living standards.

Question 25

2. How does high unemployment affect government finances?

Answer 25

High unemployment is likely to lead to a worsening of government finances with both budget deficits and the national debt increasing. This is because unemployment increases government spending through the automatic stabilizers often in place in developed countries. Government spending on unemployment benefit and other welfare payments will increase, and governments will have to increase spending to deal with the social costs that high unemployment causes. Tax revenues will decrease from income tax as incomes are lower in the economy, corporation tax as profits will be lower for businesses, and expenditure taxes like VAT as consumer spending will have reduced. Debt-fueled government spending will result in future tax rises to pay off debts, which could restrain economic growth and increase income inequality, alongside cuts to government spending in certain areas like infrastructure, public transport, health, and education, all of which will burden the poor more who use such services more than the rich.

Question 26

3. How does high unemployment affect other economies?

Answer 26

As domestic incomes are lower, the demand for imports will be lower too. Fewer imports will be ‘sucked in’ reducing overall import expenditure. Other economies will lose out as there will be less export revenue, and thus, lower economic growth.

Question 27

4. What are the social costs of high unemployment?

Answer 27

High unemployment can bring with it many social issues such as higher crime rates, more vandalism, more rioting and protests, marital and family breakdown, greater income inequality and poverty causing fractions between class groups and mental health problems. This creates more pressure on government finances, as mentioned previously (significant negative externalities), but also the social breakdown of society.

Question 28

5. What is the cost of unemployment to the individual in terms of lost income?

Answer 28

Individuals lose their income stream when they become unemployed, consequently reducing consumer spending in the economy, impacting on AD and economic growth.

Question 29

6. What is hysteresis, and how does it affect unemployment?

Answer 29

Hysteresis is the most dangerous consequence of unemployment, occurring when unemployment becomes long-term. The longer someone is out of work, the greater the loss of skills and human capital as that person becomes detached from the working environment. Furthermore, skills possessed may become outdated and no longer in demand by employers who seek to employ those with modern skill sets instead. As a result, the unemployed adjust their standard of living to a lower level, with the stigma of unemployment falling the more it persists. As a consequence, labour supply will be permanently lower in the medium term, harming future potential growth rates as LAS will decrease, but also actual growth as AD decreases due to lower incomes and reduced spending.

Question 30

1. How does unemployment benefit firms in terms of finding suitable workers?

Answer 30

Unemployment makes it easier for firms to find workers from a greater potential pool. As there is more unemployment, there will be more workers chasing jobs, increasing the choice for firms to find the most suitable worker. As a consequence, firms are likely to pick the most productive and suitable workers for the firm, increasing productivity and long-term profitability.

Question 31

2. How does unemployment benefit individuals in terms of finding a suitable job?

Answer 31

Unemployment allows workers to take time in finding a suitable, rewarding job for themselves. This is very important for both individuals and firms for productivity increases and happiness.

Question 32

3. How can unemployment help to control inflation?

Answer 32

Unemployment can help to keep inflation under control from both the demand and supply side. As incomes are lower, there will be less consumer spending and thus lower levels of AD in the economy, keeping demand-pull inflation low and stable. Once more, with higher unemployment, the bargaining power of workers reduces, keeping wage growth, and thus cost-push inflation, under control. This is good for governments as at least one of their macroeconomic objectives is likely to be met in times of high unemployment.

Question 33

What is the natural rate of unemployment and how does it relate to the benefits and costs of unemployment?

Evaluation: The level of unemployment

Answer 33

The natural rate of unemployment is the rate of unemployment that exists when the labor market is in equilibrium and there is no cyclical unemployment. At this rate, the benefits of unemployment, such as allowing for frictional unemployment and allowing for workers to move between jobs, outweigh the costs. However, when unemployment goes beyond the natural rate, the costs of unemployment start to become more severe and significantly outweigh the benefits.

Question 34

How does the duration of unemployment affect the costs of unemployment for an economy?

Evaluation: The duration of unemployment

Answer 34

The longer unemployment lasts, the more dangerous the consequences will be for an economy, particularly hysteresis. Long-term unemployment (unemployment lasting a year or more) increases the costs of unemployment substantially, whereas short-term unemployment can be argued to be a small concern and actually quite healthy for an economy.

Question 35

What are the different types of unemployment and which one is the worst?

Evaluation: The type of unemployment

Answer 35

The three main types of unemployment are structural, cyclical, and frictional unemployment. Structural unemployment is the worst type of unemployment due to its deep-rooted nature, making it long-lasting and very difficult to solve. The risk of the structurally unemployed becoming long-term unemployed is large, therefore the issues of hysteresis could be drastic. Cyclical unemployment will follow the economic cycle and is therefore less likely to be long-term but can lead to structural unemployment if workers become de-skilled in the time they are out of work. The least concerning is frictional unemployment, which is healthy for the economy as workers are searching for jobs that best suit them and thus benefit the firm through higher productivity.

Question 36

evaluation: What is the most dangerous disparity in the distribution of unemployment and why?

Answer 36

For there to be high youth unemployment is the most dangerous disparity given that the youth have high productive potential and are big contributors to future tax revenues. With high levels of youth unemployment, there is a much greater risk of hysteresis given that the youth don’t necessarily have real work skills or experience that makes them naturally employable. The longer the youth population have been out of work, the more employers are likely to look elsewhere for workers, perceiving there to be something wrong with current unemployed youth workers. This would be very damaging for the long-term growth potential of the economy. Furthermore, the social costs and impact on government finances would be much larger.