Unemployment

Updated on February 1, 2024
Article byAswathi Jayachandran
Reviewed byDheeraj Vaidya, CFA, FRM

Unemployment Definition

Unemployment refers to a situation where individuals capable of working seek active opportunities for work but cannot find any for various reasons. For a person to be considered unemployed, that individual must be an active member of the labor force actively searching for remunerative employment.

It is an indicator of the conditions prevailing in the labor market. When there is less employment, it means the economy is producing less. This hints at the decline of overall economic performance, an important element in monetary policyMonetary PolicyMonetary policy refers to the steps taken by a country’s central bank to control the money supply for economic stability. For example, policymakers manipulate money circulation for increasing employment, GDP, price stability by using tools such as interest rates, reserves, bonds, etc.read more planning. In addition, unemployment can cause personal and social distress and political turmoil.

Key Takeaways

  • Unemployment is when a person capable of working is actively looking for a job but cannot find any. They should be an active member of the labor force looking for a job to be labeled unemployed.
  • It is one of the most crucial markers for determining labor market conditions. Less employment indicates that the economy is producing less. This helps in evaluating the economy’s overall performance.
  • It reduces tax revenue, increases government borrowing, strains government resources, raises crime rates, and generates conflict. It has the potential to harm a country’s reputation.

Unemployment Explained

Unemployment in Economy

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Unemployment (wallstreetmojo.com)

Unemployment occurs when individuals cannot find jobs despite actively searching for them and being qualified enough. They should be a part of the labor force looking for paid employment. Individuals employed and those looking for it make up the labor force. However, the labor force constitutes only a portion of the total population. The labor force participation rate is the labor force ratio to the working-age population. At the same time, the unemployment rate is the percentage or proportion of the workforce searching for a job.

Finding values for these metrics is essential to determining the trajectory of the economy’s progress. If there is a wide range of unemployment present in a country, it generally means less manufacturing activity. A decline in activity in the production of goods and services may indicate a weak monetary policy. An economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more needs necessary corrections to push itself towards recovery. They can also help frame welfare policies. Sound economic policies increase the government’s revenue and save it from huge debt. People having no jobs will decrease their consumption, leading to an additional loss of income for the government. Unemployed people may indulge in crimes to earn money, and crime rates increase. This will worsen the political situation in a country.

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Types of Unemployment

Types of Unemployment

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Unemployment (wallstreetmojo.com)

Following are the common types of unemployment prevalent in society:

#1 – Cyclical unemployment

It relates to the cyclical trends in the business cycleBusiness CycleThe business cycle refers to the alternating phases of economic growth and decline.read more. They are classified as medium-term in nature (1-12months). When there is no productivity in business, consumer demand falls, and, as a result, labor demand also falls. The rise in cyclical unemploymentCyclical UnemploymentCyclical unemployment is one of the types of unemployment, which usually happens during the contraction phase of the business cycle where the unemployment rate starts rising as businesses start laying off its employees during the recession period & unemployment rate decreases during the expansionary phase of the business cycle.read more means the economy shows signs of a slowdown. Conversely, unemployment rates will be at their lowest when the economy is doing well. This is directly related to the macroeconomicMacroeconomicMacroeconomics aims at studying aspects and phenomena important to the national economy and world economy at large like GDP, inflation, fiscal policies, monetary policies, unemployment rates.read more situation of the countries. When productivity is low, and people are competing for job opportunities, they receive less money, which would lower inflation. Policies that stimulate demand and expansionary monetary policiesExpansionary Monetary PoliciesExpansionary policy is an economic policy in which the government increases the money supply in the economy using budgetary tools. It is done by increasing the government spending, cutting the tax rate to increase disposable income etc.read more are a way out of this situation.

#2 – Frictional unemployment

It happens when a person shift from their current job to another or transition into labor. When people leave employment for better opportunities or personal reasons, they may not find the next job immediately. Businesses may also take time to search for suitable candidates. The supply and demand do not meet in such situations, resulting in frictional unemploymentFrictional UnemploymentFrictional unemployment occurs when unemployed individuals look for jobs as a part of life transitions or after quitting previous employment to find a better one. Short-lived frictional unemployment, in a way, reflects that the economy has enough jobs for workers to have the courage to quit and find a replacement. read more. This is something that happens for short time span. However, they can occur at all times of a business cycle.

#3 – Structural unemployment

It occurs when there is a mismatch between what people expect and the available jobs. It may be because the individual is overqualified for the job or underqualified. Individuals may not possess the necessary skills for the job they desire, or the job available is below their qualifications, experience, or pay. Structural unemploymentStructural UnemploymentStructural unemployment is caused when there is a disparity between the knowledge and skills that are demanded by the employer and that which are offered by his or her employees and it is usually generated as a result of several changes like recession, deindustrialization, etc. in the economy and in such a situation individuals are unable to source work on account of different skills requirements.read more is long-lasting (more than 12 months) as it may take years to develop the necessary skills and expertise. It can exist even when economic conditions are good.

#4 – Underemployment

This occurs when people have jobs but cannot utilize their skills properly and work less hours. They may be part-time or full-time workers who could be qualified for better hours and more pay, but cannot find any.

#5 – Hidden unemployment

Hidden unemployment occurs when people do not belong to a labor market statistics but are willing to work if they had a chance. For example, people may have given up searching for jobs because they couldn’t fit for any. As a result, they would have given up hope and left searching for jobs. However, if given a chance, they would work.

#6 – Seasonal unemployment

They are seasonal and occur during the off-seasons. For example, in agriculture, people can go jobless after the harvest. In tourism, tour guides may be jobless as the tourist activity drops after the peak season.

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Unemployment (wallstreetmojo.com)

How to Measure Unemployment?

Measuring the unemployment rate requires identifying the labor force, including employed and unemployed people. Labor surveys of different countries are responsible for collecting, assimilating, and publishing information regarding the labor marketLabor MarketThe labour market, also known as the job market, is a well-studied market that operates on the supply and demand dynamics of people looking for work (workers) and organizations/people providing work (employers).read more. For example, in the U.S., The Bureau of Census conducts the Current Population Survey (CPS) every month for the Bureau of Labor Statistics. Generally, people above the age group of 15 (working-age population) belongs to the following broad categories:

  • Employed: this category includes people who work one or more hours per week.
  • Unemployed: This group includes people who do not have a paid job but are actively looking for one.
  • Absent from the labor force: People in this category do not work for a living and are not looking for work. They may be students, mothers, voluntarily retired people, etc.

From the above metrics, one can calculate the following labor market indicators:

  • The labor force: This group comprises both unemployed and employed people.
  • The unemployment rate: The proportion of unemployed people in the labor force.
  • Participation rate: proportion of people in the working-age population who belong to the workforce.

Example

Suppose there are 10 million individuals belonging to the employed people and 0.5 million unemployed people. We can add the number of unemployed and employed people to calculate the labor force. Here it will be 10+0.5=10.5 million. To calculate the unemployment rate, unemployed people shall be divided by the total number of people in the labor force (at present) and multiplied by 100. Because unemployed = 0.5 and labor force = 10.5, the unemployment rate is 0.5/10.5*100 = 4.7%.

Causes 

There are various causes of unemployment, and a few of them are as follows:

#1 – High-interest rates

When banks raise interest rates, the cost of borrowing goes up. As a result, companies cannot sustain increased levels of expenditure. They will have to cut down on employees’ salaries or lay off workers to save financial resources. They may not hire new employees either, contributing to unemployment.

#2 – Recession or sluggish economic growth

Here, the economy’s growth rate may be slower than anticipated, and the economy may not create adequate jobs. When there is no production, no jobs are created, and there comes no need to employ people. Hence, it contributes to unemployment.

#3 – Population increase

The number of people who need jobs also increases with a population surge. However, it is impossible to employ all the people living in a country. So the supply here is more than the demand, and hence unemployment is inevitable to a certain degree.

#4 – Technological advancements and lack of skills

Technologically, the world is making an immense progress. Jobs such as billing and accounting have been largely optimized by technology and do not require much human interference. Automation and artificial intelligence has led companies to cut down on the cost of employing human resources. This contributes to unemployment. Similarly, in this fast pace of social and economic advancements, jobs require additional skill sets and continuous upskilling. Those who cannot catch up are laid off and lags, which contributes to unemployment.

#5 – Underdeveloped labor markets

This case mostly applies to developing countries. People there may be employed in jobs such as fishing, farming, or hunting and may be paid in kind (not cash but as shelter and food). These may not be classified as underemploymentUnderemploymentUnderemployment is a condition when workers under-utilize their time or skills. This arises because workers cannot get jobs that fully utilize their skills or are getting full-time jobs that use their skills. read more and therefore belong to the unemployed category. 

#6 – The natural rate of unemployment

In every society, there exists a natural rate of unemployment. It may exist because companies decided to pause hiring due to welfare laws put by the State. However, the average rate of unemployment prolongs an economy for an extended period.

Effects

Unemployment is seen largely as detrimental to both individuals and the economy. Even if some governments give out unemployment benefits, they can hardly replace a substantial part of earned incomeEarned IncomeEarned income is any amount earned by an individual, such as a salary, wages, or employee compensation. It can also be an individual's income through their own business.read more. Financial stress makes them consume less, and less consumption brings the economy’s income down. Long-term unemployment outdates people’s skills and talents. It eats up their productive years. Education and physical and mental health suffer; this directly affects the growth and development of an economy. Crime rates can also increase when people cannot find a means to carry on their livelihood.

Unemployment benefits, food assistance, and medical aid provided stress on the government’s exchequer. It results in less tax revenue and higher government borrowing. People with no employment are absent from the workforce, and their production is also absent. This reduces the GDPGDPGDP or Gross Domestic Product refers to the monetary measurement of the overall market value of the final output produced within a country over a period.read more (gross domestic product) of the country. The cyclical flow of income gets disrupted, and efficient allocation of resources does not happen. When a section of the government’s revenue is spent on feeding unemployed people, there may not be enough funds to divert to growth and developmental activities. This hinders the development of the nation as a whole. Apart from the above, increased crime rates can demoralize a society.

Frequently Asked Questions (FAQs)

How is the unemployment rate calculated?

The unemployment rate is calculated using the formula (unemployment/labor force*100). It can also be calculated by using a simple unemployment rate calculator.

Who qualifies for unemployment?

Individuals who are actively seeking out job opportunities but cannot find any are categorized as unemployed people. They are part of the labor force.

How are unemployment benefits calculated?

In the U.S., different states offer unemployment compensation based on a worker’s previous earnings, usually for the last four quarters. The cost of living influences wages, so it is a contributing factor. However, state restrictions on benefit formulas and funding of employment programs also play a significant role. 

How does unemployment affect the economy?

It can lead a section of people to poverty, reduce the economy’s output, and, therefore, revenue through income and taxes go down. This puts pressure on government resources, increases crime rates, and causes conflicts. In addition, it can tarnish the image of a country.

This has been a guide to Unemployment and its definition. Here we discuss how to measure unemployment, its explanation ,types, causes and effects. You can learn more from the following articles –  

Reader Interactions

Comments

  1. Okayo pii says

    Got

  2. Okayo pii says

    Well

  3. Agea Bonnyface says

    Thanks

Leave a Reply

Your email address will not be published. Required fields are marked *