Three Labor Market Indicators
The
unemployment
rate
is the percentage of the people in the labor force who are
unemployed. It equals
and Labor force = Number of people employed + Number of people
unemployed.
The
employment-to-population
ratio
is the percentage of people of working age who have jobs. It equals
The
labor
force participation
rate is the percentage of working-age population who are members of
the labor force. It equals
Marginally attached workers are people who are available and willing to work but currently are neither working nor looking for work. These workers often temporarily leave the labor force during a recession and decrease the labor force participation rate. Because they are no longer counted as unemployed, marginally attached workers lower the unemployment rate. A discouraged worker is a marginally attached worker who has stopped looking for work because of repeated failures to find a job.
Types of Unemployment
Frictional unemployment is the unemployment that arises from normal labor turnover. These workers are searching for jobs. The unemployment related to this search process is a permanent phenomenon in a dynamic, growing economy. Frictional unemployment increases when more people enter the labor market or when unemployment compensation payments increase.
Structural unemployment is the unemployment that arises when changes in technology or international competition change the skills needed to perform jobs or change the locations of jobs. Sometimes there is a mismatch between skills demanded by firms and skills provided by workers, especially when there are great technological changes in an industry. Structural unemployment generally lasts longer than frictional unemployment. Minimum wages and efficiency wages create structural unemployment.
Cyclical unemployment is the fluctuating unemployment over the business cycle. Cyclical unemployment increases during a recession and decreases during an expansion.
“Natural” Unemployment
Natural unemployment is the unemployment that arises from frictions and structural change when there is no cyclical unemployment—when all the unemployment is frictional and structural. Natural unemployment as a percentage of the labor force is called the natural unemployment rate.
Full employment is defined as a situation in which the unemployment rate equals the natural unemployment rate.
What Determines the Natural Unemployment Rate?
The Age Distribution of the Population
An economy with a young population has a large number of new job seekers every year and has a high level of frictional unemployment.
The Scale of Structural Change
The scale of structural change is sometimes small but sometimes there is a technological upheaval. When the pace and volume of technological change and when the change driven by international competition increase, natural unemployment rises.
The Real Wage Rate
The natural unemployment rate increases if minimum wage is raised to exceed the equilibrium wage rate or if more firms use an efficiency wage (a wage set above the equilibrium real wage to enable the firm to attract the most productive workers and motivate them to work hard and discourage them from quitting).
Unemployment Benefits
Unemployment benefits increase the natural unemployment rate by lowering the opportunity cost of job search.
Real GDP and Unemployment Over the Business Cycle
When the economy is at full employment, the unemployment rate equals the natural unemployment rate and real GDP equals potential GDP. When the unemployment rate is greater than the natural unemployment rate, real GDP is less than potential GDP. And when the unemployment rate is less than the natural unemployment rate, real GDP is greater than potential GDP. The gap between real GDP and potential GDP is called the output gap.
The Price Level, Inflation, and Deflation
The price level is the average level of prices. The average level of prices can be rising, falling, or stable.
Inflation is a process of rising prices.
We measure the inflation rate as the percentage change in the average level of prices or the price level.
Inflation occurs when the price level persistently rises; deflation occurs when the price level persistently falls. The inflation rate is the percentage change in the price level.
Why Inflation and Deflation are Problems
Unexpected inflation or deflation is a problem for society because they redistribute income and wealth. Unexpected inflation benefits workers and borrowers; unexpected deflation benefits employers and lenders. They motivate people to divert resources from producing goods and services to forecasting and protecting themselves from the inflation or deflation.
Unexpected deflation hurts businesses and households that are in debt (borrowers) who in turn cut their spending. A fall in total spending brings a recession and rising unemployment.
Hyperinflation is an inflation rate of 50 percent a month or higher