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Unemployment
Causes of Unemployment
●The Phillips Curve
●Natural Rate of Unemployment
●Okun's Law
●
Unemployment

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Unemployment is a central problem in
modern societies.
Employed are people who perform any paid
work, those who have jobs but are absent
from work because of illness or vacations.
Unemployed (U) are people who are not
employed but are actively looking for work
or waiting to return to work.
Labour Force


Labour force (L) is the number of
employed plus the number of unemployed.
People without jobs who are not looking for
work are outside the labour force.
L=E+U
The Unemployment rate

The unemployment rate (u) is the number
of unemployed divided by the total labour
force:
U
u  100   
L
L=E+U
Two Methods to Calculate
Unemployment

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Labour Force Sample Surveys are the most
preferred method of unemployment rate calculation
since they give the most comprehensive results and
enables calculation of unemployment by different
group categories such as race and gender. This
method is the most internationally comparable.
Centre of Labour reports the unemployment rate,
based on registered unemployed. Labour offices only
include unemployed persons who enter employment
offices.
Three Categories of
Unemployment
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Frictional unemployment
Structural unemployment
Cyclical unemployment
Frictional Unemployment
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Frictional (turnover) unemployment
includes people unemployed for a relatively
short period of time while searching for
employment.
Frictional unemployment arises because
neither labour market information nor
mobility is perfect.
Structural Unemployment

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Structural unemployment is long-term
unemployment resulting from a lack of workers
skills or a mismatch between worker skill and
job requirements.
The reasons for structural unemployment can
be:


Changes in demand conditions or technology that
have eliminated certain types of jobs.
Changes in world trade patterns that have
transferred certain types of production to other
countries.
Cyclical Unemployment


Cyclical unemployment exists when the
overall demand for labour is law.
It occurs when employment falls as a result
of an imbalance between AS and AD. When
the economy moves into an expansion
period, cyclical unemployment gradually
declines.
Short-Term Unemployment And
Long-Term Unemployment

Short-term unemployment is lasting for
several weeks. It is typical in economies
with flexible labour markets.

Long-term unemployment in European
Union statistics is defined as unemployment
lasting for longer than one year. It is an
important indicator of social exclusion.
The Causes of Unemployment
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Although no universally accepted theory has
emerged, many analyses share the common
observation that unemployment arises
because wages are not flexible enough to
clear markets.
A labour market characterized by perfectly
flexible wages will not contain involuntary
unemployment.
Flexible Wages
W
SL
DL
W
E
Wages move up or down to
clear the labour market. There
is never any involuntary
unemployment
Voluntary unemployed
workers are voluntary
in the sense that they do
not want to work at the
going market wage rate.
L
Inflexible Wages
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Wages and salaries adjust to reflect
shortages or surpluses in a particular market
only over an extended period of time.
The theory of sticky wages and involuntary
unemployment holds that slow adjustment
of wages produces surpluses and shortages
in individual labour markets.
Inflexibility arises because of costs involved
in administering the compensation system
(union contracts, non-union settings,
minimum wage).
Inflexible Wages
W
SL
DL
If wages do not adjust to
clear the labour market,
at too high wages W1
there are
involuntary unemployed
people.
W1
E
L
The Natural Rate of
Unemployment
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The natural rate of unemployment is that
rate at which upward and downward forces
on price and wage inflation are in balance.
At the natural rate, inflation is stable, with
no tendency to show either accelerating or
declining inflation.
When cyclical unemployment is zero and
the economy is operating at the stable output
level, the actual unemployment rate equals
the natural rate.
The Natural Rate of
Unemployment

The factors that affect the natural rate of
unemployment:
 Demographic factors – the age and sex
composition of the labour force is an important
determinant of the natural rate of
unemployment.
 Government policy:
The expansion of unemployment insurance can
increase the natural rate.
 Tax policy that increases the cost of investing or
the cost of production has negative effects on the
unemployment rate.

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Increasing of structural unemployment.
The Natural Rate of
Unemployment
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How to reduce the natural unemployment
rate:
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Improve labour market services
Bolster government training programs
Remove government obstacles
The Phillips Curve
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The Phillips curve shows the inverse
relationship between inflation and
unemployment.
It illustrates the trade off theory of inflation.
According to this view, a nation can buy a
lower level of unemployment if it is willing
to pay the price of a higher rate of inflation.
The Phillips Curve
P
W
Inflation
Rate (%)
Phillips Curve
0
Unemployment Rate (%)
The wage scale
is higher than
the inflation
scale by the
assumed 2 %
rate of growth
of average
labour
2 productivity.
The Vertical Long-Run Phillips
Curve
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The tradeoffs between inflation and
unemployment remains stable as long as the
inertial inflation rate remains unchanged.
When the inertial inflation rate changes, the
short-run Phillips curve will shift.
The Vertical Long-Run Phillips
Curve
Inflation
rate
Long-run
Phillips curve
D
i2
i1
C
B
A
U2
U1
Unemployment rate
The Vertical Long-Run Phillips
Curve
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The economy starts at point A at the natural rate of
unemployment.
The economy then expands, with unemployment
falling below the natural rate at point B. As output
exceeds its potential, wages and prices begin to
accelerate.
With higher rate of wage and price inflation, firms and
workers begin to expect higher inflation. The rate of
inflation thus increases → the short -run Phillips curve
shifts upward. The new short-run Phillips curve
reflects the higher expected rate of inflation.
In the final period, as the economy slows the
contraction in economic activity brings output back to
its potential, and the unemployment rate returns to the
natural rate.
The Vertical Long-Run Phillips
Curve
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According to the natural rate theory, the
only level of unemployment consistent with
a stable inflation rate is the natural rate of
unemployment.
The long-run Phillips curve must, in this
theory, be drawn as a vertical line, rising
straight up at the natural unemployment rate,
as shown by the vertical line.
Impact of Unemployment
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Economic impact: when unemployment is
high, much output is lost, incomes decline.
Okun's law states that for every1 percent
that unemployment rate rises GDP falls by 2
percentage relative to potential GDP. It
describes the association between short-run
movements in real GDP and changes in
unemployment.
Social impact: unemployment leads to a
deterioration of both physical and
psychological health.