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Lesson summary: Unemployment

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In this lesson summary review and remind yourself of the key terms and calculations used in measuring unemployment, the labor force, the unemployment rate, the labor force participation rate, and the natural rate of unemployment. Topics include cyclical, seasonal, frictional, and structural unemployment.

Lesson overview

A country’s economic performance is measured using three key indicators, one of which is the unemployment rate. When adults who are willing and able to work cannot find a job, it may be a sign that an economy is producing less than it could. On the other hand, unemployment is also a natural phenomenon that even healthy economies experience. While the official unemployment rate is helpful in representing the state of a nation’s workforce, it does have some shortcomings that should be considered, such as excluding discouraged workers.
There are three types of unemployment that economists describe: frictional, structural, and cyclical. During recessions and expansions, the amount of cylical unemployment changes. Cyclical unemployment is closely related to the business cycle, and causes the deviations of the current rate of unemployment away from the natural rate of unemployment.

Key Terms

Key TermDefinition
unemploymentwhen people are not working, but they are actively looking for work; for example, Glenn did not work at all last week, though he tried to find a job, so he is considered unemployed.
unemployeda term that describes a person who could be working, and wants to work, but is not working; to be counted as unemployed you must be part of the eligible population, not working, and actively looking for work.
unemployment ratethe percentage of the labor force that is unemployed
labor forcethe number of people in a population who are either employed or unemployed
eligible populationthese are the people deemed likely to be in the labor force; for example, in the United States, the eligible population in the US is anyone 16 years of age or older who is not institutionalized (i.e., not in prison) and not in the military.
labor force participation ratethe percentage of the eligible population that is in the labor force
discouraged workerspeople who do not have a job, but they will take a job if offered one. However, they have given up looking for work, so they are not counted in the labor force; for example, if Carol gives up looking for work because she is having trouble finding a job, she is no longer in the labor force and therefore is not counted as unemployed.
underemployedpeople who work part-time, but they really want to work full time if they could find a full-time job; for example, Tyreese wants to work full time as an engineer, but he can only find a part-time job.
full employment output(also called the full employment real output) the amount of output that is produced in an economy when that economy is using all of its resources efficiently; the full employment output would be a combination of output that is on that country’s PPC.
natural rate of unemploymentthe unemployment rate that exists when an economy is producing the full employment output; when an economy is in a recession, the current unemployment rate is higher than the natural rate. During expansions, the current unemployment rate is less than the natural rate.
frictional unemploymentthe component of the natural rate of unemployment that occurs because the job search process is not instantaneous; for example, after Rosita graduated from dental school, it took her a few weeks to find a job as a dentist. During this period she will be frictionally unemployed.
structural unemploymentunemployment that occurs as a result of a structural change in the economy, such as the development of a new technology or industry; this is a part of the natural rate of unemployment. For example, Negan finds a cure for all dental diseases, and as a result, Rosita loses her job as a dentist and is now structurally unemployed.
cyclical unemploymentthe unemployment associated with the recessions and expansions; this can have a positive or negative value. The current unemployment rate will depend on both the natural rate of unemployment and the amount of cyclical unemployment at the time.

Key takeaways

The labor force participation rate (LFPR)

The labor force participation rate (LFPR) is another measure of labor market activity in the economy. The LFPR is the percentage of the adult population that is in the labor force. The labor force includes everyone who is either employed or unemployed. The adult population is defined as anyone who is over the age of 16 who potentially could be part of the labor force. Anyone who is less than 16 years old, is in the military, or is institutionalized is not considered to be potentially part of the labor force and is excluded from this calculation.
When people enter the labor force the LFPR increases, and when people exit the labor force the LFPR decreases. A decrease in the LFPR that occurs at the same time as a decrease in the unemployment rate can signal that there are more discouraged workers.

Limitations of the unemployment rate

The unemployment rate as it is measured officially is often criticized for understating the level of joblessness because it excludes anyone working at all or people who aren’t looking for work. In particular, the official unemployment rate leaves out discouraged workers and the underemployed. People who have given up looking for work because they are convinced that they cannot find jobs are considered discouraged workers. Some people are counted as employed because they are working part-time, even though they really want full-time work.

Three types of unemployment

Economists primarily focus on three types of unemployment: cyclical, frictional, and structural. Cyclical unemployment is the unemployment associated with the ups and downs of the business cycle. During recessions, cyclical unemployment increases and drives up the unemployment rate. During expansions, cyclical unemployment decreases and drives down the unemployment rate.

The natural rate of unemployment

The natural rate of unemployment (NRU) is the unemployment rate that exists when the economy produces full-employment real output. NRU is equal to the sum of frictional and structural unemployment. When an economy is producing an efficient amount of output (meaning it is operating on its PPC), the unemployment rate will be equal to the natural rate of unemployment. Even though an economy may be operating efficiently, there will still be some unemployment. Because of that, the natural rate of unemployment is never equal to zero.

Changes in the natural rate of unemployment (NRU)

The natural rate of unemployment (NRU) can gradually change over time due to events such as changes in labor force characteristics. The NRU can change due to changes in structural and frictional unemployment. For example, a firm may want to hire fewer workers because the skills of those workers are not needed as much as they used to be. That will cause more structural unemployment, and the natural rate of unemployment will increase.

Key Equations

The labor force:

The labor force is made up of the number of people unemployed and the number of people employed:
To be employed you must have worked at all (even just one hour) for pay in the “reference week” (the week that you are being asked about). To be counted as unemployed you must not have worked at all in the reference week and be actively looking for work.

The labor force participation rate (LFPR)

The LFPR is the percentage of the eligible population that is in the labor force.
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People are not considered part of the eligible population if they are not working age (defined as 16 years or older), institutionalized (for example, in prison), or in the military.

The unemployment rate (UR)

The unemployment rate is the percentage the labor force that is unemployed.

Common Misperceptions

  • Not everyone who is out of work is unemployed. In order to be counted as unemployed you have to be out of work, looking for work, and able to accept a job if one is offered to you. If you are out of work and not looking, then you are considered “not in the labor force” rather than unemployed.
  • We tend to think of unemployment as an undesirable thing, but a certain amount of unemployment is actually part of a healthy economy. Structural unemployment occurs when new industries are created and old industries become obsolete. For example, when we moved from using horses and buggies to using cars to get around, this put a lot of buggy makers in the structurally unemployed category.
  • Frictional unemployment might not seem very fun, but consider what it means to have zero unemployment—nobody ever looks for a job, they just remain in whatever job they are given! In fact, a number of dystopian novels have been written in which everyone in a society is automatically assigned a fixed career (such as the Divergent series). Those societies have zero frictional unemployment, but they are also quite unpleasant if you are unhappy with that career!
  • A decrease in the unemployment rate isn’t necessarily a sign of an improving economy. When people stop looking for jobs and drop out of the labor force as discouraged workers, the unemployment rate will decrease even though the true employment situation hasn’t gotten any better. This is why it is important to look at both changes in the unemployment rate and changes in the labor force participation rate. Looking at both changes let’s you get a more complete idea about changes in the employment situation.

Discussion Questions:

  1. An inventor in Burginville developed a fantastic new dictation machine that perfectly records speech and turns it into a typed document. Unfortunately, that meant that unemployment increased among typists working in offices. Which type of unemployment is this? Explain.
  2. The nation of Fitlandia has 120, comma, 000 people. Of these, 20, comma, 000 are children under the age of 16, 72, comma, 000 have jobs, 8, comma, 000 don’t have jobs and are looking for work, and 20, comma, 000 people are retired. Assuming that these are all noninstitutionalized civilians, calculate the labor force participation rate and the unemployment rate.
  3. Explain why a decrease in the unemployment rate can actually signal a tough job market.
Explanation: If unemployed workers give up looking for jobs, they become “discouraged” workers and are no longer considered part of the labor force. But since they are no longer unemployed the nation’s unemployment rate actually decreases. In such a scenario, a decrease in the unemployment rate is actually a sign of a tough job market (and a weak economy).

Want to join the conversation?

  • blobby green style avatar for user Raaghav Chaudhry
    why isnt the military counted as labor force?
    (12 votes)
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    • starky tree style avatar for user melanie
      There is an interesting history behind that, and the reason has more to do with practicalities than anything else. When the unemployment rate first began being calculated in the United States the military operated under a draft system which meant that kind of labor is very different from a voluntary labor force. In the 1980s, after the US moved to an all volunteer military, the Bureau of Labor Statistics decided to start counting the military in labor statistics. But it turns out this is tricker than it sounds. For example, is a person who is a resident of Florida but temporarily stationed in Germany employed in Florida or Germany? It turned out that the labor statistics really did not change at all when the military started to be counted, but the additional expense of dealing with all the peculiarities of that data added a lot to the cost of calculating the unemployment rate. So, it was decided to go back to omitting the military.
      (24 votes)
  • blobby green style avatar for user devcdesai
    Why is there no upper age limit for calculating the
    eligible population when calculating the LFPR? I mean should people above an arbitrary age like 60 or 65 years be excluded from the labour force? In Q2, I actually omitted the 20k odd retired people (assuming they had reached the age of retirement) and then saw that in the answer provided they are part of eligible population.
    (9 votes)
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    • duskpin ultimate style avatar for user rjohnson98126
      they ARE excluded from the labor force, if they both arent working AND aren't looking for work. like if they're retired. they're just not part of the labor force, whatever age they might be

      they are INCLUDED in the labor force, if they're EITHER working OR actively looking for work

      it would make no sense whatsoever to arbitrarily exclude people based on age
      (3 votes)
  • blobby green style avatar for user devcdesai
    If I am a citizen of country X but currently working in country Y, then am I counted in the employment figures of country X or country Y?
    (9 votes)
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  • blobby green style avatar for user devcdesai
    How is the 'Natural Rate' of unemployment, 'Frictional Unemployment' and 'Structural Unemployment' practically calculated? How does the computing authority know which skills are obsolete and which are not?
    (4 votes)
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    • male robot hal style avatar for user Andrew M
      There is no calculation that gives the answer. Economists have to estimate it based on observations about what's going on in the labor market and what's going on with inflation. For a long time the consensus view was that the natural rate would be around 5% but now a lot of economists are wondering if maybe it's lower.
      (5 votes)
  • old spice man blue style avatar for user Liam Mullany
    Could it be said that the natural employment rate is the Long term unemployment rate? (To put it in the terms we were using before with long and short run supply/demand)
    I think natural unemployment (NRU) is a highly politicised term because it suggests that there is a natural rate which cannot be altered by society. This is obviously not true as a decrease in frictional employment (caused by an improvement in communication between employers and potential employees) would have an effect on the NRU
    (3 votes)
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    • starky tree style avatar for user melanie
      The term "long-term unemployment" generally refers to people who have been unemployed for a very long time (such as more than 27 weeks in the United States), rather than a long-run trend in unemployment. The concept of a natural rate of unemployment doesn't necessarily imply that society cannot do anything to alter that rate, the concept of NRU is that things like monetary and fiscal policy will not alter the unemployment rate in the long run. The amount of unemployment that is "natural" is dependent on the underlying labor market structure, which depends on things like demographics and labor market characteristics.
      (5 votes)
  • duskpin seed style avatar for user stphnchvs
    How can unemployment and employment rise at the same time?
    (3 votes)
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    • starky tree style avatar for user melanie
      Can you clarify? Is this comment about an error you spotted, or how something like this is possible?

      If it is the latter, how is it possible for the unemployment rate to increase, even while employment is increasing, the answer is that its all about labor force participation.

      For example, suppose you have 100 potential workers in an economy. Only 80 of them are in the labor force (maybe the other 20 are so discouraged they gave up looking and are not in the labor force). Of those 80 in the labor force, suppose 65 are employed and 15 are unemployed. This yields an unemployment rate of 18.75%:
      #unemployed/# in labor force x 100% = 15/80 x 100% = 18.75%
      Now, suppose there is some attitude change, like people become optimistic about the economy. 4 of those people not in the labor force decide to start looking again, which puts them back in the labor force. Suppose 1 of them even instantly gets a job! That means the numbers are now:
      Labor force=84 (the 80 before, plus the 4 that re-entered the labor force), # employed=66 (the 65 from before, plus the person who re-entered and instantly found a job), #unemployed = 18 (the 15 from before, plus the 3 who just re-entered the labor force who are looking). So employment has increased. What about the unemployment rate?
      # unemployed/# in labor force x 100% = 18/84 x 100% = 21.43%
      So the unemployment rate actually increased! This is why it is important to look at employment data in its totality, rather than just the official unemployment rate in isolation.
      (4 votes)
  • piceratops ultimate style avatar for user Nicholas Turecamo
    Shouldn't Abby be considered Out of the Labor Force? She is looking for a job for the future, but she wouldn't be able to accept it to start immediately if it were offered to her because she's still in school full-time.
    (2 votes)
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  • blobby green style avatar for user Mukilan sethuraman
    "the full employment output would be a combination of output that is on that country’s PPC." what this statement is meant to be?
    (2 votes)
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    • blobby green style avatar for user Hinklet Everest
      It refers to the Production Possibilities Curve, or the Production Possibilities Frontier.

      If you take a peek at the micro-economics segment you can get a better idea of what such a thing is.

      In unduly brief summary: It represents the achievable outcomes when an economy is producing at its current max efficiency/capacity, and movements along the Production Possibilities Curve show tradeoffs between production of one thing and production of another.
      (1 vote)
  • blobby green style avatar for user frankbansah1998
    is an increase in unemployment rate necessarily a good thing for a nation?
    (2 votes)
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    • male robot johnny style avatar for user Mastermind Vivaan
      No, a decrease in the unemployment rate is not necessarily a good thing for a nation. ... Since unemployment only measures those seeking a job and not those who would work but no longer believe they can find work, the drop in unemployment may reflect a stagnating national economy.
      (1 vote)
  • boggle blue style avatar for user Bryan
    I don't quite understand the paragraph;
    The actual unemployment rate is lower than the natural rate of unemployment. What is actually going on is that some people who are frictionally unemployed become employed, even though under normal circumstances they would still be unemployed. When firms get desperate for workers, they might be more willing to hire whoever they can, even if that person is not a great fit for the job.

    If firms, during economic expansions, are hiring workers who would normally be frictionally unemployed, wouldn't frictional unemployment decrease and therefore NRU decreases, along with the decrease in the actual unemployment rate? How is it that the actual unemployment rate is less than the NRU then?
    (1 vote)
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