Chapter 8: Unemployment

frictional unemployment

Unemployment that results when people are new to the job market (for example, recent graduates) or are transitioning from one job to another. 

structural unemployment

Unemployment caused by a mismatch in the skills held by those looking for work and the skills demanded by those seeking work.

cyclical unemployment

Unemployment associated with recessions in the business cycle.  

seasonal unemployment

Unemployment caused by changes in the weather or seasons

implicit contract

Employer will try and keep wages from falling when the economy is weak or the buisness is having trouble the employee will not expect a huge salary increases when the economy or the buisness is strong

efficiency wage theory

Argues that workers’ productivity depends on their pay, and so employers will often find it worthwhile to pay their employees somewhat more than market conditions might dictate.

discouraged worker

• A discouraged worker is someone who has stopped looking for work because they believe no jobs are available for them or they won’t be hired.

• They are not counted as part of the labor force, since they are not actively seeking employment.

• As a result, discouraged workers cause the unemployment rate to appear lower than it actually is.

• Example: A person who has been unemployed for months and stops applying for jobs due to repeated rejections.

labor force participation rate

• The labor force participation rate (LFPR) shows the percentage of the working-age population (ages 16+) that is either employed or actively seeking work.

• Formula:
  LFPR = (Labor Force / Working-Age Population) × 100

• Indicates how engaged people are in the labor market.

• A low LFPR may suggest discouraged workers, retirement, or people staying out of the workforce (e.g., students, caregivers).

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natural rate of unemployment

• The natural rate of unemployment is the normal level of unemployment that exists when the economy is producing at full employment (no cyclical unemployment).

• Formula:
  Natural Rate of Unemployment = Frictional Unemployment + Structural Unemployment

unemployment rate

• The unemployment rate measures the percentage of the labor force that is unemployed and actively seeking work.

• Formula:
  Unemployment Rate = (Number of Unemployed / Labor Force) × 100

• It does not include discouraged workers or anyone not actively looking for a job.

• A rising unemployment rate often signals economic slowdown, while a falling rate suggests economic growth.

Understand which individuals are part of the civilian non-institutionalized working age population.

• individuals over age 16 who are not in the military, and are not living in institutional settings like prisons, mental hospitals, or nursing homes. It represents the number of individuals who are available to work in the US. ~268 million 

• This is slightly different from the working age population which just measures individuals ages 16-64. 

What conditions must be met for someone to be considered unemployed?

To be counted as unemployed, a person must meet all of the following:

1. Be part of the civilian non-institutionalized population (16+ and not in military or an institution).

2. Have no job during the reference week.

3. Be available for work (able and willing to accept a job if offered).

4. Have actively looked for work in the past four weeks (e.g., submitted applications, attended interviews).

Which individuals are not part of the labor force?

• Retired individuals – Not seeking employment.

• Full-time students – Not working or looking for work.

• People on voluntary leave from work – Not seeking a job during their leave.

• Institutionalized people – In prisons, nursing homes, etc.

• Discouraged workers – Want a job but stopped looking.

• People unemployed for more than 4 weeks who stopped searching – No longer considered “unemployed” because they aren’t actively looking.

Understand how the unemployment rate is calculated.

• The U.S. Bureau of Labor Statistics (BLS) calculates the unemployment rate using data from the Current Population Survey (CPS).

• About 60,000 households are surveyed each month.

• Survey process:

  • Each household is interviewed for 4 consecutive months,

  • Then rotated out for 8 months,

  • Then surveyed again for 4 months before being permanently removed.

• Participants are asked if they:

  1. Have a job

  2. Are looking for work

  3. Are available to start work

Why wouldn’t we strive for an unemployment rate of 0%?

• 0% unemployment is not realistic or desirable because some unemployment is natural and healthy.

• Includes:

  • Frictional unemployment – People between jobs or entering the workforce.

  • Structural unemployment – Skill mismatches between workers and available jobs.

• Benefits of some unemployment:

  • Encourages job mobility and better job-worker matches.

  • Keeps wages stable; 0% unemployment could lead to inflation as employers compete for workers.

• Natural rate of unemployment exists even in a strong economy and represents a healthy labor market.

Understand how to calculate labor force participation rate, unemployment rate, and the natural rate of unemployment.

1. Labor Force Participation Rate (LFPR):
   LFPR = (Labor Force / Working-Age Population) × 100

2. Unemployment Rate (UR):
   UR = (Number of Unemployed / Labor Force) × 100

3. Natural Rate of Unemployment (NRU):
   NRU = Frictional Unemployment + Structural Unemployment

What factors will influence the unemployment rate in the short-run vs the long-run?

Short-Run Factors (affect cyclical unemployment):

• Business cycles: Recessions ↑ unemployment; expansions ↓ unemployment

• Demand shocks: Sudden drops in consumer or government spending can ↑ unemployment

• Temporary layoffs: Seasonal or short-term reductions in labor demand

Long-Run Factors (affect natural rate of unemployment):

• the natural unemployment rate is ralted to full employment and potential GDP.

  • full employment is when the actual emplyments rate is eaual to the natural unemployment rate

  • when the economy is at full employment, real GDP is equal to Potential GDP

• natural rate of unemployment has decreases due to: the introduction of the internet, growth of temporary worker industru, the aging out of baby boomers

How does cyclical unemployment impact the labor market graph?

Labor demand curve (Dₗ) shifts left → fewer jobs at each wage → unemployment rises.

Cyclical unemployment reflects short-run fluctuations in the labor market, not structural issues.

Why are wages sticky downwards?

• Wages are “sticky downward” because they do not easily decrease, even when labor demand falls.

• Reasons:

  1. Contracts & agreements: Many workers have fixed wages in contracts or union agreements.

  2. Worker morale & productivity: Efficiency wage theory

  3. Minimum wage laws: Legal limits prevent wages from falling below a certain level.

  4. Implicit contrast

What is the dual mandate of the Fed?

The dual mandate refers to the two main goals of the U.S. Federal Reserve (Fed):

1. Maximum employment – Promote a labor market where most people who want jobs can find them. ( an unemployment rate around the natural rate of unemployment)

2. Price stability – Keep inflation low and stable to preserve purchasing power.

(an inflation rate of 2%)

What are some short-comings with the way the unemployment rate is calculated?

• Excludes discouraged workers – People who want a job but stopped looking are not counted.

• Doesn’t reflect underemployment – Part-time workers who want full-time jobs are considered fully employed.

• Doesn’t show job quality – A person may have a job but in a low-skill or low-pay position.

• Self-reporting errors – People may misreport their employment status.

• Lagging indicator – The rate may not immediately reflect sudden changes in the economy.