Unemployment

You’ll be able to

Calculate the unemployment rate and labor force participation rate
Distinguish frictional, structural, and cyclical unemployment
Explain the natural rate of unemployment and full employment

Who counts as unemployed

To be unemployed, a person must be without a job, available to work, and actively looking for work. The labor force is the sum of the employed and the unemployed. People who are neither working nor actively seeking — retirees, full-time students, stay-at-home parents, and discouraged workers who have given up searching — are not in the labor force and are excluded from the unemployment rate. This is why the official rate can fall when discouraged workers stop looking, even though no new jobs were created.

Three types of unemployment

Economists sort unemployment by cause. Frictional unemployment is short-term joblessness from people between jobs or newly entering the labor force — searching for the right match. Structural unemployment arises when workers’ skills or locations no longer match available jobs, often due to technology or permanent shifts in the economy. Both frictional and structural unemployment exist even in a healthy economy. Cyclical unemployment is caused by a downturn in the business cycle — a recession — and it is the type that rises and falls with GDP. Cyclical unemployment is zero at full employment.

The natural rate and full employment

The economy is at full employment when there is no cyclical unemployment — but not when unemployment is zero. Frictional and structural unemployment always remain, and their sum is the natural rate of unemployment. When the actual unemployment rate equals the natural rate, the economy is producing at its full-employment (potential) output. An actual rate above the natural rate signals a recessionary gap with cyclical unemployment; a rate below it signals an overheating economy in an inflationary gap.

Unemployment rate & natural rate

Unemployment rate = (Unemployed / Labor force) × 100 · Natural rate = frictional % + structural %

Labor force = employed + unemployed. The natural rate excludes cyclical unemployment, which is zero at full employment.

Worked example

A country has 120 million employed, 8 million unemployed, and 22 million adults not in the labor force. Calculate (a) the unemployment rate and (b) the labor force participation rate. The working-age population is the sum of all three groups.

1.Labor force = employed + unemployed = 120 + 8 = 128 million.
2.Unemployment rate = (unemployed / labor force) × 100 = (8 / 128) × 100 = 6.25%.
3.Working-age population = 128 + 22 = 150 million.
4.Labor force participation rate = (labor force / working-age population) × 100 = (128 / 150) × 100 ≈ 85.3%.

Answer: The unemployment rate is 6.25% and the labor force participation rate is about 85.3%. Note that the 22 million not in the labor force are excluded from the unemployment rate’s denominator.

Checkpoint

A skilled factory worker loses her job permanently because automation has replaced her position, and her skills no longer match available jobs. This is an example of:

Watch out

Full employment does not mean a 0% unemployment rate. It means no cyclical unemployment, with the rate equal to the natural rate (frictional + structural). Some unemployment is normal and even healthy in a dynamic economy.

Checkpoint

Over the past month, a large number of discouraged workers stopped actively searching for jobs. Holding all else constant, what happens to the measured unemployment rate?

On the exam

Watch the labor-force denominator. Adding or removing people who are not actively seeking work changes the unemployment rate without any change in the number of jobs. The exam loves discouraged-worker and new-entrant scenarios.

Answer the 2 checkpoints as you read.