Measurement of unemployment and the unemployment rate
Unemployment
When people of working age (16-65) who are actively seeking and able to work, but are not employed.
Unemployment Rate
The number of unemployed people expressed as a percentage of the labor force.
The formula for calculating the unemployment rate is:
$$\text{Unemployment Rate} = \left(\frac{\text{Number of Unemployed People}}{\text{Labor Force}} \right) \times 100$$
NoteThe labor force consists of those who are employed plus those who are unemployed but actively seeking work.
ExampleCalculating the unemployment rate from a given data set
Imagine an economy, Econland, with the following statistics:
- Number of unemployed people: 2,500
- Total labor force: 50,000
Applying the formula for the unemployment rate:
$$\text{Unemployment Rate} = \left( \frac{2500}{50000} \right) \times 100$$
$$=5\%$$
Final Answer: There is a 5% unemployment rate in Econland.
Common MistakeStudents often incorrectly assume that part-time workers are counted as unemployed.
However, anyone who has any paid work, even if only for a few hours per week, is counted as employed in unemployment statistics.
Difficulties in measuring unemployment
Measuring unemployment has some underlying difficulties including:
- Accounting for hidden unemployment.
- Factoring the impact of underemployment.
- Measuring the informal sector employment.
Hidden unemployment
- The hidden unemployment in an economy is represented by the individuals who have stopped actively looking for work but are still willing to work.
- These individuals are not counted as unemployed in official statistics because they are no longer actively seeking jobs, despite being discouraged job seekers.
In the aftermath of the 2008 Global Financial Crisis, many job seekers in the U.S. gave up on finding work, temporarily leading to an underestimation of unemployment.
Underemployment
Underemployment occurs when workers:
- Are involuntarily working part-time but desire full-time jobs.
- Are overqualified for their current jobs, meaning their skills and education are underutilised.
- Therefore, the unemployment rate does not fully reflect the unemployment of human capital in an economy, since many part-time workers seeking full-time jobs are classified as employed, even though their resources are not fully utilised.
In many European countries post-COVID-19, skilled workers (like engineers) took up roles in retail or gig jobs due to limited opportunities in their fields
Informal sector employment
- The informal sector consists of workers engaged in unregulated, unregistered, or casual jobs without official contracts.
- Since these workers do not have formal employment records, they are often excluded from unemployment statistics, despite facing job insecurity and low wages.
- This may lead to overestimations of the unemployment rate.
In developing economies like India, a large proportion of workers in street vending or domestic services are part of the informal sector and uncounted in employment surveys.
Causes of unemployment
TipThis topic has been asked several times in IB exams. Read carefully!
There are 4 main causes of unemployment:
- Cyclical unemployment.
- Structural unemployment.
- Seasonal unemployment.
- Frictional unemployment.
Cyclical unemployment
Cyclical unemployment
Cyclical unemployment occurs during economic downturns when demand for goods and services falls, leading to job losses.
Figure 1 below shows how an inward shift of aggregate demand ($AD_1$ → $AD_2$) creates a deflationary gap and leads to cyclical unemployment:
Understanding how a fall in AD leads to cyclical unemployment (Figure 1)
Figure 1 illustrates how a fall in AD leads to cyclical unemployment:
- Initial equilibrium ($AD_1$, $Y_p$):
- At $AD_1$, the economy is at its full employment level of output ($Y_p$).
- Firms produce at their maximum sustainable capacity, and unemployment is low (only frictional and structural unemployment exist).
- Decrease in aggregate demand ($AD_1$→ $AD_2$):
- A decline in consumption (C), investment (I), government spending (G), or net exports (X - M) causes AD to shift inward from $AD_1$ to $AD_2$.
- This may be due to economic recessions, financial crises, or external shocks (falling consumer confidence, reduced business investment, global economic downturns...).
- Deflationary gap and output decline:
- The fall in AD lowers real GDP from $Y_1$ to $Y_2$, creating a deflationary gap.
- Since firms sell fewer goods and services, they cut production costs, including wages and jobs.
- Increase in cyclical unemployment:
- As firms reduce output, unemployment rises, especially in cyclical industries such as construction, manufacturing, and retail.
- With fewer job opportunities, households have less income, further reducing consumer spending, worsening the decline in AD, and creating a negative spiral of unemployment and reduced demand.
Cyclical unemployment is closely linked to the business cycle and is often temporary, improving as the economy recovers.
Structural unemployment
Structural unemployment
Structural unemployment happens when there is a mismatch between workers’ skills and available jobs.
