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Sunday, 22 January 2012

Unemployment Notes

Full employment is, according to the Beveridge definition, when 3% or less of the work force is unemployed. At current, the unemployment rate is 8.4% of the labour force, indicating that the UK is performing far from full employment and full productive capacity. More detail can be found from notes published on 5th August.

The Natural Rate of Unemployment (NRU) is the rate of unemployment that occurs even when the aggregate labour market is in equilibrium (ADL = ASL). Below is a diagram illustrating NRU.

Point X is the equilibrium, ADL = ASL, the market going wage rate is WFE and full employment occurs when EFE workers are hired. ASLN shows how many more workers are willing and able to work at different wage rates but cannot due to frictional (geographical immobility) and structural unemployment (lack of skills). The NRU can be calculated by EFE – E1.

NRU can also be linked with inflation. NRU is also known as the Non- Accelerating Inflation Rate of Unemployment (NAIRU). This means that it is the only rate of unemployment that does not alter the rate of inflation.

Causes of unemployment

·     Frictional unemployment relates to the time taken to find a new job, the period between switching from one job to another. Frictional unemployment is caused by:

Ø  Occupational immobility of labour: Workers need more time to switch between jobs because they don’t have new skills to offer new employers. Lack of training courses, for example, makes the search period longer. Along with that, the longer the search period, the less employable the worker gets because they are losing their employability skills (work ethics, behaviour…).
Ø  Furthermore, new employment practices such as laws on equality (race, gender, sexual orientation...) can prevent perfectly capable workers from finding a job. This is one case against government intervention in the economy.

Ø  Geographical immobility of labour: The difficulty of moving to another location to find a new job. For example, the North South divide in the UK means house prices are too high in the South where more jobs may be available. Other reasons that cause difficulties are family ties and attitudes towards moving to new and unknown locations.

Ø  Search theory of unemployment: Those who are unemployed will continue to look for the ‘right’ job, comparing their old job with the other jobs available, for example, pay, travelling distance….etc. Because of this, workers may reject job offers, leading to a longer period of unemployment.

·   Structural unemployment means that workers lose their jobs due to changes in the structure of the economy. For example, the UK’s economy moved from an industrial one in the early 1900s to one based on providing financial services now. This led to the loss of jobs in the manufacturing sector (read this article:

·   Seasonal unemployment occurs because of changes in the weather. When the UK’s climate changes, it affects the agricultural and tourism industries, leading to job losses in the winter.

·   Cyclical unemployment is caused by deficient aggregate demand. Also known as Keynesian unemployment or demand deficient unemployment, the diagram below displays a fall in  ADL after a fall in AD. This causes employment to drop from EFE to E2. See a more detailed explanation as posted on 3rd October.

·   Real wage/classical unemployment is caused by wage stickiness. Collective bargaining by trade unions (see here) causes wages to remain high, causing unemployment.

Ø  The diagram shows that point X is the equilibrium point. The real wage rate is WFE and employment is EFE. When trade unions cause the real wage rate to rise, wages become W1. This causes an excess supply of labour because at W1, E1 workers are willing and able to work at this wage rate. However, demand for labour is only E2, more workers are willing to work than firms wish to hire, thus creating unemployment equal to E1 – E2. W1 is known as the disequilibrium wage rate.

Ø  Free market economists believe that labour market competitiveness would drive down wage levels in time, however trade unions cause wage rigidity preventing it from going back to equilibrium.

It is important to note that unemployment is a waste of human capital. The disadvantages of unemployment are shown in the table below.

One positive of unemployment that classical economists believe is that it brings a downward pressure on inflation. But that’s up to you to decide whether you agree and be sure to write your opinion in the exam. See tomorrow’s post on government policies aimed at reducing unemployment.