Unemployment:
Full Employment and Underemployment
Full employment: Full employment in an economy does not mean that there is
absolutely no unemployment. Full employment is considered the situation wherein
everybody in an economy that wants to work and is willing to work at market wage is
able to. Even under full employment there will be some unemployed people who do not
want to work and there will also be people who are unemployed because they are
between jobs. Graph A shows an economy operating at full employment.
Graph A
Price Level
Full
Employment
AS
Pf
AD
Output
Qf
Underemployment: A situation wherein a worker is employed, but is not at the
desired capacity. Their current position could be below them in terms of skill level, work
hours, or wage rate. Underemployed persons are not being used to their full capacity such
as a college graduate working as a street vendor.
Unemployment Rate:
A measure of unemployment which accounts for the normal increase in
unemployed persons as a result of an increase in population. The unemployment rate is
expressed as a percentage and is calculated using the formula
Unemployment Rate = Unemployed Workers
Total Labor Force
Costs of Unemployment:
The costs of unemployment can be broken down into two groups personal and
societal.
Under personal costs of unemployment are the issues of homelessness, mental
illness, debt, and poor health. Homelessness can result from an unemployed person’s
inability to pay their mortgage or rent. Mental illness may occur from the lack of self
esteem associated with unemployment, as well as the psychological pressures which
occur for the unemployed. Debt is an obvious consequence of unemployment as
unemployed persons are unable to pay for things with actual capital and are forced to use
credit cards. Poor health is a consequence of unemployment as many people’s health
insurance is tied to their job. Also, independent health insurance is astronomically
expensive so without a job people cannot afford to purchase it.
Under societal costs of unemployment are the issues of not fully utilizing
resources, as well as a decrease in GDP. The productions possibilities frontier may shift
in as a result of high unemployment as due to a lower level of workers an economy is not
able to produce at its maximum level of output and efficiency. Because of lower levels of
employment and therefore income there will be lower levels of demand and consumer
spending which will cause aggregate demand to shift in therefore signaling a decrease in
GDP.
Types of Unemployment:
1. Structural Unemployment: Structural unemployment is long term perpetual
unemployment. It results from discrepancies in the skill levels and demands of workers
with the needs of employers. It generally results from lack of demand for workers by
employers either because the prospective employees do not possess the desired skills or
are not in the specific job market (in terms of physical location) as prospective
employees. An example of this would be a deep sea fisherman looking for work in
Kansas where there is not job market for his skills.
2. Frictional Unemployment: Frictional unemployment is unemployment which occurs
in the transitional period between jobs. During the period that an employee is searching
for a new job either because they have quit their previous job or because they are a
recently graduated student just entering the job market, they are frictionally unemployed.
An example of this would be a business student just out of college searching for their first
job.
3. Seasonal Unemployment: Seasonal unemployment is unemployment which occurs
yearly at a specific time due to a lack of demand for the worker at that given time of year.
Seasonal unemployment generally tends to occur in industries such as tourism, hotel and
catering, and fruit/crop picking/harvesting. An example of a seasonally unemployed
person would be a ski instructor during the summer.
4. Cyclical/Demand Deficient Unemployment: This type of employment is based on
inefficiency in the market in that there is not enough demand for employees to employ
every person who wants to work. Cyclical unemployment varies with the trade/business
cycle. This means that when the economy is up that the rate of cyclical unemployment is
much lower. However, when the economy goes into recession cyclical unemployment
will increase and workers will get laid off as demand for them decreases. An example of
a cyclically unemployed person would be any of the thousands of laid off workers who
have lost their jobs during this current recession.
Real Wage Unemployment: Real wage unemployment is also known as classical
unemployment. It occurs when real wages are set above the market-clearing level and as
a result employers cannot afford to employ as many workers. This setting at the market
clearing price is often caused by government intervention, such as minimum wage, or
labor unions.
Measures to Deal with Unemployment:
Demand Side Policies: Unemployment may be approached from many
perspectives. Demand side policies may be used to help remedy unemployment. Under
the auspice of demand side policies include taking measures to help increase aggregate
demand. As the demand for goods and services increases so will revenue to the
companies producing and providing these things. As revenue and profit rises these
corporations will demand more workers and unemployment will fall.
Monetary Policy:
Monetary policy may be used to increase growth in the
economy and shift out the aggregate demand curve thereby increasing the demand for
labor. Expansionary monetary policy would be employed through increasing the money
supply. This is done through the purchase of open market operations, the reduction of the
reserve requirement, and the decrease of the discount rate. All of these actions would
serve to increase the amount of hard currency in a market which would make money
more available and prompt spending which would result in a shift out of Aggregate
demand and a decrease in unemployment.
Fiscal Policy:
Easy money Fiscal Policy can be used to help stimulate
aggregate demand and reduce unemployment. An easy money fiscal policy includes
increasing government spending, which as a factor of GDP, would directly result in a
shift out of the aggregate demand curve. Also, easy money policy includes decreasing
taxes. This leaves the population with more disposable income which would result in
increased demand and therefore a shift in the aggregate demand curve and decreased
unemployment.
Supply Side Policy:
Supply side policy may also be used to combat
unemployment. These policies include making the labor market more flexible to the
needs of employers. This could translate into dissolving minimum wage requirements and
reducing labor union power. Education and improving the skills of workers in order to
make them more attractive to prospective employers is also an approach of supply side
policies.
A. Inflation
a. Inflation- rate at which the general level of prices for goods and services is
rising
i. Costs:
1. Decrease in purchasing power, cause individuals to purchase
inferior goods
ii. Example: As inflation rises, every dollar will buy a smaller percentage
of a good. For example, if the inflation rate is 2%, then a $1 pack of
gum will cost $1.02 in a year.
b. Deflation- general decline in prices, often caused by a reduction in the supply
of money or credit. Deflation can be caused also by a decrease in government,
personal or investment spending.
i. Costs:
1. Side effect of increased unemployment: since there is a lower
level of demand in the economy, which can lead to an
economic depression, this creates a fall in profits, closing
factories, shrinking employment and incomes, and
increasing defaults on loans by companies and individuals
c. Causes of Inflation
i. Cost push
1. Price levels rise (inflation) due to increases in the cost of wages
and raw materials. Cost-push inflation develops because the
higher costs of production factors decrease in aggregate supply
(the amount of total production) in the economy, a shift of the
AS to the left. Because there are fewer goods being produced
(supply weakens) and demand for these goods remains constant
and the prices of finished goods increase
2. Since AS decreases and less is produced the decrease in
productivity causes less need of workers, causing
unemployment to increase.
ii. Demand pull
1. A result of too many dollars chasing too few goods. This type
of inflation is a result of strong consumer demand, shifting AD
to the right. When many individuals are trying to purchase the
same good, the price will inevitably increase.
2. As AD increases there is a need to increase production in
goods so there is a need of more workers to produce more,
causing the unemployment rate to decrease.
iii. Excess monetary growth
1. Monetary growth in excess of increases in the public’s demand
for money balances will eventually decrease the purchasing
power of money or, equivalently, raise the general price level
d. Methods of measuring inflation
i. Consumer Price Index-A measure that examines the weighted
average of prices of a basket of consumer goods and services, such as
transportation, food and medical care.
1. The CPI is calculated by taking price changes for each item in
the predetermined basket of goods and averaging them; the
goods are weighted according to their importance. Changes in
CPI are used to assess price changes associated with the cost of
living.
2. CPI = 100 X Cost of basket in current year
Cost of basket in base year
3. Inflation rate = CPI this year – CPI last year X 100
CPI last year
ii. Problems of CPI measuring inflation
1. Substitution bias –
a. some prices rise faster than others over time
b. consumers substitute toward goods that become
relatively cheaper
c. CPI misses this substitution because it uses fixed basket
of goods
d. CPI overstates increases in cost of living
2. Introduction of new goods
a. when new goods become available variety increases
allowing consumers to find products that more closely
meet their needs
b. making each dollar more valuable
c. CPI misses effect because it uses a fixed basket of
goods
d. overstates increases in cost of living
3. Unmeasured quantity change
a. improvements in quantity of goods in the basket
increases value of each dollars
e. Phillips curve
i. Inflation and unemployment have a stable and inverse relationship.
According to the Phillips curve, the lower an economy's rate of
unemployment, the more rapidly wages paid to labor increase in that
economy. The theory states that with economic growth comes
inflation, which in turn should lead to more jobs and less
unemployment.
ii. Unemploy. Rate = natural rate – (actual infla.- expected inflation)
Of unemplo.
iii. Short run- Fed can reduce unemployment rate below natural
unemployment rate by making inflation greater
iv. Long run- unemployment rate goes back to natural unemployment rate
(NU) no matter inflation is high or low
v. A Shift of AS then there is a shift of PC but a shift in AD then there is
a movement of PC
vi. AS shifts in b/c wage pressure
vii. AD shifts out b/c Fed makes inflation increase
viii. Increases in expected inflation causes PC to shift out
ix. Showing economic growth
f. Natural Rate of unemployment
i. Hypothetical unemployment rate consistent with aggregate production
being at the "long-run" level, shown on the graph as NU. This level is
consistent with aggregate production in the absence of various
temporary frictions such as incomplete price adjustment in labor and
goods markets.
g. Non-Accelerating Inflation Rate of Unemployment (NAIRU)
i. NAIRU is calculated from the Philips Curve. The point at which the
Philips curve, which relates unemployment to inflation, intersects the
horizontal axis indicates the NAIRU. In terms of output, the NAIRU
corresponds to potential output, the highest level of real gross
domestic product that can be sustained at any one time.