§2.3 Unemployment



  1. Unemployment is a situation that exists when people of working age, who are available for work and actively seeking employment, cannot find a job.
  2. Full employment is when the number of jobs available is equal to the number of people actively seeking employment, i.e. the supply for labor equals to the demand of labor in an economy.
  3. Underemployment is hidden unemployment that exists when workers are carrying out jobs which they are overqualified, i.e. they are not using their full skills and abilities or they are part time workers, even though they are available for full time employment or when workers in a planned economy are undertaking jobs that would not exist in a free market economy.
  4. Unemployment rate is the number of unemployed workers (people of working age, who are available for work and actively seeking employment, but cannot find a job) expressed as a percentage of the total labor force.
  5. Structural unemployment is an equilibrium unemployment that exists when the patterns of demand and production methods change in the long term, and there is a permanent fall in demand for a particular type of labor. There is a mismatch between skills and jobs available.
  6. Frictional unemployment is short term equilibrium unemployment that exists when people have left a job and are in a process to find another one, or leaving their education and waiting up to take their first job.
  7. Seasonal unemployment is an equilibrium unemployment that exists when people are out of work because their usual job is out of season. Examples include ski instructors, tourist industries etc.
  8. Demand deficient/cyclical unemployment is a disequilibrium unemployment that exists when there is a decreased aggregate demand in an economy, resulting in a decrease in demand for labor, and wages do not fail to compensate for this
  9. Wage unemployment is a disequilibrium unemployment that exists when real wages in the economy gets pushed up above the minimum wage rate, either by the government or trade unions.
  10. Crowding out is a situation where the government spends more than it receives in revenue (mainly taxation) and needs to borrow money, forcing up interest rates and “crowding out” private investment and private consumption, since it becomes more expensive to borrow money.



  • Unemployment rate is no. of people who are unemployed expressed as a % of the total labor force.
  • People who aren’t considered to be a part of labor force are children, students, stay-at-home parents, retired people and others who choose not to work.


Hidden Unemployment

  • Also known as underemployment.
  • Consists of three groups of people:
  • People who have been unemployed for a long time and have given up looking for work.
  • People who work part-time but would like to work full-time.
  • People who are working for jobs they are overqualified for.


Costs of unemployment


1. To the unemployed people

  • They receive less income than they would if they are employed.
  • Therefore, they will receive some kind of unemployed benefits.
  • Leads to lower standards of living for unemployed people and their families.
  • Likely to be highly dejected and have high levels of stress, anxiety and depression.
  • This will lead to breakdowns and even suicide if the person is severely depressed.


2. To the society

  • Socials costs of unemployment can be seen in areas whether there is poverty, homelessness, higher rates of crime and vandalism, increased gang activities.
  • These problems aren’t entirely connected to unemployment as other factors have to be considered.


3. To the economy as a whole

  • PPC curve can be used to illustrate the economy with unemployment.
  • Increased unemployment can lead to lots of problems for the economy.
  • For example, there’s opportunity cost of the government’s spending on unemployed benefits.
  • If unemployed people have lower incomes pay less direct tax and spend less, then, the government earns less indirect taxes as well.
  • Therefore, government has to spend a lot of money to deal with increased unemployment in their society.


Disequilibrium employment

  • Occurs when there are any conditions that prevent the labor market from reaching labor market equilibrium.


1. Real-wage (classical) unemployment

  • Unemployment is caused by trade unions and government minimum wages interfering with the labor market.

Trade unions negotiate wages that are higher than the equilibrium and a minimum wage is set up above the equilibrium.

  • Unemployment is represented as points a + b.

●       Solutions for real-wage unemployment:

  • Governments should reduce the ability of unions to negotiate higher wages.
  • Minimum wages should be reduced, or in extreme cases, abolish.

●       Consequences for solutions for real-wage unemployment:

  • Difficult to reduce union power.
  • Harms the poorest workers the most as their standards of living and income are already low.
  • Worsen distribution of income within an economy → Greater inequality.


2. Demand-deficient (cyclical) unemployment

  • As the economy moves into slower or negative growth → Aggregate demand falls as consumers spend less on goods and services → Fall in demand for labor as firms cut back on production.
  • This might lead to reduced wages and employees aren’t happy with reduced wages.
  • Therefore, wages are ‘downward sticky’ as it is highly unlikely wages will fall.


  • Reasons for downward stickiness:
    • Lowering wages = Dissatisfaction for workers → Demotivated workers.
    • Firms might not be able to reduce wages due to trade union power and labor contracts.

  • Wages don’t actually fall from We to W1 as it is downward sticky. So unemployment is

a + b instead of a + b + c.

●       Solutions to demand-deficient unemployment:

  • Government intervention through fiscal or monetary policies.
  • Governments could increase money supply or their spending, or reduce taxes and interests to increase employment.

●       Consequences of solutions to demand-deficient unemployment:

  • Governments will have an opportunity cost on spending on unemployed people rather than focusing on health, education etc.




Equilibrium unemployment (natural unemployment)

  • The labor market might be in equilibrium, but that doesn’t mean all people are employed.
  • When in equilibrium, number of vacancies = number of people looking for work.
  • This is called full employment when jobs exist but people aren’t willing to work or unable to take jobs that are available.

  • The TLF curve is below the AS curve because it shows how there’s more people looking for jobs than those who are willing and/or able to work for those jobs.
  • a + b represents the unemployment in the economy.
  • The gap between TLF and AS curve gets shorter as wage rates increase because more people are willing to take the jobs.
  • Solutions to equilibrium employment tends to be supply-side policies.


1. Frictional unemployment

  • Short-term unemployment that takes place when people are in between jobs or they have left their education and waiting for their first job.
  • Mostly known as natural unemployment since it is natural for people to leave jobs and hope for a better job.

●       Solutions to frictional unemployment:

  • Governments should provide unemployment benefits for unemployed people until they get a job.
  • Improving flow of information to potential employees so that people would look for jobs. This can be done through newspapers, internet jobs sites such as linkedin, job centres etc.

●       Consequences to solutions to frictional unemployment:

  • Providing unemployment benefits can lead to people stop looking for jobs as they lack an incentive to find jobs as they are getting money from the government.
  • Leaking information about potential jobs might be inaccurate or fake as some might use it for scamming people.


2. Seasonal unemployment

  • Natural for employees to be employed for certain seasons.
  • Examples include hiring ski instructors in winter, but they might be unemployed during summer. Farmers might not be employed during winter, but they will be employed during spring season.

●       Solutions to seasonal unemployment:

  • Same as frictional unemployment, but governments could also encourage them to take another job during their off-season.

●       Consequences to solutions to seasonal unemployment:

  • Same as frictional unemployment.


3. Structural unemployment

  • Occurs as a result of changing structure of an economy.
  • Occurs when there’s a permanent fall in demand for a particular type of labor.
  • Natural in growing economy, as new jobs are being created, other jobs in the economy may disappear.
  • Workers might lack skills to take on newly created jobs.

●       Causes of structural unemployment:

  • Advanced technology might makes some jobs unnecessary.
  • Demand for particular jobs might fall due to low-cost labor in foreign countries.
  • Changes in consumer tastes might result in fall of demand for particular jobs.

●       Solutions to structural unemployment:

❖      Interventionist policies

  • Create an education system that makes people flexible to do different jobs.
  • Spend on adult retraining programs to help people acquire necessary skills to match with available jobs.
  • Governments should provide subsidies to provide training for their workers.
  • Foreign countries might provide subsidies or break taxes if to encourage people to work in their country, which also increases their geographical mobility.
  • Governments can support apprenticeship programs so that workers can gain useful skills needed in the labor force.

❖      Free-market/Market based policies

  • Governments should reduce unemployment benefits to give unemployed people an incentive to take up jobs that are available.
  • Reducing or removing legislation that business must follow in their hiring, firing and employment practices

●       Consequences to solutions to structural unemployment:

❖      Interventionist policies

  • Governments will have to spend less on other merit products in order to help the unemployed people, therefore they have an opportunity cost.
  • They are only effective in the long term.

❖      Free-Market/Market based policies

  • Not giving unemployment benefits will lead to unemployed people continue to live in lower standards of living and not able to afford basic needs, which leads to increased inequality in the economy.
  • Labor regulations tend to help employees get fairer treatment in their jobs. By removing that, it increases inequity in an economy.





Crowding out

  • When governments run budget deficits to stimulate the economy and reduce unemployment, it leads to the economy “crowding out”.

  • To run a budget deficit, governments have to borrow money.
  • They do this by selling bonds such as treasury bills or bonds to financial institutions, who sell it to people who wants to save money.
  • Therefore, this increases the demand for savings or loanable funds.
  • This leads to higher interest rates in the economy → Discouraging businesses to invest → Decrease in aggregate demand.


Paper 3 Question


Calculate the unemployment rate using the data below: