What’s is: The unemployment rate is the percentage of the labor force that is currently unemployed. Economists define the labor force as the share of the working-age population currently employed plus unemployed workers who are actively looking for work.
Indeed, the unemployment rate is closely related to the business cycle. It decreases during economic expansion and increases during recessions.
However, the unemployment rate is never zero, even when the economy is prosperous.
Unemployment rate formula
Calculating the unemployment rate is easy. You only need to divide the number of unemployed by the total labor force.
Unemployment Rate = Number of unemployed / Labor Force
You can find figures at national statistical agencies or the department of labor. For comparisons between countries, you can look for them at institutions such as the World Bank, OECD, IMF, or on websites of statistical providers such as ceic.com and tradingeconomics.com.
Types of unemployment
Economists classify the unemployed into four groups, namely:
- Structural unemployment. This unemployment arises because unemployed workers do not have skills. Or, they have skills but don’t match the demand. The cause is due to changes in the economic structure, for example, due to changes in technology.
- Frictional unemployment. Often times, individuals take their time before finding the right job. When actively looking for work, they are categorized as unemployed.
- Cyclical unemployment. During the business cycle, it is not only real GDP that fluctuates, but also the unemployment rate. Although labor supply remains unchanged, the demand for labor changes during phases of the business cycle. Thus, there are periods when demand is high (cyclical unemployment is low). And there are periods when demand is low (cyclical unemployment is high).
- Seasonal unemployment. This is like cyclical unemployment, but the problem stems from seasonal factors. It is not caused by the ups and downs of economic activity. For example, the demand for certain jobs during holidays is often higher than the regular season.
Structural unemployment plus frictional unemployment forms the natural rate of unemployment. It will exist over time, even though the economy is at full employment (GDP is at its potential level). So the unemployment rate never equals zero.
Causes of the unemployment rate
Unemployment occurs when the demand for labor is higher than the supply of labor.
Demand refers to how much employment is available. When it is low, job availability is insufficient to absorb the labor supply, resulting in a high unemployment rate. Conversely, when demand is high, people find it easy to find a job, and the unemployment rate falls.
The demand for labor depends on the profit prospects of businesses. Better profit prospects encourage them to increase production. They will recruit more workers. Demand is high when the economy is prosperous (economic expansion).
But, if the profit outlook worsens, they streamline operations. They don’t just stop recruiting but may fire employees. It usually happens during an economic recession.
Labor supply refers to the number of people available and ready to work. Labor supply depends on population growth, labor force participation rate, and net immigration.
Please remember. The demand-supply of labor does not only talk about quantity but also the quality of labor—some types of work demand higher-skilled workers than others. Thus, even though labor demand is high, the unemployment rate may remain high because most workers do not meet the qualifications.
Let us discuss the causes of each type of unemployment.
Causes of structural unemployment
People are unemployed because they don’t have the skills that businesses demand. Problems may stem from fundamental changes in the economy, caused by factors such as technology, competition, or government policies.
For example, when the economy shifts from industry-based to service-based, some individuals are unemployed. The demand quantity may remain the same, but the quality does not meet business requirements. That results in unemployment.
For example, a business asks workers who can operate computers. Workers with manual skills are likely to remain unemployed. They don’t meet the qualifications. Except, they take courses to improve their skills.
So, the solution to tackling structural unemployment is to retrain workers.
Recently, technological changes also have the potential to increase structural unemployment in the future. Those without expertise in technology will be marginalized. Even those who have skills can also be unemployed due to high job redundancy.
Causes of frictional unemployment
The Central Bureau of Statistics categorizes individuals as unemployed because they do not have a job, even though they are currently active in looking for work. Thus, frictional unemployment occurs due to the transition from one job to another. Or, recent graduates are unlucky and unable to find the right position.
People move to other jobs for a variety of reasons, including better opportunities, wages, benefits. Or, they are unsatisfied with their previous job.
Frictional unemployment occurs because the labor market is imperfect. What does it mean?
Workers do not have perfect information about supply, demand, or even wages in the labor market. Therefore, even if they have found the right job, they have to negotiate a salary first. They may ask for a lower or higher salary because they do not know the market’s equilibrium wage.
Not only wages, the mismatch of supply and demand also comes from skills, working time, location, attitudes, or tastes. Of course, that prolonged their unemployment.
In this case, imperfect labor market information creates labor immobility. Making those who change jobs takes more time to find the right job.
Causes of cyclical unemployment
Cyclical unemployment is related to economic cycles. It is the ups and downs of economic activity.
During economic expansion, the demand for labor is high. Businesses need to increase production.
During that period, they saw more robust profit prospects due to strong consumer demand. So they want to increase the output. For that, they employ more workers. As a result, cyclical unemployment was low during this period.
Conversely, during an economic contraction or recession, the demand for labor decreases. Businesses cut production as their profit prospects deteriorate. They not only stopped hiring new workers but also chose to fire existing employees in line with the efficiency program. That results in high unemployment during recessions.
Causes of seasonal unemployment
Seasonal unemployment is high during regular seasons and falls during peak seasons. For entrepreneurs, the peak season is the best time to generate more revenue and profits. For this reason, they will recruit more workers.
The demand for jobs in specific industries is more seasonal than others. Tourism and recreation, construction, agriculture, and retail are some of them. For example, fruit pickers were heavily employed during the summer. Likewise, retail jobs are more prospective during pre-Christmas than on regular days.
Impacts of the unemployment rate on the economy
Those who are unemployed do not get a salary. Therefore, when the unemployment rate is high, it indicates that more and more households have less money.
Consequently, they spend less money on goods and services. When consumer demand weakens, businesses reduce their production. That further slows economic growth and leads to higher cyclical unemployment.
Unemployment is also responsible for social problems such as poverty and crime. Suppose the unemployment rate rises 1 percentage point. It increases the poverty rate by 0.4 to 0.7 percentage points, based on studies in the United States.
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