Lecture 6 - Unemployment

So far, the module has focused on output, production, growth, and prices. This lecture introduces unemployment, a macroeconomic outcome that is inseparable from output and inflation. Unemployment matters both because of its human cost and because unemployed workers represent unused productive capacity, lowering aggregate output below potential.

The lecture situates unemployment within a broader roadmap:

The emphasis here is on long-run unemployment, abstracting from business-cycle fluctuations.

Unemployment is defined in a precise statistical sense. An individual is unemployed if they:

Those who are not employed but do not satisfy all these conditions are classified as economically inactive.

This classification matters because it determines who enters the labour force statistics. Crucially, economically inactive individuals are excluded from the labour force, meaning they do not affect the unemployment rate even though they are not working.

The labour force is defined as:

The unemployment rate is:

Because the denominator excludes the economically inactive, the unemployment rate can appear low even when a large share of the adult population is not working. This distinction is essential for interpreting headline unemployment figures.

Unemployment is a dynamic state rather than a permanent condition. Many individuals move:

A striking empirical fact is that:

This highlights that unemployment statistics partly reflect participation decisions, not just job creation.

Some economically inactive individuals would like to work but have given up searching. These are known as discouraged workers. Others may be inactive due to long-term illness, even if they would prefer employment.

From an economic perspective, discouraged workers represent hidden slack in the labour market. Their exclusion from unemployment statistics can understate the true extent of labour underutilisation.

The labour-force participation rate measures engagement with the labour market:

Changes in participation can significantly affect unemployment figures. A fall in participation can reduce unemployment even if employment does not rise, which is why participation and unemployment must always be analysed together.

Over the past century, female labour-force participation has risen sharply, while male participation has declined.

Key economic drivers include:

These structural shifts illustrate how labour markets evolve with technology, demographics, and institutions.

There are two main methods of measuring unemployment in the UK:

For economic analysis, the LFS is generally preferred, as it better captures labour supply behaviour.

Unemployment varies systematically by:

Youth unemployment tends to be higher due to:

This reinforces the idea that unemployment is partly a matching problem, not just a lack of jobs.

The lecture distinguishes between:

The natural rate does not disappear automatically and is shaped by institutions, incentives, and market frictions.

Structural unemployment arises when:

Examples include:

These factors can keep real wages above equilibrium, creating persistent unemployment.

Frictional unemployment reflects the time needed for workers and firms to find suitable matches.

It arises due to:

In a constantly evolving economy, frictional unemployment is unavoidable and may even signal a healthy process of reallocation.

Policies aimed at reducing frictional unemployment focus on speeding up matching and retraining workers.

Examples include:

These policies can reduce the natural rate of unemployment without suppressing wages.

Addressing structural unemployment often involves politically contentious measures:

Such policies may reduce unemployment but at the cost of lower wage security, highlighting a trade-off between efficiency and equity.

Minimum wage laws can create unemployment by setting wages above the equilibrium level.

When :

This surplus represents unemployment caused by wage rigidity.

Unions bargain collectively on behalf of workers and tend to raise wages above market levels.

This creates:

The economic debate weighs wage protection against reduced labour market flexibility.

Efficiency wage theory suggests that firms may rationally pay wages above equilibrium to increase productivity.

Mechanisms include:

This provides an alternative explanation for persistent unemployment that does not rely on government intervention.

Mankiw, N.G. and Taylor, M.P. (2023) Macroeconomics. 6th edn. Andover: Cengage Learning EMEA.

Office for National Statistics (ONS) Labour Force Survey.

Bank of England (2011) Quarterly Bulletin.

Trading Economics (UK labour market indicators).