QuickMBA / Economics / Unemployment


The percentage of the labor force that is seeking a job but does not have one is known as the unemployment rate. The unemployment rate is defined as follows:

Unemployed Workers

    x   100%

Employed  +  Unemployed Workers

Unemployed workers are those who are jobless, seeking a job, and ready to work if they find a job.

The sum of the employed and unemployed workers represent the total labor force. Note that the labor force does not include the jobless who are not seeking work, such as full-time students, homemakers, and retirees. They are considered to be outside the labor force.

The labor force participation rate is the percentage of the adult population that is part of the total labor force. All of these measures consider only persons 16 years of age or older.

The movement among the three groups can be illustrated as shown in the following diagram.

Model of Labor Force Movement





  Not in the  
  Labor Force  

The diagram shows seven possible movements:

  1. Employed  to  Employed  -  an employed person moves directly from one job to another job.

  2. Employed  to  Unemployed  -  an employed person moves to unemployed status either as a job loser leaving against one's will or as a job quitter who leaves voluntarily with the intention to search for another job.

  3. Employed  to  Not in the Labor Force  -  an employed person quits a job with no intention of immediately finding another job, for example, to return to school, to raise a family, or to retire.

  4. Unemployed  to  Employed  -  an unemployed person finds and accepts a job.

  5. Unemployed  to  Not in the Labor Force  -  an unemployed person ends the job search and leaves the labor force, often because of lack of success in finding a job after an extended period of time (discouraged workers).

  6. Not in the Labor Force  to  Unemployed  -  a person who is not in the labor force begins a job search, for example, a student who seeks a job after graduation.

  7. Not in the Labor Force  to  Employed  -  a person not in the labor force moves directly into a job, for example, a student with a job waiting upon graduation.

From this model, we see that a worker may end up in the grouping of "unemployed" from one of two possible paths:  1) by job separation, either as a job loser or a job quitter, and  2) by moving into the labor force, either as a new entrant or as a re-entrant.

Full Employment and the Natural Rate of Unemployment

It commonly has been the goal of policy makers to use monetary policy to achieve the goal of full employment in the economy. Over the years, several different definitions have been proposed for full employment, but such a definition is complicated by the fact that the economy always has some unemployment, even during economic expansions. This non-zero rate of unemployment is due to:

  • Frictional unemployment  -  caused by the fact that it takes time for employers and workers to find an appropriate match. For example, job seekers tend to spend time to find the best possible job rather than take the first one available, and employers take the time to interview several candidates to find the best fit. Unemployment insurance increases frictional unemployment by decreasing the opportunity cost of unemployment, thereby increasing the lowest wage that the job seeker would be willing to accept and lengthening the job search.

  • Structural unemployment  -  refers to unemployment caused by a mismatch between workers and jobs. This mismatch may be in geographical location or in skills. For example, technological change may have caused a worker's skills to become obsolete, and he or she may experience a period of unemployment before finding the opportunity to develop new skills and to adapt. The resulting surplus of labor (quantity supplied is greater than quantity demanded) is influenced by minimum wage laws, collective bargaining, and efficiency wages, all of which create higher wages that attract more people into the labor force while decreasing the demand for labor.

Since zero unemployment is unachievable in a free labor market, Milton Friedman used the term natural rate of unemployment to describe the baseline rate of unemployment, considering that some unemployment cannot be avoided. The natural rate of unemployment is the sum of the frictional and structural unemployment rates. It does not include cyclical unemployment that results from a downturn in the business cycle.

When the unemployment rate falls below its natural rate, there is upward pressure on wages, and the economy runs the risk of inflation. Rather than a simple trade-off between the rate of inflation and the rate of unemployment, under the natural rate hypothesis once the rate went below the natural rate, inflation would accelerate. The natural rate of unemployment became known as the non-accelerating inflation rate of unemployment (NAIRU).

The natural rate of unemployment changes over time. In the U.S., some mainstream economists have placed the natural rate of unemployment in the 5% to 6% range, though other economists have placed it as low as 4% and as high as 7% over the past several decades. This variability and lack of precision in the natural rate of unemployment represent a source of uncertainty with which policy makers must deal.

Public policy itself has an impact on the natural rate of unemployment. With regard to frictional unemployment and labor surplus we see at least two levers controlled by public policy: 1) unemployment insurance, and 2) minimum wage laws. As discussed above, both of these tend to increase the natural rate of unemployment, and there is a trade-off between the benefits of such labor policies and an increased natural rate of unemployment.

Seasonal Variations

The number of job seekers changes over the course of the year due to seasonal effects. For example, weather patterns, harvests, tourist seasons, school and university calendars, and holidays all influence unemployment numbers. If left unadjusted, such changes make it difficult to compare unemployment figures from one month to the next.

To address seasonal variations, the U.S. Bureau of Labor Statistics adjusts the monthly unemployment rate numbers based on a statistical analysis of previous years. The result is that the reported unemployment rate more accurately reflects the underlying state of the economy.

Duration of Unemployment

In addition to the unemployment rate itself, the average length of time that a person remains unemployed also is of interest. The severity of the impact of unemployment depends in part on how quickly and easily an unemployed person can find work. For example, teenagers have an unemployment rate that is much higher than average, but also find jobs quicker and therefore have a lower duration of unemployment. Statistics reported by the U.S. Department of Labor indicate that since 1948, the average duration of unemployment in the U.S. ranged from a low of approximately 7 weeks to a high of approximately 20 weeks.

Statistics such as the number of workers unemployed for more than half a year provide additional information about the unemployment situation.

Limitations of the Unemployment Rate Measurement

The unemployment rate is not a perfect indicator of employment in the economy. The following are some reasons:

  • Discouraged workers - those who want a job but have given up looking and therefore do not fall within the definition of the labor force. These persons tend to make the reported unemployment rate lower than it otherwise would be.

  • Collecting benefits but not job seeking - while a state unemployment office may require a person to actively seek a job in order to collect unemployment insurance benefits, some benefit recipients do not really want a job and do not put much effort into the job search. Due to this effect, the reported unemployment rate is higher than it otherwise might be.

  • Underemployed - a person is counted as employed if he or she is working part-time; however, that person nonetheless may be seeking full-time work.

Discouraged workers and ones collecting unemployment benefits without seeking a job make it difficult to distinguish between those who are unemployed and those who are not in the labor force. These effects work in mixed directions; unemployment may be overstated or understated by the unemployment rate. As long as any bias in the unemployment rate is relatively constant over time, then the rate is still useful for measuring changes in the economy from one period to the next.

Other indicators such as the number of discouraged workers and part-time labor statistics all can supplement the unemployment rate data to provide additional insight.

Impact of Unemployment

Unemployment presents problems for both the individual and for the economy as a whole.

  • Individual hardship (financial and psychological) can arise when a person needs a job and cannot find one. The individual's economic hardship is mitigated somewhat by unemployment insurance benefits.

  • Aggregate economic output is less than the potential GDP level due to loss of production from those who are unemployed.

Recommended Reading

Schaum's Outline of Macroeconomics, Third Edition

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