Unemployment: Disequilibrium and Equilibrium (Natural Rate)

Unemployment: Disequilibrium and Equilibrium (Natural Rate)

  • Two major groups of unemployment in the labor market:
    • Disequilibrium unemployment
    • Equilibrium unemployment (also known as the natural rate of unemployment)

Disequilibrium unemployment

  • There are two types under disequilibrium: cyclical unemployment and real wage unemployment.

Cyclical unemployment (demand-deficient unemployment)

  • Definition: unemployment that occurs in a recession due to a lack of aggregate demand (AD) in the economy.
  • Intuition: labour demand is a derived demand; it depends on demand for goods/services.
    • When AD falls, demand for goods/services falls, reducing derived demand for labour.
    • Firms sell less output; revenues fall; to protect profit margins, firms cut labour costs (fire/reduce workforce).
  • Diagrammatic idea: a simple AD curve shifts left; real GDP falls; unemployment rises.
  • Why leftward AD shift causes more unemployment:
    • Lower AD => lower demand for labour (derived demand).
    • Firms respond to lower revenues by cutting staff to maintain margins.
  • Why it’s called cyclical/unemployment caused by the economic cycle (recession, trough, slowdown).
  • How AD can shift left (illustrative examples):
    • Increase in interest rates
    • Falling income tax or falling corporation tax
    • Falling consumer confidence or falling business confidence
    • Cut in government spending
    • Stronger exchange rate
  • Big, concrete recessionary causes: housing market crash, financial crisis, banking crisis, global pandemic, stock market crash.
  • Why it falls under disequilibrium (Keynesian view):
    • When a recession hits and demand for goods/services falls, there is a fall in demand for labour.
  • Keynesian mechanism with wages:
    • Labour market diagram: downward-sloping demand for labour (DL) and upward-sloping supply of labour (SL).
    • A leftward shift of labour demand would, in a flexible-wage world, clear the market to a lower wage and higher unemployment.
    • Keynesians argue wages are sticky downwards, so excess labour supply persists, keeping cyclical unemployment.
    • Hence, cyclical unemployment is also called Keynesian unemployment.

Real wage unemployment (classical unemployment)

  • Definition: unemployment caused by wages being forced above the wage equilibrium in the labour market, creating excess supply of labour.
  • Concept: When wages are above equilibrium, firms hire less (contraction in labour demand), while workers want to work more (expansion in labour supply).
  • Diagrammatic idea: Wage axis (W) and employment axis (Q). Demand for labour QD decreases when W rises; supply of labour QS increases; excess supply is QS − QD, i.e., unemployment.
  • Causes of wages being above equilibrium:
    • Government interventions with high minimum wages
    • Strong trade unions pushing wages up
  • This creates real wage unemployment (classical unemployment).

Equilibrium unemployment (Natural rate of unemployment)

  • Concept: It is possible for the labour market to be in equilibrium yet still have unemployment; the best the economy can do is achieve equilibrium in the labour market, not zero unemployment.
  • Therefore there is always some unemployment in the economy; the best outcome is the natural rate of unemployment (the rate at which the labour market is in long-run equilibrium).
  • Three subtypes of unemployment within the natural rate:
    1) Structural unemployment
    2) Frictional unemployment
    3) Seasonal unemployment

Structural unemployment

  • Definition: unemployment due to immobility of labour caused by a long-term change in the structure of an industry.
  • Key idea: a mismatch between skills workers have and the skills vacancies require; this includes occupational immobility and geographical immobility.
  • Immobility types:
    • Occupational immobility: mismatch between workers’ skills and jobs available (skills not aligned with new industry needs).
    • Geographical immobility: workers unwilling or unable to move to where vacancies exist (due to housing, transportation, cost of living, family ties, personal preferences).
  • What causes structural unemployment?
    • Long-term changes in industry structure (shock to industry)
    • Technological advancement and automation that substitute for human labour (e.g., digital banking, farming mechanization, retail shift to online platforms, car manufacturing robotics)
    • Loss of comparative advantage in certain industries (global competition reducing domestic demand for specific sectors)
    • Transition of the economy from one sector to another (e.g., primary → secondary → tertiary, or manufacturing → tech-based production)
    • Education system not keeping pace with changing skill needs (especially in developed and high-income developing countries; can be worse in lower-income countries due to limited educational infrastructure)
  • Examples and context:
    • The UK in the 1970s and 1980s: decline of manufacturing, especially in the Midlands and the North, and a loss of comparative advantage to the Far East; workers became occupationally immobile or unwilling to relocate south where new services jobs existed.
    • Modern shifts: automation in manufacturing and services; increased online retail reduces demand for physical store staff; robotic adoption in car manufacturing; banking moving towards digital platforms.
  • Conceptual takeaway: structural unemployment arises from long-term shifts; it may require policies addressing retraining, relocation support, and adjustments in education and training systems.

Frictional unemployment

  • Definition: unemployment that occurs when workers are between jobs or are searching for a better match.
  • Characteristics:
    • Voluntary quits and searches for better opportunities
    • The period of job search or waiting for a suitable job
    • Time spent matching workers to vacancies

Seasonal unemployment

  • Definition: unemployment due to predictable seasonal patterns in demand for certain kinds of labour.
  • Examples:
    • Ski instructors in summer
    • Fruit pickers in off-season
    • Tourism workers in the off-season
  • Nature: temporary changes in demand tied to seasons; part of normal fluctuation in the labour market.

Summary and connections

  • The two big groups (disequilibrium vs equilibrium) cover all unemployment types described in the transcript.
  • Disequilibrium unemployment focuses on deviations from full employment due to cyclical factors (recessions) or wage rigidities (real wage unemployment).
  • Equilibrium unemployment (natural rate) acknowledges that even at market-clearing wages there can be unemployment due to structural, frictional, and seasonal factors.
  • The transitions and shocks driving structural unemployment often involve technology, global competition, and sectoral shifts; education and mobility are central to mitigating it.
  • Policy implications (implicit in the discussion): policies that affect AD (to reduce cyclical unemployment) versus policies that address structural mobility (education, retraining, housing/transport infrastructure) and those affecting wages (minimum wage, unions) have different effects on unemployment types.
  • A reminder about the next topic: the natural rate and how unemployment can persist even at equilibrium; the upcoming video/plenary would cover how this works in detail.

Key equations and notation (to memorize)

  • Labor demand and supply balance (diagrammatic):
    • QD^L = f(W) , rac{dQD^L}{dW} < 0
    • QS^L = g(W) , rac{dQS^L}{dW} > 0
    • Equilibrium: QD^L(W^) = QS^L(W^) = Q^* , \, W = W^*
  • Leftward shift in AD (macro, not a direct labor market equation): AD
    ightarrow AD' ext{ with } AD' ext{ left of } AD
  • Excess supply when wage is above equilibrium (real wage unemployment):
    • If wage rises to W1 > W^*, then QD^L(W1) = QD^L' and QS^L(W1) = Q_S^L' with
    • Excess supply (unemployment): E = QS^L(W1) - QD^L(W1) > 0