Low Unemployment (DP IB Economics)

An Introduction to Unemployment

• Key terms to understand are employment, labour force, unemployment, and full employment
  

1. Employment: refers to the economic use of labour as a factor of production
   

2. Unemployment: Someone is considered to be unemployed if they are not working but actively seeking work
    

3. Labour force: A country's population is divided into the labour force - and non labour force

   • The labour force consists of all workers actively working PLUS the unemployed (who are seeking work)

   • The non labour force includes all those not seeking work e.g. stay at home parents, pensioners, and school children (these people are economically inactive)
     

4. Full employment: describes the ideal situation when everyone in the economy who is willing and able to work has a job

Measuring Unemployment

• Unemployment is measured in many countries using two different approaches

  • The International Labour Organisation (ILO) Survey

  • The Claimant Count
    

The Differences Between the ILO Labour Force Survey and The Claimant Count

Three Metrics are Commonly used when Analysing the Labour Market in an Economy

• The employment rate could be increasing even as the unemployment rate is increasing:

  • May be caused by increased immigration which causes working age population to increase

  • May be caused as people move from being economically inactive to employed
    

• Unemployment rates do not capture the hidden unemployment that occurs in the long term

  • Workers look for a job but may eventually give up and become economically inactive

  • This actually improves the unemployment rate as fewer people are actively seeking work
    

Difficulties in Measuring Unemployment

• There are several difficulties involved in the measurement and use of unemployment statistics

1. Underemployment

• Workers who are underemployed do not appear in unemployment statistics

• Unlike the unemployed, people who are underemployed are working
   

• Someone is underemployed when:

  • They want to work more hours than they currently work

  • They are working in a job that requires lower skills than they have e.g. an architect working as a gym instructor

• Underemployment is often a consequence of cyclical unemployment

  • Workers who have lost their jobs in a weak economy are willing to take part-time jobs or accept roles outside of their main skill base

• Underemployment is also a consequence of structural unemployment

  • Unless workers retrain and gain new skills, it will be hard for them to gain full employment
    

2. Hidden unemployment

• Hidden unemployment occurs when workers lose their jobs and then attempt to get a new job, usually for a very long period of time, after which, they give up

  • This often occurs during severe recessions

  • They give up looking for work as they feel that they no longer have the skills desired by the market

  • Once they stop looking for work, they are no longer considered to be unemployed

• Unemployment rates would be much higher if this hidden unemployment was considered

3. Unemployment disparities

• The headline unemployment rate is an average

• It does not provide insight into ethnic, regional, gender or youth unemployment disparities which may exist in an economy e.g. in 2022 the USA unemployment rate was 3.8% with Nebraska having the lowest unemployment level at 2%.and the District of Columbia the highest at 6%. White workers had an unemployment rate of 3% and black workers 6.5%

Understanding Labour Market Diagrams

• Labour market equilibrium occurs where the demand for labour (DL) is equal to the supply of labour (SL)

  • The DL is the demand by firms for workers

  • The SL is the supply of labour by workers

• Individual firms are price takers in the labour market as they have to accept the wage rate that workers are being paid in the industry

  • If they offer a lower wage, they will likely struggle to recruit workers

  • If they offer a higher wage there will be a large number of workers applying to work there

In the labour market for graphic designers, the equilibrium wage rate is W and the equilibrium quantity is Q. At this point the D_L = S_L

Diagram Analysis

• The market for graphic designers is in equilibrium where D_L = S_L 

• The equilibrium wage is W and the quantity of labour is Q

• There is no excess supply of labour

• There is no excess demand for labour 

• There are several causes of unemployment, all of which cause disequilibrium in the labour market. These include:

  • Real wage unemployment (minimum wages)

  • Structural unemployment

  • Cyclical (demand deficient) unemployment

  • Frictional unemployment

  • Seasonal unemployment

Real Wage Unemployment (Minimum Wages)

• Real wage unemployment occurs when wages are inflexible at a point higher than the free-market equilibrium wage

  • Usually caused by the existence of minimum wage laws

  • The higher wage creates an excess supply of labour

  • This excess supply represents real wage unemployment

• A minimum wage is a legally imposed wage level that employers must pay their workers

  • It is set above the market rate

  • The minimum wage/hour varies based on age

A national minimum wage (NMW₁₎ is imposed above the market wage rate (W_e) at W₁ 

Diagram Analysis

• The market equilibrium wage and quantity for truck drivers in the UK is seen at WeQe

• The UK government imposes a national minimum wage (NMW) at W₁

• Incentivised by higher wages, the supply of labour increases from Q_e to Q_s

• Facing higher production costs, the demand for labour by firms decreases from Q_e to Q_d

• This means that at a wage rate of W1 there is an excess supply of labour and the potential for real wage unemployment equal to Q_dQ_s

Structural Unemployment

• Occurs when there is a mismatch between jobs and skills in the economy

• It usually happens as the structure of an economy changes e.g. the secondary sector is declining and the tertiary sector is growing

• There is no longer a need for a specific type of worker e.g. shipbuilders in Glasgow

• Many Western industries have relocated production to China causing structural unemployment in their economies

• Unless workers receive help to retrain, they are often left unemployed or under-employed
    

Structural unemployment occurs in a specific industry when the demand for labour (D_L) shifts left as workers are no longer required

Diagram Analysis

•  The initial labour market equilibrium in the USA steel industry can be seen at W₁Q₁

• The USA began to import more and more steel from China and with fewer workers required the demand for labour (D_L) shifted left from D_L→D_L1

• Wages fell from W1→W2 and the quantity of workers in the industry reduced from Q₁→Q₂  (structurally unemployed) 

Cyclical (Demand Deficient) Unemployment

• Cyclical or demand deficient unemployment is caused by a fall in AD in an economy

  • This typically happens during a slow down or recession

  • The demand for labour is derived from the demand for goods/services

  • As output falls in the economy, firms lay off workers

A fall in aggregate demand (AD) leads to a fall in output. Fewer workers are required so the demand for labour (D_L) shifts left and wage rates fall

Diagram Analysis

• Using a Keynesian national income model, the macroeconomic equilibrium is initially at AP1Y_FE

• At this level of national output, the labour market is in equilibrium at W₁Q₁

• A recession causes AD to shift left from AD₁ → AD₂ 

• This leads to a fall in real GDP from Y_FE → Y₁

• With lower levels of output, fewer workers are required and the demand for labour (D_L) in the labour market shifts left from D_L → D_L1

• The new labour market equilibrium is now at W₂Q₂

• The labour market has a lower wage rate and increased unemployment equal to Q ₁- Q₂

Frictional and Seasonal Unemployment

• Seasonal unemployment occurs as certain seasons come to an end and labour is not required until the next season

  • E.g. fruit pickers; summer seaside resort workers; ski instructors

• Frictional unemployment occurs when workers are between jobs

  • This is usually short-term unemployment

  • Workers have voluntarily left their previous job to search for another

The Natural Rate of Unemployment

• The natural rate of unemployment (NRU) is the lowest achievable level of unemployment  in an economy

• The unemployment rate can never be 0% as there is always some unemployment due to the existence of frictional, seasonal and structural unemployment

• The natural rate of unemployment = frictional + seasonal + structural unemployment

The Costs of Unemployment

• The effects of unemployment, especially long-term unemployment, are extremely damaging

  • There are impacts on the individual, the economy, the government, and firms

Long term unemployment affects individuals, the economy, government, and firms
 

• Government's receive less tax revenue and have higher expenditures in the form of welfare payments

• Individuals suffer significant emotional, relational and financial consequences

• Firms may find it harder to find workers to employ (as they have moved on) once the economy starts to recover

• The economy contracts as there is a higher level of inefficient use of available resources