Huegel 1
John E. Huegel
Ronald P. Volpe, Ph.D.
Financial Markets 4836/3372
5 March 2008
The Impact of Unemployment on the Economy and Capital Formation Process
Abstract:
People can lose their jobs for various reasons and become unemployed.
Unemployment is defined as persons who are not currently employed, are
available to work, and are actively seeking employment. This research paper will
explain several reasons for the occurrence of unemployment, different types of
unemployment, and most important the impact unemployment has on the
economy and the capital formation process.
Most factors faced in unemployment can be traced back to economic conditions.
Cyclical unemployment, one of the main types of unemployment, is a direct cause
of low market demand for products. The lower gross domestic produce (GDP) is,
the higher the unemployment rate is. This paper will examine other types of
unemployment that can also be attributed to certain economic conditions.
Calculating the unemployment rate isn’t inherently efficient so this paper will also
discuss the problems with measuring unemployment. Finally we will discuss
recessions and the impact unemployment has on the economy, consumer
spending, and the capital formation process.
Huegel 2
The Impact of Unemployment on the Economy and Capital Formation Process
I. Unemployment Defined The term Unemployment attempts to define the number of people in the labor force who
are not currently employed, but are actively seeking employment and are unable to find jobs
(“Unemployment Rate (1)”). The common definition of unemployment does not include persons
who are not working and not seeking work. Therefore, it does not include those who are not
willing to work and ‘fudges’ the unemployment rate numbers. The unemployment rate is the
percentage of the labor force that is unemployed or jobless and is seeking employment, and is
able and willing to work. According to Investopedia.com, “From 1948 to 2004, the monthly U.S.
unemployment rate has ranged between about 2.5% to 10.8%, averaging approximately 5.6%”
(“Unemployment Rate (2)”). Basically this means that on average about 5.6% of the labor force
that is available and willing to work is unemployed. Remember, this figure does not include
those who are not willing or able to work. The unemployment rate provides data for uses such as
economic indicators, characteristics of the labor force, measure of potential labor supply, and
evaluation of wage rates and earnings trends (“Labor Force Statistics from the Current
Population Survey Overview”).
II. Causes –
One of the main causes of unemployment is weak demand for products and services. Low
market demand causes low demand for employees and fewer jobs are available (“Cyclical
Unemployment”). This is a form of cyclical unemployment which will be discussed later. People
may be laid off due to low demand for products and services and while they are searching for
new jobs they are unemployed. This is frictional unemployment because they are searching for
work.
Another cause of unemployment relates to government regulations. Minimum wage laws
and other government regulations have an effect on unemployment. The government regulates
Huegel 3
the minimum wage to help provide fair wages to workers. When a company has to pay more in
wages than they are willing to pay, because of minimum wage laws, they cut back by providing
fewer jobs. This increases the unemployment rate because fewer unemployed people can be
placed in jobs. This causes classical unemployment where there are more workers available than
there are jobs.
III. Types of Unemployment –
Now that we know some of causes of unemployment, we can examine the types of
unemployment and what they are associated with. There are several types of unemployment
which reflect the various reasons people who are willing and able to work are jobless.
a. Cyclical Unemployment In cyclical unemployment the number of people available to work exceeds the number of
job vacancies. An inadequate number of jobs that were available become filled and those who
could not find a job remain unemployed. Cyclical unemployment is tied to changes in the
economy, business cycle, and demand. According to Mike Moffatt from the economics
department at About.com, “Cyclical Unemployment occurs when the unemployment rate moves
in the opposite direction as the GDP growth rate. So when GDP growth is small (or negative)
unemployment is high” (“Cyclical Unemployment”). When there is low demand for products or
services, less people are needed to produce the product or service, and therefore there are fewer
jobs available. Conversely, when the economy is doing well there are more jobs available and it
becomes easier for those who are unemployed to find work.
b. Frictional Unemployment –
Frictional Unemployment, also-known-as search unemployment, is when people are
temporarily between jobs. It is known as search employment because it involves people that are
searching for work. This type of unemployment exists when there is a mismatch between the
worker and the job. The worker may want more money, his or her skills may not match, or the
Huegel 4
location might not match. Whatever the reason frictional unemployment is still a function of
supply and demand. There are enough jobs available but the qualified candidates are searching
for something better. Therefore, there is enough supply of jobs but demand is low because the
supply of jobs is not a match to the qualified candidates. Frictional unemployment also includes
seasonal unemployment, which occurs when people are out of work because the job and season
do not match. For example, a snow plow truck driver can usually only be employed in that job
during the winter season. When winter is over he becomes unemployed while he searches for a
new job. This is frictional-seasonal unemployment. When calculating the unemployment rate,
economists take this into effect and calculate a ‘seasonally adjusted’ unemployment rate (“How
the Government Measures Unemployment”).
Additionally, unemployment can never be zero because of frictional unemployment
because there is always somebody that is between jobs. According to Barron’s “Normal and
unavoidable unemployment caused by people changing jobs, moving, rearranging their economic
activity, and so on” (“Frictional Unemployment”).
c. Structural Unemployment –
Similar to frictional unemployment, structural unemployment involves a mismatch
between good workers and vacant positions (“Structural Unemployment”). However, in
structural unemployment the mismatch is caused by a low number of workers with adequate skill
levels to perform a certain job. Nurses, for example, obviously have a high level of skills they
perform in their job. A hospital cannot just pull somebody off the street to be a nurse. There is a
mismatch in the skills of the labor force and jobs available. This causes unemployment because
available workers don’t have the skills to perform the jobs that are available.
d. Classical Unemployment –
Classical unemployment, compared to cyclical unemployment, is when the number of
available workers exceeds the number of vacant positions. The cause is different, however.
Huegel 5
Whereas in cyclical unemployment low demand for products was the cause of less jobs, classical
unemployment deals with paying employee wages (“Unemployment”). Employers cannot hire as
many workers because wages would be too high. Therefore, there become less job vacancies and
higher levels of unemployment because of an excess supply of labor.
e. Marxian Unemployment –
Karl Marx, a philosopher and economist, started the theory that some level of
unemployment is necessary to keep wages down, keep workers motivated and disciplined, and
maintain business profitability (“Unemployment”). Marxian unemployment is similar to both
cyclical and classical unemployment in that there are less vacant positions than the number of
jobless people. The notion is that the scarcity of jobs is a motivator for those who are already
employed. In other words, people will perform their jobs better to keep them since they know
there are not a lot of jobs available if they are fired.
IV. Problems with Measuring Unemployment –
The unemployment rate is the percentage of unemployed people to the total labor pool.
One of the main problems with calculating the unemployment rate is how people are categorized
by the definition of unemployment. Remember, those who are unemployed must be out of work
and currently seeking work. Therefore people who are jobless but do not want to or can’t work
are not considered part of the labor pool.
Another factor that may provide an inaccurate unemployment rate is the manner that data
is gathered. According to the Bureau of Labor Statistics website they conduct surveys with a
sample of only 60,000 households (“How the Government Measures Unemployment”). Although
the sample is selected to represent the entire country, the data may yield a different
unemployment rate depending on the sample.
Huegel 6
V. Recession Fears –
Whenever the economy loses jobs there is a general concern about the overall economy.
With fears looming that the U.S. will soon be facing a recession, losing jobs only adds to that
fear. According to Tom Harris, writer for howstuffworks.com, a recession is characterized by a
prolonged slowing economy caused by people buying less, growing unemployment, a slump in
personal income, among other things.
Currently it seems as though unemployment and recession is on the minds of a lot of
people, especially economists. Economist David Rosenberg expects the unemployment rate to
reach 5.75% by the end of the year, and 6% in early 2009, compared with the January 2008 rate
of 4.9% (Todorova). The economy is definitely in a slowdown but that doesn’t necessarily mean
that we are in a recession, yet.
VI. Overall Impact on the Economy –
The unemployment rate can always be related to the economy. When the rate is low or
average there are more jobs available which equates to more consumer spending. When people
can make money, they will spend it. On the other hand when the unemployment rate is high, and
some do not have jobs, they have no money to spend which slows the economy even further. It is
a vicious cycle that can plague the economy or spur consumer spending. On that note, consumer
spending was only up by 0.2% in December compared to a 1% increase in November. The
Federal Reserve also cut interest rates by 1.25 percentage points to spur the economy (Evans 2).
In conclusion, a low or average unemployment rate can have a productive role in the
capital formation process. When the unemployment rate is average the economy operates at
normal efficiency. Consumers spend money and invest, some may even save. GDP increases
based on the rules of supply and demand, where there is a lot of demand now that people have
money to spend. On the other hand, when the unemployment rate is high the economy may see a
slowdown which fosters a destructive role in the capital formation process. Since there are some
Huegel 7
individuals that are not working, consumer spending decreases because they have no money to
spend. GDP also suffers because there is less demand for products since consumers are not
spending.