Download Chapter 51: Types and causes of unemployment (2.3)

Chapter 51: Types and causes of unemployment (2.3)
Key concepts
 Types of unemployment
o Structural unemployment
o Frictional unemployment
o Seasonal unemployment
 Equilibrium unemployment
o Full employment and natural rate of unemployment
 Disequilibrium unemployment
o Cyclical unemployment
o Real wage unemployment
 Government policies to deal with unemployment
Types and causes of
unemployment
•
Describe, using examples, the meaning of frictional, structural,
seasonal and cyclical (demand-deficient) unemployment
•
Distinguish between the causes of frictional, structural, seasonal and
cyclical (demand-deficient) unemployment
•
Explain, using a diagram, that cyclical unemployment is caused by a
fall in aggregate demand
•
Explain, using a diagram, that structural unemployment is caused
by a fall in demand for a particular type of labour
•
Evaluate government policies to deal with the different types of
unemployment
Since unemployment is a stock concept the level will change continuously as people enter and leave the labour force. An
increase or decrease in population, school-leavers, and people simply returning to the job market after illness or
paternity/maternity leave will serve to increase/decrease the size of the labour pool. Conversely, assuming a constant labour
force, there will be people from the labour force gaining and losing jobs for any number of reasons, so if more people gain jobs
than lose jobs unemployment will fall.

Types of unemployment
This ongoing process of in- and outflows into the labour market and available jobs will necessarily mean a degree of
unemployment will always exist at any given point in time; this is equilibrium unemployment and consists of three main types;
structural, frictional and seasonal unemployment.
(Smaller heading) Structural unemployment
The most difficult type of unemployment to deal with is when it is ‘built-in’ to society by forces inherent to the economy itself.
Structural unemployment is basically the mismatch of available labour skills and the demands of the economy. The main
forces affecting unemployment levels here are labour mobility, declining (‘sunset’) industries and job redundancies resulting
from technological advances in production. Any changes of these variables will give rise to structural unemployment since
labour is configured to match certain demands in the labour market. There will be job losses when labour demands change,
often resulting in very painful long run unemployment for large numbers of workers in a specific industry – e.g. there is
structural change in the economy whereby demand falls (permanently) for labour in a certain industry.
Figure 51.1 Structural unemployment amongst coal miners, Northumberland UK, 1980s
Figure 51.1 shows the resulting increase in unemployment as demand for coal miners fell in the UK during the 1980s. The deep
mine pits in Northumberland region could not compete with far cheaper surface coal in China and Indonesia and as production
shifted away from the UK and the newly elected conservative government of Margaret Thatcher stopped subsidising
production, demand for coal miners plummeted (DL0 to DL1). In 1984 coal miners comprised about 1% of the total labour force
and 20 years later less than 0.02%.1 Structural unemployment is one of the most serious macroeconomic problems facing
nations today, and three (often overlapping) types of structural unemployment can be identified.
1.
Regional unemployment happens when a main industry in a region suffers from permanent loss of jobs, such as the
fishing industry along the Norwegian coast (caused by depleted fish stocks); the steel industry in North America’s socalled “Rust Belt” (caused by increased global competitiveness); and coal mining in the Northumberland region of
England.
2.
Very similar, and indeed often arising simultaneously, is sectoral unemployment. This is when a specific sector of the
economy suffers from lengthy and often permanent decline. Industries producing horse-drawn buggies, mechanical
adding machines and typewriters, and slide rules were all once commonplace but are now largely relegated to being part
1
See a very good article at http://www.geographyinthenews.rgs.org/news/article/?id=273
of history. In each case, skilled labour was made redundant.
3.
In 1811 and 1812, during the first part of the Industrial Revolution, there was a great number of violent attacks on
weaving machines in the Lancashire and Yorkshire districts of England. Men and women in the weaving industry
destroyed textile machines that were replacing their labour during this transformation of English economy and society. 2
This violent reaction was to on-going technological unemployment, where new technology in textiles shifted the entire
manufacturing base from labour intensive manufacturing to capital intensive. This is a continuous process in economies,
since ever-improving technology will increase output per labourer and in many cases create large scale redundancies
amongst professional groups. As one of many possible examples, just think of how computer technology has vastly
increased the capacity of putting together a newspaper; thousands of highly trained professional typesetters were made
redundant within a few years.
Where have all the horse buggy makers gone?
(Smaller heading) Frictional unemployment
Labourers leaving/losing one job will mostly set out to find another. This is frictional (or search) unemployment and is
mostly short term. The speed with which job seekers are able to find new employment depends on their work skills and
education, plus the needs of the labour market. In addition to these market forces, there are a number of ‘interventionist’
variables which will affect the ability/willingness of employers to hire and labourers to accept jobs. For example if labour law
makes it difficult for employers to lay off workers then there will be greater care – and time spent – in hiring new workers. If
unemployment benefits are high, the unemployed will have relatively low incentives in looking for jobs. (See Supply side
policies in Chapter 60.) In addition to this, the availability and efficiency of job centres and unemployment agencies will affect
time between jobs.
(Smaller heading) Seasonal unemployment
Waiters in holiday resorts; ski instructors; construction workers on North Sea oil platforms will all have to deal with longer
periods of inactivity, giving rise to varying patterns of seasonal unemployment. Other than these workers finding backup jobs
in off-seasons, there is little to be done about this type of unemployment. This type of unemployment will often overlap
regional unemployment.
2
These became known as ‘Luddites’ in reference to a fictitious ‘General Ludd’ that the workers professed to follow. Today the term
Luddite is used rather derogatorily as someone who is ‘techno phobic’ and ‘backward striving’.
Definition: Structural, frictional and seasonal unemployment
 Structural unemployment is “built into the very fabric” of society – labour
immobility, declining industries and technological advances all contribute to
structural unemployment. Three sub-types within structural unemployment are
regional, sectoral and technological unemployment.
 When workers are between jobs and actively seeking employment, one speaks of
frictional unemployment. (Also known as search unemployment.)
 Workers who are unemployed in industries subject to “off-seasons” such as tourism
are seasonally unemployed.

Equilibrium unemployment – why we are different from chickens
Chickens rarely – if ever – volunteer their services on the food market.3 Labour is a little different from the market for chickens
(or any other good, of course) in that the ‘good’ on offer (e.g. labour) has a mind of its own and will therefore cause its own
supply. In other words, there will be a difference between the total potential supply of labour – the labour force – and the actual
supply of labour. While the illustration of the market for chickens simply shows the supply and demand at any given price, it is
far more interesting when one is illustrating the labour market to show how many chic….eh, labourers are NOT part of supply.
The difference between the people supplying their labour and the total labour force is of course unemployment.
(Type 4 Smaller heading) Equilibrium unemployment – the natural rate of unemployment
Figure 51.2, diagrams I and II illustrate how structural, frictional and seasonal unemployment together make up the natural
rate of unemployment. The aggregate supply of labour, ASL, shows the quantity of labour supplied at any given wage level,
while the total labour force, TLF, shows the potential amount of labour available if everyone who offered their services had a
job. (Think of the ASL curve as the “job acceptance curve” – it shows the willingness of labourers to accept a job at a give real
wage rate.) The TLF curve is upward sloping since higher wages would induce more people to enter the labour force, for
example recent retirees and discouraged workers who would find it increasingly worth their while to offer their labour on the
market. Notice that the TLF curve is steeper than the ASL curve, indicating that as the real wage rate increases, ever fewer
people will spend time unemployed so the distance between the two curves decreases.
3
But the genetic modifiers are probably working on it. Kamikaze chickens, coming up.
Figure 51.2 Equilibrium in the labour market
a: Supply and demand for labour
b: Full employment on labour market
PL (real
wage rate)
PL (real
wage rate)
ASL
W*
U0
U1
TLF
U2
ASL TLF
NRU
W*
ADL
FE
U* QL/t
FE
U*
ADL
QL/t
Equilibrium
unemployment
There will always be a degree of unemployment – even when the labour market has
cleared. Equilibrium unemployment is therefore the same as the natural rate of
unemployment (NRU) shown as the difference between FEU*.
The curves don’t meet since there will always be someone unwilling to accept a job no matter what the wage level. 4 In figure
51.1a, the labour market is in equilibrium at the full employment level, FE. At the going wage rate of W*, there will still be a
number of people in the labour force who are unemployed; the structurally unemployed (U0), the frictionally unemployed (U1)
and the seasonally unemployed (U2). The sum of unemployment at the market clearing real wage level W* is FEU*. This is
the equilibrium level of unemployment.
Diagram 51.1b (note; different scale) shows the sum of the three unemployment types. Structural, frictional and seasonal
unemployment together comprise what rather contradictorily is called the full employment level of unemployment. A
proportion, e.g. percentage, of the total labour force which chooses not to accept jobs at the going wage rate will vary but exist
at all wage levels; thus it is also the natural rate of unemployment.
4
His name is Lars Swahn. I went to university with him.
Definition; full employment and equilibrium/voluntary/natural unemployment
I know all the terminology gets confusing, so allow me to do the definitions via another
syllogism:
1) If everyone in the labour force who wants a job at the going wage rate has a job, there is full
employment.
2) Since these people accept the real wage rate, ASL equals ADL and the labour market is in
equilibrium – any existing unemployment is thus equilibrium unemployment.
3) Since there is always an element of voluntary unemployment in the economy, it is natural.
The percentage of workers voluntarily unemployed is the natural rate of unemployment.
Hence: Full employment = equilibrium unemployment = natural rate of unemployment.

Disequilibrium unemployment
When unemployment exceeds the rate at which the labour market is in equilibrium, there is disequilibrium unemployment.
Economic theory identifies two main reasons for disequilibrium unemployment and the debate over which is a more accurate
view is frequently rather high-pitched and politicised – this is at the core of the Keynesian – new-classical debate.

The Keynesian/demand-side view is that disequilibrium unemployment is caused by too little demand in the economy.

The new-classical/supply-side view is that disequilibrium unemployment is caused by market imperfections such as
minimum wages and strong unions.
(Smaller heading) Cyclical unemployment (or ‘demand-deficient’ unemployment)
We start off by looking at cyclical (or demand-deficient) unemployment. In this view, unemployment is strongly linked to
phases in the business cycle, as the demand for labour is derived from the demand for goods and services. This is known as
cyclical unemployment since it is connected to cyclical variations of economic activity. When total unemployment is higher
than the natural rate of unemployment there is a cyclical addition to total unemployment caused by relatively low aggregate
demand.
Figure 51.3 Disequilibrium unemployment – cyclical or demand-deficient unemployment


Diagram I in figure 51.3 utilises the aggregate demand and aggregate supply curves for labour to illustrate how a change in the
demand for labour during a recessionary period causes disequilibrium on the labour market, i.e. a degree of cyclical
unemployment. The decrease in the demand for labour from ADL0 to ADL1 adds U0FE unemployment to the previous
(natural rate of) unemployment FEU* shown in diagram II. The question you should now be asking yourself is why the real
wage rate doesn’t fall to W1 and create a new equilibrium level of unemployment lower than the rate at W*.
Here’s a clue; cyclical/demand deficient unemployment is also known as Keynesian unemployment! Recall that Keynesian
economics views markets as imperfectly functioning in general, and that labour markets specifically suffer from downward
stickiness. The concept of cyclical unemployment, in accordance with Keynesian assumptions, means that real wages will not
fall in the short run and the market will be in disequilibrium. In other words, since labourers will be highly unlikely to accept
lower wages (and firms will also be reluctant to lower them) the real wage rate will remain at W* and create an excess supply
of labour at the going wage rate. While the labour market might ultimately clear, the proportion of people not accepting jobs at
lower rates might last for some time, with unemployment rates above the market clearing level of W1. Keynesian economics
looks upon markets as inherently unstable/imperfect – which explains the propensity towards government intervention.
Definition: Cyclical (or demand deficient…or Keynesian) unemployment
Cyclical unemployment is the addition to equilibrium unemployment (full employment)
resulting from a contractionary economy. Since the demand for labour is largely derived from
the demand for goods and services, a fall in aggregate demand (and/or aggregate supply)
during a recessionary period will decrease the demand for labour. The term derives its name
from the cyclical variations in economic activity.
WARNING! Using labour market diagrams
Here are a few common mistakes you will want to avoid – plus a few comments on my
labour market diagrams.
Common errors:
 A common error in using labour diagrams is to mis-label the axes. (Rory, I’m
still confused about the plural form of “axis”.) Quite frequently – when exam
stress sets in – students will use “AD” rather than “ADL”.
 Another common error is to put “P” on the P-axis rather than the correct “P L” or
“Real average wage rate”.
 Include relevant assumptions! Here, you should include whether you are
assuming real wages to be downward sticky or not.
Comments on my use of diagrams to illustrate unemployment:
I know of no secondary school textbook which consistently uses the TLF curve in
diagrams seeking to illustrate changes in ASL or ADL. Commonly, textbooks briefly
explain labour market equilibrium – e.g. the natural rate of unemployment – and then use
a rather simplistic diagram omitting the TLF curve. My question is invariably: “Right,
now how can you see the quantity of unemployment?!” Well…no, as a matter of fact. A
shift in ADL shows the change in people who have jobs – not the amount of labourers
who do not have jobs. Thus I have decided to retain the TLF curve in all diagrams. I am
telling you the above simply to point out that you will NOT be penalised in your
exams or IA by using the more common version without the TLF curve.
(Type 4 Smaller heading) Aggregate demand and demand for labour
The relationship between aggregate demand and the demand for labour should be fairly clear cut; a rise in aggregate demand
will lead to an increase in the demand for labour and vice versa – the demand for labour is derived from the demand for goods
and services. Figure 51.4 shows how a decrease in aggregate demand during a recession will affect the aggregate labour
market.
Figure 51.4 Disequilibrium

During a recession (figure 51.4, red section in diagram I) aggregate demand falls which is shown in diagram II as a
decrease in aggregate demand from AD0 to AD1.

This will cause a decrease – ultimately, remember that there are lags to take into consideration – in the demand for
labour, shown by the decrease in the aggregate demand curve for labour from ADL0 to ADL1 in diagram III. This
creates a cyclical addition to unemployment of U1FE – cyclical unemployment – increasing total unemployment
from FEU* to U1U*.
OUTSIDE THE BOX: THE KINKED SUPPLY CURVE FOR LABOUR
(Smaller heading) Real wage unemployment
By now you will need some revision. Here are three introductory points to real wage unemployment:
1.
Disequilibrium unemployment – e.g. where unemployment exceeds the equilibrium or natural rate of unemployment –
can be explained by a decrease in economic activity which leads to a decrease in the aggregate demand for labour.
Since wages are “downward sticky” the labour market does not clear and the addition to total unemployment is called
cyclical or demand-deficient unemployment. This is the Keynesian/demand-side view of disequilibrium
unemployment.
2.
There is another way to view disequilibrium unemployment, namely that the labour market does not clear at the real
wage rate because there are structural hindrances which disallow the market to clear. This is known as real wage
unemployment. In short, the real wage rate is too high. The real wage is too high since there are “labour market
impurities” or “rigidities” disallowing the market to clear. For example, minimum wage legislation and union
bargaining power helps keep wages too high resulting in non-market clearing real wages. This is the new-classical
view. Here’s another clue; real wage unemployment is also known as classical unemployment. Classical theory views
labour markets as not entirely dissimilar to the market for goods…such as, em, chickens.
Definition: Real wage unemployment (or “classical” unemployment)
Real wage unemployment is the new-classical view that any addition to equilibrium
unemployment is due to labour market imperfections such as minimum wage, union
bargaining power, high social and unemployment benefits and other labour market rigidities.
These imperfections keep real wages too high and disallow market clearing, leading to
increased unemployment.
The difference between cyclical and real wage unemployment is worlds apart – since the former is based on Keynesian
premises and the latter on new-classical – but you’d have a hard time discovering these differences by simply looking at the
labour market diagrams. You see, the difference lies not so much in the fact that there is an excess of labour supply at a given
wage rate but in why there is disequilibrium unemployment – and what should be done about it.
Figure 51.6 is virtually the same as in the diagram showing demand-deficient unemployment; real wage rates (W0) are such
that the market has not cleared, creating disequilibrium unemployment of U0U1. Why is there disequilibrium unemployment
in the economy according to real wage theory?
Figure 51.6 Disequilibrium unemployment – real wage unemployment
U0U1: Real wage unemployment arises
since at W0, U2 labourers are willing to work
but only U0 are demanded by firms. The real
wage is too high and total unemployment is
U0 to U1.
According to new-classical views, when the real wage rate is above market equilibrium wage, W* in figure 51.6, there will be
more labourers willing to accept jobs than there is demand from firms. More labourers are willing to accept a job (e.g. there is a
movement along the ASL curve) at W0 but there is less demand from firms, shown by the quantity demanded for labour at U0.
There is now more labour willing to take jobs than there are offers of jobs. According to the new-classical view, disequilibrium
unemployment (e.g. unemployment above the natural rate) exists because labour market forces have not been able to clear the
market by lowering the real wage rate sufficiently. The wage rate of W0 is above the market clearing rate of W*, creating real
wage unemployment of U0U2. Total unemployment is thus U0U1, above what would be the level of unemployment if the
labour market cleared at a wage rate of W* - the natural rate of unemployment of FEU*.
How is the real wage rate set at above market clearing level (W* in figure 51.6) and why can it remain there? The new-classical
view gives three main reasons:
1.
One main reason is that the government might have instigated minimum wage legislation which sets the price of labour
higher than the labour market would.
2.
Another common argument is that social welfare states might have social/unemployment benefits which would
decrease the propensity of people in the labour force to accept wages below a certain rate. High unemployment
benefits mean that the opportunity cost of remaining unemployed is relatively low – labourers lack incentives to take
jobs at the going real wage rate.
3.
Trade union power might serve the same purpose; by successful bargaining of wages, wages are bid up above
equilibrium level. (Note that the concept of downward sticky wages is relevant here too.)
All in all, these three factors are considered to build in market imperfections and hinder the labour market from clearing. The
result of these structural impediments (= hindrances) is a higher level of unemployment than the full employment level.

Government policies to deal with unemployment
The two big policy areas are the Keynesian and new-classical approaches to disequilibrium unemployment and will be dealt
with in further chapters. Here we will look at possible solutions to the three components of equilibrium unemployment;
frictional, seasonal and structural.
(Smaller heading) Decreasing frictional unemployment
Frictional unemployment is conceptually based on the notion that a suitable job exists for the job-searcher and that it is a matter
of finding that job. The basic issue in decreasing frictional (also known as “search”) unemployment is to shorten the time
workers spend between jobs. That narrows down the options – in reality, it is a matter of creating a better “match” between
seekers and employers and/or incentivising workers to take jobs that might not be at the top of the list. Yes, we are back to the
“able and willing” concepts of supply and demand.





Government run work offices with centralised computer systems linking employers to job searchers has worked
very well in Sweden, Denmark and Germany.
Worker programs aimed at increasing skill levels, such as apprentice programs and government run training
schemes have been implemented in many European countries.
A particularly Scandinavian attempt at lowering search unemployment for young people was to offer firms a
“discount” on labour taxes when employing under-20s. (Yes, this met with some considerable criticism and it was
finally dropped when it turned out that firms’ demand for over20s labour dropped more than new hiring of youths
increased!)
Lower income tax rates for low paying jobs can increase the net wage and thus incentivise workers to take ‘second
best’ options while continuing to search.
Governments can also increase the opportunity costs of remaining unemployed during job searching by lowering
social and unemployment benefits.
(Smaller heading) Decreasing seasonal unemployment
Here too is the issue of getting labourers to accept jobs – but often it means that labour has to move geographically and/or
industrially. A lobsterman in the off-season will have to move elsewhere and an Alpine ski instructor might find herself having
to work in a restaurant. It is worthy of noting that since seasons are rather regular and therefore predictable, one often finds that
people in seasonal industries manage to earn enough over the course of the season to get by the rest of the year. For example,
my favourite island in Greece, Sifnos, sees a population go from just over a thousand during the winter to well over 3,500
during the May to September high season. Barba Niko, my wonderful Syfnian ‘uncle’ who lovingly chastises me for going on
long distance runs in 40C heat, works 16 hours a day but can then spend a rather chilled-out off-season in Athens.


Frequently market forces seem to take care of many cases of seasonal unemployment. Many regions simply rely on an
influx of temporary labour during peak times and revert to ‘back burner’ levels in the off season. Good examples of
this are found in tourist areas (Greece), wine making regions (France) and extensive sheep farms (Australia).
Central and regional government can offer various forms of regional incentives aimed at reallocating labour from areas
with highly seasonal demand for labour to areas in need of labour, for example free train fare to job interviews and
financial help in moving to another region.
(Smaller heading) Decreasing structural unemployment
Keep in mind that structural means ‘build in to the fabric of society’, e.g. unemployment arising from a permanent decline in
the demand for certain types of labour. The problem is like a very difficult form of frictional unemployment where workers
need to find alternative jobs in other fields. However, the ‘time between jobs’ in the case of structural unemployment can be a
very long time indeed since a coal miner (sunset industry) with 30 years experience losing his/her job will have a hard task
getting a job as a computer programmer (so-called ‘sun-rise industry’). Putting a harsh point on it, what needs to be done is
increase the adaptability of the workforce so that time between jobs is cut down. Such policies, commonly referred to as
structural reforms, take on both interventionist and market-based forms:
Interventionist policies
o Government-run retraining schemes and tax breaks to firms which supply re-education for redundant workers
can increase labour market flexibility.
o Several Nordic countries (Sweden and Finland for example) have ‘outsourced’ government agencies to
regions with high levels of structural unemployment. This also goes for universities and R&D institutions.
Higher paid jobs create regional multiplicative effects and increases demand for labour in other areas such as
services and recreation.
o Subsidies and grants can help firms establish in areas with sectoral/regional unemployment.
o ….other supply-side policies, see Chapters 60 – 62
Market-based policies
o Lowering unemployment and social benefits can create incentives for workers to move geographically and/or
take jobs at lower wage levels. This was a policy during the Thatcher era in the 1980s.
o Labour market legislation making it easier to hire/fire can increase labour mobility between jobs. This was
done in Denmark during the 1990s which has resulted in one of the world’s most mobile labour force and also
a consistently lower unemployment level than the rest of the EU.
o …other supply-side policies, see Chapters 60 – 62
The overall aim of market solutions to unemployment is to alleviate supply and demand mismatches, i.e. to improve labour
allocation. Proponents of market solutions point to the US and Great Britain as examples of how long run unemployment rates
fell markedly during and after the Reagan and Thatcher reforms of the 1980s. This will be covered in depth in Chapters 60 – 62,
supply-side policies.
Summary and revision
1.
Equilibrium unemployment consists of structural, frictional and seasonal unemployment.
a. Structural unemployment arises when there is a permanent decline in the demand
for labour in certain industries. Three types of structural unemployment exist:
sectoral, regional and technological.
b. Frictional unemployment is the result of workers being in-between jobs – they
are actively seeking jobs, which is why this type of unemployment is also called
search unemployment.
c. Seasonal unemployment arises for workers in off-season in seasonal industries
such as tourism.
2.
Equilibrium unemployment is also known as the full employment level of
unemployment…which is also the natural rate of unemployment.
3.
There are two types of dis-equilibrium unemployment:
a. Cyclical (or demand-deficient) unemployment – a Keynesian view that the
disequilibrium is caused by low aggregate demand.
b. Real wage (or classical) unemployment – a new-classical view where
unemployment above the natural rate of unemployment is caused by too-high real
wages in the economy.
4.
Government policies to reduce unemployment:
a. Frictional – examples include improved matching of available labour and firms via
centralised job search agencies; training and education; and lower income taxes on
low-paying jobs.
b. Seasonal – not a major policy issue, yet various regional incentives have often
been implemented to reallocate labour from low to high demand areas.
c. Structural – interventionist policies focus on use of government subsidies and tax
breaks to increase demand for labour in regions and industries, while market-based
policies are intended to increase labour mobility by incentivising workers to move
and/or take available jobs and ease the hiring of labour for firms.