Chap 9
Unemployment
Unemployment
Unemployment is calculated by measuring level of unemployment or by taking rate of
unemployment.
Level of unemployment is calculated by subtracting people who are on job from participating
population.
Level of unemployment= participating population – employed workers
Participating population include numbers of employed plus numbers of unemployed. In fact it
determines the labour force in the economy at point of time.
Rate of unemployment is calculated by
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑢𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡 =
𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑢𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑
× 100
𝑝𝑎𝑟𝑡𝑖𝑐𝑖𝑝𝑎𝑡𝑖𝑛𝑔 𝑝𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛
Labour force
The total number of people in a country who are either in work or unemployed but looking for work.
In an economy population is categorized into three age groups i.e. (1) school going children (below 16
years), (2) working population (between 16years to 65years) and (3) retired population or old age
(above 65years). Labour force is also considered as participating population which is part of the
working population and actually willing to work.
There are many factors which determine size of the labour force. Firstly, the size of population,
secondly, the age distribution as mentioned above, thirdly, gender distribution i.e. number of males
and females, fourthly, number of people who want to remain in full time education after their
secondary education and the number of women who want to join work on a full or part time basis.
Rate of participating population determines that what percentage of total population is actually willing
to work. A low rate shows either a high percentage of working population is engaged in higher
education or many of the workers have taken early retirement or there is a possibility that large
proportion of the working population is made up of female who are not actually willing to work.
Employed, underemployed and unemployed
Underemployed workers may include part time workers even one needs and desires full time
employment or may be inadequately employed, especially, employed at a low paying job that requires
fewer skills which one possesses.
Measurement of unemployment
Claimant count
The claimant count records the number of people claiming unemployment related benefits. They must
declare that they are out of the work, capable of, available for and actively seeking the work during
the time period in which their claim is made.
Claimant count is a simple and economical way to measure unemployment. It provides updated and
readily available information.
Problems regarding claimant count
This method is applicable in such economies which offer job seekers‟ allowances”; perhaps claimant
count is not workable in most of the economies. Secondly, it may not portrait real picture of
unemployment because many of the people are part time worker or may be employed in informal
sector of the economy but still they register themselves as unemployed. Similarly many of the people
are actually unemployed but they are reluctant to register themselves as unemployed due to some
social reasons.
Survey count
According to this method a survey is conducted to measure unemployment. According to the
definition of International Labour Organization (ILO), “number of people who are willing and able to
work at the given wage rate but they are unable to get any job and they do not expect any job within
fortnight”.
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One of the advantage of this count that it is applicable everywhere. Since it is survey based hence it is
claimed as more accurate because it also includes unemployed which may not be included otherwise.
However, this method is complicated, expensive and time consuming. Secondly, to conduct a survey
an accurate „sample‟ is required, and there is every possibility of „sampling error‟, due to which it is
difficult to get perfect outcomes.
Even with such limitations this method is more commonly used and reliable because one, it is
applicable everywhere and secondly it is near to accurate.
Causes or types of unemployment
Types of Equilibrium Unemployment
In this case demand for labour is equal to the supply of labour or labour market is at its equilibrium
but still no. of workers is unemployed.
DL
SL
Wage rate
E
Number of workers
Structural unemployment
It occurs in an economy when there is a change in methods of production or in pattern of
consumption. For example if firms become capital intensive instead of labour intensive many of the
firms will make workers redundant, which causes unemployment. It is called as technical
unemployment. Similarly if people change their patterns of consumption and stop buying certain
good, firms stop producing and many of the workers become unemployed.
Structural unemployment sometimes causes regional unemployment. It occurs when in the
particular region of an economy; a certain industry is highly concentrated. If that industry closes, a
large number of workforces will become unemployed.
Immobility of labour may severe this problem where labours are reluctant to change their profession
or the place.
To reduce such kind of unemployment, rate of technological changes must be reduced as well
as increase occupational and geographical mobility among workers.
Frictional unemployment
It exists in an economy all the time. It occurs when a worker leaves a job voluntarily or in search of
better job, it is called as voluntary unemployment or when a worker is made redundant because of a
completion of a task or a contract. For instance, a whitewasher will be frictional unemployed when he
completes a job and searching for another or a film star, who will be considered unemployed between
two projects. It may prolong if there are lack of information about job opportunity.
Seasonal unemployment
It exists in seasonal industry where workers become unemployed in off season because of fall in the
demand for the good or service. For example in tourism industry workers are just employed in
particular months and remained unemployed rest of the year. It may be severe if there is occupational
or geographical immobility among labour force.
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Disequilibrium unemployment
It occurs when labour market is at its
disequilibrium due to recessionary pressure, trade
union, and minimum wage rate, excess supply of
labour or due to wage stickiness.
For example in the diagram as supply of
labour increase, there must be a reduction in the
wage rate according to price mechanism and as a
result more workers can be employed and the
market stay at new equilibrium. However, due to
wage stickiness, wage rate remains the same and
all excess workers remain unemployed (N1N2).
Cyclical or demand deficient unemployment
It is associated with economic recession. As the economy moves in recession, consumers‟
demand falls. It is also called as „Keynesian unemployment‟. During recession firms find it difficult to
sell their current level of output. Therefore they cut back their output (Y1 to Y2) as well as the number
of labour they employ. This is why it is also called as demand deficient unemployment. As demand
for labour falls there must be fall in wage rate, but, because of wage stickiness market will be in the
state of disequilibrium and unemployment occurs N1N2.
Other reasons of unemployment
Trade union and Government intervention
Trade union may causes unemployment
in an economy. Due to the intervention of trade
union cost of labour increases, therefore firms
make redundant to many of their employees.
The introduction of minimum wage rate
legislation also causes unemployment. Because
an increase in minimum wage rates increases
cost of production hence many of the firms
make their workers redundant, for instance in
the following diagram N1N2 workers are made
redundant.
Unemployment benefits are another reason for unemployment. Sometimes people are
reluctant to work and pretend as unemployed when considerable amounts of benefits are given to
them.
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Nature of unemployment in different economies
In an economy there is a possibility of existence of all types of unemployment but usually in
developing countries structural and seasonal unemployment are very common. In developing
countries mostly workers are engaged in seasonal industries like farming (primary sector), therefore,
in off-season a massive number is unemployed. Secondly, since most of workers are semi-skilled or
do not have required skills, hence they find difficulties to coop or take longer time to adjust as
technological changes occur, so there are more possibilities of structural unemployment.
Pakistan is also a developing country and unemployment is the major macroeconomic
problem. In Pakistan structural unemployment is quite common because mostly industries are closed
down or shifted to other part of the world not because of demand deficiencies but due to increase in
cost of production which make them less competitive in the global market. Their costs are increased
due to increase in oil and electricity prices and also because of unfriendly and unstable policies of the
state. Secondly, Pakistan‟s economy also rely on primary sector so, they also experience seasonal
unemployment too.
On the other hand in developed economies there are more possibilities of frictional, voluntary
and cyclical unemployment. In developed economies workers are looking for better opportunities to
improve their income to live better life. They are said to be between jobs. Sometimes the duration is
prolonged due to frictions like lack of information or due to lack of mobility among workers. Even in
some cases workers refuse to accept existing wage rate and prefer to remain voluntarily unemployed
in the short run to get better jobs in the long run. The other type of unemployment is perhaps cyclical
unemployment. In the recent past most of the countries of Europe suffered in cyclical unemployment
due to persistent recession. Even in US average recession rate is 1.7 in each decade; therefore there
are more chances of this kind of unemployment.
Cost of unemployment
-Due to unemployment, an economy is unable to produce to its potential and its output locates below
than the production possibility curve.
-Government budget‟s deficit may be increased because on one side there is an increase government
spending and on the other hand there is a fall in government‟s tax revenue.
-Government will have to forgo many of its projects because of lack of funds hence infrastructure
may remain poor and it restrict economic development.
-There is an increase in dependency ratio, i.e. increase in number of dependents upon one worker, and
it deters living standard.
-To bridge up the gap between income and spending whether government will have to impose more
taxes on employed which reduces their disposable income and purchasing power and it may be
disincentive to work or may incur national debts which have its own long term repercussion.
-Unemployment causes political and social unrest which leads to political and economical instability.
Full Employment and Natural Rate of Unemployment (NAIRU)
According to Friedman a monetarist economist, full employment means the lowest level of
unemployment that can be sustained given the structure of the economy. This equals the NonAccelerating Inflation Rate of Unemployment (NAIRU) when the real gross domestic
product equals potential output. This concept is identical to the "natural" rate but reflects the fact that
there is nothing "natural" about an economy. At this level of unemployment, there is no
unemployment above the level of the NAIRU. That is, at full employment there is no cyclical or
deficient-demand unemployment. Long run Philip‟s curve shows value of NAIRU. If rate of
unemployment remains below then this natural rate for a long time then it will accelerate rate of
inflation provided that there is no control on wages and prices and, if rate of unemployment is above
then the natural rate for a long time it decelerate inflation. The theory says that inflation does not rise
or fall if unemployment rate is equal to the natural rate of unemployment.
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Philip‟s curve shows short run tradeoff
between unemployment and inflation. To
reduce unemployment government forms
policies to increase aggregate demand. It
encourages firms to employ more workers,
hence unemployment falls (A→B). It will have
an upwards pressure on wage rates which
increase cost of production. However, firms
realize that they should cut back their output,
cost and some workers. Now there is a shift
from initial Philip‟s curve to new short run
Philip‟s curve (B→C). It shows new inflation
rate is adjusted to the system and once again
economy at its „natural rate of unemployment‟
which can be shown by long run Philip‟s
curve.
Monetarist argue that it is a short run
tradeoff between unemployment and inflation
rate, in the long run expansionary monetary or fiscal policies will have no impact to reduce
unemployment but succeed in raising the inflation rate which can be shown in above fig. It is called
expectations-augmented Philips curve and presented by Milton Friedman, where vertical curve
shows natural rate of unemployment and called as long run Philip‟s curve.
Policies to improve rate of employment
It is difficult to gain „zero unemployment‟ in an economy and therefore, according to
Keynesian models an economy may be at its equilibrium before full employment because certain „rate
of natural unemployment‟ exists in an economy all the time.
Usually policies are made to improve employment according to causes of unemployment. For
instance if economy face „cyclical or demand deficient‟ unemployment, then government makes
expansionary fiscal and monetary policies. As expansionary fiscal policy is formed, i.e. reduction in
direct and indirect taxes which encourage consumers to spend more, and firms are encouraged to
increase investments and along with increase government spending will increase aggregate demand.
As a result economic activities are increased which leads to increase in national output and
employment.
Similarly, government makes expansionary or reflationary monetary policies i.e. reduction in
interest rate and increase in money supply. Once again reduction in interest rate will encourage
consumers to increase borrowing and spending as well as firms also prefer to make more investments
due to fall in cost of capital. Increase in money supply (Quantitative easing) also increase consumers‟
spending and firms‟ investments and therefore, there are possibilities of increase in economic
activities in the economy. According to Okun’s law if unemployment rate is above than the natural
rate of unemployment and if economy‟s growth rate is 3% or above on average then it will be able to
reduce its unemployment at the rate of 1%. However, this growth rate is varied from country to
country, for example in France this rate in the last decade was around 1.9%.
However, it all depends on some other factors too; like value of „multiplier‟ and „optimism‟.
For instance, if value of multiplier is low then the multiplier impact will be weak and no considerable
changes in national output and employment and vice versa. However, if value of multiplier is
undermined by policy makers and actually it is above than the desirable value, then it may cause
inflationary pressure in the economy.
Similarly, optimism is a „psychological‟ factor which can determine the change in consumers‟
spending and firms‟ investments. If consumers are optimistic, they increase their spending otherwise
they prefer to save large proportion of their increased income for future. Similarly, if firms are
pessimistic about future, they do not increases investments even reduction in taxes or interest rates.
To reduce structural unemployment government needs to make structural changes like
provision of educational and training facilities to workers to enhance their skills according to the
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changing structure of employment. Government needs to make policies to increase occupational and
geographical mobility among workers which create more job opportunities for unemployed. Same
policies can be formed to reduce seasonal unemployment.
Usually frictional unemployment exists and prolonged due to lack of information. So, needs
for provision of quick and first hand information to unemployed and secondly perhaps it may be
prolonged due to considerable unemployment benefits, therefore, government should make substantial
difference between minimum wage rate and unemployment benefits. It is also important to reduce
„poverty trap‟ in the country and a part of government supply side policies.
Government can make other policies like to curb down power of trade unions which
contribute a lot in unemployment. Minimum wage rate also cause reluctance among firms to employ
more workers so this policy should be revisited too. In many countries government subsidize such
industries which contribute to maintain level of employment in the economy.
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