Cyclical Unemployment Definition
Cyclical unemployment is one of the types of unemployment, which usually happens during the contraction phase of the business cycle where unemployment rate starts rising as businesses start laying off its employees during recession period & unemployment rate decreases during the expansionary phase of the business cycle.
Cyclical Unemployment Phases
Cyclical unemployment is directly related to the macro-economic factor in an economy as the unemployment rate moves along with the business cycle phases. Usually, the business cycle has four phases i.e. trough, expansion, peak & contraction which define the fluctuation in demand or production activity in an economy which is measured by a growth rate of real gross domestic product (GDP) of an economy.
Let’s get into each phase of the business cycle to understand its impact on cyclical unemployment.
#1 – Expansion Phase
In this phase of the business cycle, overall economic activity increase which represents the spike in the overall demand & consumer starts buying more items. To meet this increase in demand, businesses react by increasing their production capacity by investing in equipment to produce more of their product & support this increase in their production capacity businesses require more people, which forces them to hire more employees to fulfill the ongoing demand in an economy. Hence, this results in an overall drop in the unemployment rate in an economy & overall GDP growth rate increases.
#2 – Peak Phase
As the name suggests, the business cycle reaches its peak & also the maximum level of economic output. Both consumer spending & business investment increases but at slower rates. The product price increases due to an increase in an inflation rate & at this point the economy is at its full potential employment which means the unemployment rate is near to zero. The economic growth stabilizes for some time & then starts to decline. The unemployment rate decreases but new hiring slow down.
#3 – Contraction Phase
After reaching the peak, the inflation rate is rising which force product prices to rise but consumer income was stable. So, they start cutting their expenses which affects the overall economic demand and thus it starts declining. Businesses also cut their production capacity & produce less product to react to this consumer demand. Now as demand & production both have decreases employers initially decrease the employees working hours & then start laying off its employees to manage its cost of production. This cyclical increase in the unemployment rate creates a loop, where this recently unemployed person cannot afford to buy basic stuff which in turn decrease even more consumer demand in an economy. Hence, even more, people will lose their job because of lower consumer spending & inflation, as a result, the unemployment rate starts increasing. GDP growth rate becomes negative.
#4- Trough Phase
The trough is a phase in the business cycle where contraction period ends & GDP growth rate changes from negative to positive. once again overall consumer demand starts increasing in an economy which leads to the starting of expansion period in an economy. The unemployment rate stops increasing & begins to fall as economic demands pick up.
How to Calculate Cyclical Unemployment Rate?
The cyclical unemployment rate can be calculated by subtracting the frictional unemployment rate & structural unemployment rate from the current unemployment rate.
Unemployment Rate formula = No. of unemployed persons / Labor force.
Labor force = No. of employed persons + No. of unemployed persons.
- Frictional Unemployment
It is temporary unemployment which occurs because of time lag i.e. when a person searches for a job or in a process to moving from one to another job. It can be calculated by taking a worker who is actively looking for jobs by dividing with the labor force.
This is usually caused due to technological advancement in an economy & workers lack the skills to perform the task using this improvement in the technology which makes it difficult for the worker to find the job. It can be calculated by taking a worker who is structurally unemployed by dividing with the labor force.
- A person is considered as unemployed only if he/she is not working but actively searching for the work.
- A person who doesn’t want to be part be a part of the labor force is voluntarily unemployed & these persons are not included in the calculation of the unemployment rate.
Example of Cyclical Unemployment
There are industries that are highly sensitive to the business cycle with respect to the unemployment rate such as the Automobile industry, Construction industry, other Consumer durable manufacturing industry, etc.
Let’s take look into one of these industries & find out how it is related!
When an economy is struggling with the recession period, consumer spending goes down which directly related to overall demand in an economy. One of the examples is the Automobile industry, during the contraction period in the business cycle where consumer demand goes down for automobiles products then automobiles manufacturer deal with it by decrease supply of their products & to do so fewer workers are needed. To the main cost of production & profit margin, the manufacturer cut the worker’s strength which increases the cyclical unemployment rate. Once the expansion period starts, consumer spending increases & overall demand in an economy increases. To meet this increase in the demand automobiles manufacturer need to produce more of their product & they need more workers so they start hiring more workers once again, which decreases the cyclical unemployment rate.
The increase and decrease in the cyclical unemployment rate is temporary. During the contraction period, overall consumer demand decreases which leads to an increase in the unemployment rate. As the contraction period end, the economy is entering into the expansion period of the cycle where consumer demand starts increasing & the unemployment rate starts decreasing.
As the economy moves with the business cycle phase its unemployment also keeps changing with it. Just remember that it usually considered to be recession period, when there are two consecutive quarters of negative economic growth & when there are two consecutive quarters of positive economic growth then it is considered to be an expansionary period in an economy.
This has been a guide to Cyclical Unemployment and its definition. Here we discuss how to calculate the cyclical unemployment rate along with its formula, example, and its reasons. You can learn more about accounting from following articles –