ECON 252:

Principles of Economics II

Course Instructor
Dr Enock Kojo Ayesu
[email protected]

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Learning objectives
1. Define the unemployment rate and the labour force participation rate,
and understand how they are calculated.
2. Explain the economic costs of unemployment.
3. Identify the types of unemployment.
4. Explain what factors determine the unemployment rate.
5. Discuss the possible effects on unemployment.

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why is unemployment it important to economic
development?

 Why Do Economists Care about Unemployment?

1. Direct effect on the welfare of the unemployed, especially
those remaining unemployed for long periods of time.

2. A signal that the economy is not using its human resources

efficiently.
–Very low unemployment can also be a problem as the
economy runs into labor shortages.

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 FOCUS: Unemployment and Happiness
● Results of the German Socio-Economic Panel survey suggest that:

– (1) becoming unemployed leads to a large decrease in

happiness,
– (2) happiness declines before the actual unemployment spell,
and
–Figure 1 Effects of Unemployment on Happiness
(3) happiness does not fully recover even four years later.

Source: Winkelmann 2014.

 2-4 Output, Unemployment, and the Inflation Rate: Okun’s Law
Figure 2-5 Changes in the Unemployment Rate versus Growth in the
United States, 1960–2014

Output growth that is higher than

usual is associated with a
reduction in the unemployment
rate.

Output growth that is lower than

usual is associated with an
increase in the unemployment
rate.
 Concepts and definitions

 Labour force: The sum of employed and unemployed workers in the

economy.

 Participation rate: The participation rate is the ratio of the labor force
to the total population of working age.
–Because of discourage workers, a higher unemployment
rate is typically associated with a lower participation rate.

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 Concepts and definitions

 Unemployment: is the number of people who do not have a job but are
looking for one.
–a person must not have worked at all in the week before
the survey, must have been actively looking for work in
the past four weeks, and must be ready to start work
immediately. (ABS)

 Unemployment rate: The unemployment rate is the ratio of the

number of people who are unemployed to the number of people in the
labor force.

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 Concepts and definitions
●The meaning of ‘unemployment’
●Unemployment: those of working age who are
without work, but who are available for work at
current wage rates.
●It excludes students above 18 years, housewives,
discouraged workers (those who look for jobs and
give up their search in frustration), etc.
●(ILO/OECD)
– In this measure, the unemployed are defined as
people of working age who are without work,
 Concepts and definitions

 Discouraged workers: People who are available for work but have not
looked for a job during the previous four weeks because they believe no
jobs are available for them.
–are those who give up looking for a job and so no longer
counted as unemployed.
 Employment is the number of people who have a job.
–To be classified as employed, a person must have worked
only one hour or more in the week before the survey

 What about those how are not looking for job?

–Those who do not have a job and are not looking for one
are counted as not in the labor force
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 The employment status of the population,
Australia, August 2016: Figure 7.1 (cont'd)

Source: Based on Australian Bureau of Statistics (2016), Labour Force, Australia, Detailed-Electronic Delivery, August, Cat. No. 6291.0.55.001 at <www.abs.gov.au>; Australian
Bureau of Statistics (2016), Persons Not in the Labour Force by Age, Reason not in the Labour Force and Sex, January 1991 onwards, DataCube NMI, at <www.abs.gov.au>; both
viewed 5 October 2016.
 Measuring the unemployment rate and the labour force participation
rate
The labour force survey (cont’d)

 The unemployment rate measures the percentage of the labour force that
is unemployed.
Numberof unemployed
Unemployme
ntrate X 100
Labourforce
0.721million
Unemployme
ntrate X 1005.7%
12.686million

 Labour force participation rate: The percentage of the working age

population that is in the labour force.
Labourforce
Labourforceparticipat
ionrate X 100
Workingagepopulation
12.686million
Labourforceparticipat
ionrate X 10064.8%
19.587million
 Problems with measuring the unemployment rate

 The number of discouraged workers increases during a recession;

therefore, the official unemployment rate appears lower than it would
otherwise be.

 Underemployed workers—workers who want to work more hours than

they have currently.

 People who claim to be unemployed but are not, can lead to the
unemployment rate being overstated.


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 Other concepts of unemployment
●Underemployment - This constitutes the section of the
labour force seeking for full-time paid employment but
unfortunately, the structure of the employment permit
them to work for only part-time or are employed below
capacity.
●Claimant Unemployment: This is simply a measure of
those in receipt of unemployment related benefits
●The duration of unemployment
●What determines the average duration of unemployment?
There are three important factors here.
●Determinants of average duration of unemployment

 Flows into and out of unemployment
From jobs From outside the labour force
• People made redundant • School/college leavers
• People sacked • People returning to the
• People temporarily laid off labour force (e.g. after
• People resigning raising children)
INFLOWS
(per period of time)

UNEMPLOYMENT
 Flows into and out of unemployment
From jobs From outside the labour force
• People made redundant • School/college leavers
• People sacked • People returning to the
• People temporarily laid off labour force (e.g. after
• People resigning raising children)
INFLOWS
(per period of time)

UNEMPLOYMENT

To jobs OUTFLOWS To outside the

(per period of time) labour force
• People taking new jobs • People who have become disheartened
• People returning to old and give up looking for a job
jobs who had been • People who have reached retirement
temporarily laid off age
• People who temporarily withdraw from
labour force (e.g. to raise a family)
• People who emigrate
•
Note: the duration of unemployment (DU) will equal the
stock of unemployment (U) as a proportion of the outflow
(F) from unemployment. DU=U/F
The number unemployed (the size of the stock of
unemployment).

The phase of the business cycle

At the onset of a recession, unemployment will rise, but
average length of unemployment is likely to be short
Lasted recession would mean longer duration of
unemployment
 The cost of Unemployment
 Costs to the economy

 Loss of gross domestic product (GDP)

 Loss or deterioration of human capital

 Retraining costs

 Costs to the government:

–Unemployment benefit payments are a net drain on the

federal budget.
–The opportunity cost of funds directed towards
unemployment benefits.
–Loss of tax revenue—personal income tax, company tax,
GST and excise taxes. 17
 The cost of Unemployment
 Costs to the individual
–Loss of income;
–Loss of skills;
–Retraining costs;
–Loss of self-esteem
 Social costs:

–Unemployment may contribute to family break-

ups,
–health problems,
–mental illness,
–crime and political unrest.
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 TYPES OF UNEMPLOYMENT

 Cyclical unemployment
 Unemployment caused by a business cycle contraction.
–Also known as ‘demand deficient’ unemployment.

 Falling sales lead to cut-backs on production and the sacking of workers.

 When the economy begins to recover, the unemployment rate usually

continues to rise for some time because:
–discouraged workers re-enter the workforce
–some firms have excess capacity, and also want to wait
to see if the recovery lasts before hiring new workers.
 TYPES OF UNEMPLOYMENT

 Frictional unemployment:

 Short-term unemployment arising from the process of matching workers

with jobs:
• school leavers, college and university graduates looking for their first
job
–people re-entering the workforce after an absence
–people who have lost or quit their job and are looking for
their new job.
 Some frictional unemployment is good for the economy because:
–it means that workers and employers are taking the time
necessary to match worker attributes with job
characteristics
–new workers with skills (graduates) are entering the
labour force.
 TYPES OF UNEMPLOYMENT

 Frictional unemployment:

 Short-term unemployment arising from the process of matching workers

with jobs:
• school leavers, college and university graduates looking for their first
job
–people re-entering the workforce after an absence
–people who have lost or quit their job and are looking for
their new job.
 Some frictional unemployment is good for the economy because:
–it means that workers and employers are taking the
time necessary to match worker attributes with job
characteristics
–new workers with skills (graduates) are entering the
labour force.
 TYPES OF UNEMPLOYMENT (cont'd)
 Seasonal unemployment:

 Unemployment due to factors such as weather, variations in tourism

and other calendar-related events.
 Structural unemployment

 Unemployment arising from a persistent mismatch between the skills

and characteristics of workers and the requirements of jobs.
–e.g. New technology and changes in consumer tastes
may make some workers redundant.
 Full employment

 Economists say that full employment occurs where there is no cyclical

unemployment.
–At full employment, the ‘normal’ types of
unemployment still exist—frictional and structural.
 CAUSES OF UNEMPLOYMENT
●Unemployment and the labour market
– Aggregate demand and supply of labour
– Aggregate supply of labour curve shows the
number of workers willing to accept jobs at each
wage rate. The curve is relatively inelastic (why?)
– Aggregate demand for labour curve shows the
total demand for labour in the economy at different
average real wage rates.
– Real average wage rate is plotted on the
vertical axis.
Aggregate demand and supply of labour

ASL
Average (real) wage rate

ADL

No. of workers
 Aggregate demand and supply of labour

ASL
Average (real) wage rate

We

ADL

O
Qe
No. of workers
 CAUSES OF UNEMPLOYMENT
● Disequilibrium unemployment (2 conditions)
● The Aggregate supply of labour much exceed the aggregate demand at
current wage rate
– This can occur due to various reasons such as minimum wage
laws, labor market rigidities, or changes in labor demand and
supply conditions.
● There must be a “stickiness” in wages. In other words, the wage rate
must not immediately fall to the equilibrium wage.
● Equilibrium (“natural”) unemployment
 This is the level of unemployment that occurs when the economy is at full
employment (equilibrium).
 It is the difference between those who would like employment at the
 Disequilibrium unemployment

ASL
Average (real) wage rate Disequilibrium
unemployment

B A
W2

We

ADL

O Q2 Q1
No. of workers
 Aggregate demand and supply of labour

ASL
Average (real) wage rate

We

ADL

O
Qe
No. of workers
 Equilibrium unemployment

ASL N
Average (real) wage rate

e d
We
Equilibrium
unemployment

ADL

O
Qe Q2
No. of workers
 CAUSES OF UNEMPLOYMENT
●NOTE

– Understanding the natural rate of

unemployment is crucial for policymakers,
economists, and businesses because
• it provides insights into the underlying structural
and frictional dynamics of the labor market.

• It helps in assessing whether unemployment

levels are within the normal range or if there
are systemic issues affecting job creation and
 Equilibrium and disequilibrium
unemployment
ASL
Average (real) wage rate Disequilibrium
unemployment

b a
W2
e
We

ADL

No. of workers
 Equilibrium and disequilibrium unemployment

ASL
N
Average (real) wage rate Disequilibrium
unemployment

b a c
W2
e
We Equilibrium
unemployment

ADL

No. of workers
 CAUSES OF UNEMPLOYMENT

●Disequilibrium unemployment

●Causes of disequilibrium
unemployment

– Real-wage (classical) unemployment

(occurs when trade unions use their
monopoly power to drive wages above
the market clearing level.

– It could also be caused by the

 Real-wage unemployment

ASL

Average (real) wage rate

b b’ a
W1

We

ADL 2
ADL

O Q2 Qe Q1
No. of workers
 CAUSES OF UNEMPLOYMENT

– Demand-deficient (cyclical)
unemployment

• Unemployment caused by a fall in

aggregate demand with no corresponding
fall in the real wage rate.
 Demand-deficient unemployment

ASL

Average (real) wage rate Sticky

wages

Demand-deficient
unemployment

W1 Reduction in
aggregate demand
W2

ADL 1
ADL 2
O Q2 Q1
No. of workers
 CAUSES OF UNEMPLOYMENT
●Disequilibrium unemployment
– real-wage (classical) unemployment

– demand-deficient (cyclical) unemployment

–Unemployment arising from a growth

in the labour supply
 CONTROLLING UNEMPLOYMENT

– Demand Management/Demand Side Policies:

Fiscal and monetary policies are intended to
increase aggregate demand and, therefore the
equilibrium level of national income.
– Supply – Side Policies: Policies are intended to
increase the economy’s potential rate of output
by increasing the supply of factor inputs, such as
labour inputs and capital inputs, and by
increasing productivity
 EXPLAINING FRICTIONAL AND STRUCTURAL UNEMPLOYMENT
 Government policies and the unemployment rate

 Most job search is carried out privately.

 Government policies can help to reduce structural unemployment

through retraining programs.
–Job Services Australia: A national network of private and
community recruitment agencies that find jobs for unemployed
people and other job seekers.

 Social security and other payments to the unemployed

 These may have two main effects:
–Allow more time for job search and therefore improve
labour market efficiency.
–Reduce the opportunity cost of unemployment and
therefore lead to longer periods of unemployment.
LABOUR MARKET REGULATION AND DEREGULATION (cont'd)

 Efficiency wages:

 A higher-than-market wage paid by a firm to increase worker

productivity.
–May reduce the need for worker monitoring.
–May provide motivation for more productive work.
–But, efficiency wages increase the labour supply, so
may increase unemployment.
 DISCUSSION QUESTION 1

1. Explain how an increase in the unemployment rate will

affect bargaining power and nominal wages.

 As the unemployment rate increases, it is more difficult for

individuals to find employment at other firms.

 So, workers' bargaining power will fall. As bargaining

power falls, the nominal wage will fall.
 DISCUSSION QUESTIONS 2 AND 3

2. What will happen to unemployment statistics in the presence of discouraged

workers?

Discouraged workers are usually not counted and hence may cause the official
unemployment rate to understate the amount of unemployment.

3. Assuming the total population is 10 million, the civilian labour force is

5million, and 4.7 million workers are employed, the unemployment rate:

6% (Students are expected to use the unemployment rate formula to do the
calculation)
 DISCUSSION QUESTION 2
AND 3
2. What will happen to unemployment statistics in the presence of discouraged
workers?

Discouraged workers are usually not counted and hence may cause the official
unemployment rate to understate the amount of unemployment.

3. Assuming the total population is 10 million, the civilian labour force is

5million, and 4.7 million workers are employed, the unemployment rate:

6% (Students are expected to use the unemployment rate formula to do the
calculation)
 Group Assignment
(31st July 2024)
Form a group (between 5 and 6)

Questions: Each group is to select a developing
country and discuss the following:
(A) The economic impact of rising public debt on the selected country
(B) Explain the fiscal and monetary policy response to rising public debt
(c) Make appropriate recommendation (with explanation) on the policy (fiscal or
monetary) that you think is more effective in reducing public debt in the selected
country.
word count = 1,500 (+10%, -10%); APA referencing Style
 Group Assignment
(19 August 2022)

The following assessment criteria (proposed) may applied:

 Accuracy of information used, referencing and argument.
 Structure and logic;
 Analytical argument.
 Use of graphs and tables to summarise information.
 Clarity of expression.
 Accurate referencing