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 (AD_L = AS_L). Below is a diagram illustrating NRU.

Point X is the equilibrium, AD_L = AS_L, the market going wage rate is W_FE and full employment occurs when E_FE workers are hired. AS_LN 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 E_FE – 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: http://www.guardian.co.uk/business/2011/nov/16/why-britain-doesnt-make-things-manufacturing?newsfeed=true).

·   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  AD_L after a fall in AD. This causes employment to drop from E_FE 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 W_FE and employment is E_FE. 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.

Supply Side Economics

Supply side economic policy is a set of government initiatives that aim to improve the economic performance of markets and industries. Policies tend to be more microeconomic because they focus of individual economic agents. Policies aim to:

· Increase competition within markets

· Increase efficiency within markets

· Increase the economy’s potential production – PPF/LRAS (see here for more)

Supply side fiscal policy

· Creating personal incentives to improve economic performance of the supply-side of the economy

· Since 1979, supply-side fiscal policy had been used by Labour and Conservative governments

· Supply-side economists believe that high levels of government spending, taxation and borrowing lead to crowding out (see below) of the public sector.

The intended effects of supply-side policies are shown below:

It is the free market view that supply-side policies should be used to increase efficiency and competition within markets.

Crowding out

Resource crowding out

Assuming there is no spare capacity in the economy and full employment of all resources, resource crowding out is when employing more labour and capital in the public sector sacrifices the use of the same resources by the private sector. Resource crowding out does not happen when there is spare capacity in the economy because government spending can be seen as ‘picking up the slack’ of the private sector. The private sector can be stimulated and crowding in can occur.

Financial crowding out

Increasing taxes to facilitate for high levels of government expenditure reduces the spending power of private sector firms.

Word of the Day

Production Possibility Frontier

The PPF curve shows the combination of capital and consumer goods that can be produced within the economy. The PPF curve essentially shows what the economy can produce. See Production Possibility Frontier and Long Run Aggregate Supply for a more detailed view.

Production Possibility Frontier and Long Run Aggregate Supply

The PPF shows the combination of capital and consumer goods that can be produced within the economy. The PPF shows what the economy can produce. If the economy is producing inside the PPF, point X, it is in a recession. Unemployment is high and the economy is not producing at it’s full productive capacity.

When the economy is producing on the PPF, point Y, it IS producing at its full productive capacity. It is also producing on the LRAS curve, point V on the supply/demand diagram. Real national output is YFE and the price level is P1. Full employment of resources has been achieved, which means that the labour force is fully employed, see Word of the Day. The only way to increase output is by increasing investment in capital goods (which increases consumer goods) thereby increasing LRAS. If this happens, economic growth is occurring in the long run. See Word of the Day. LRAS1 moves rightward to LRAS2 and thus SRAS1 shifts rightward to SRAS2. Real national output in the economy has increased from YFE to YFE2. Assuming AD remains unchanged, the price level falls from P1 to P2.

Word of the Day

Full Employment

According to Beveridge's definition, which is perfectly acceptable to use in the exam, full employment is when 3% or less of the labour force is unemployed.

According to the free market definition, full employment occurs when ASL = ADL

Full employment also occurs when the economy is producing on the LRAS curve, see PPF and LRAS. This is because when there is no spare capacity, all workers willing and able to work are working.

It does not mean that all members of the working population are in employment, frictional and structural unemployment is always occurring.