Unemployment
Unemployment means that labour markets are not clearing. Some of those people willing and able to work cannot obtain a job. The existence of unemployment means that a country is not producing all that it is capable of. It will not be producing on its production possibility frontier and, therefore, will not be achieving productive efficiency.
The extent to which unemployment causes labour market failure is obviously influenced by the number of people who are out of work. It is also influenced by how long people are out of work. The longer someone is unemployed, the more they get out of touch with the skills required and the greater the risk that they may give up hope of gaining a job.
Unemployment can arise as a result of a lack of A.D. in the economy. Such cyclical unemployment can also be referred to as DISEQUILIBRIUM UNEMPLOYMENT, as it occurs where the aggregate demand for labour (A.D.L.) is not equal to the aggregate supply of labour (A.S.L.) at the going wage rate.
The graph below shows A.S.L. exceeding A.D.L, leading to unemployment of Q1-Q2 :
It might appear that the solution to this type of unemployment would be to cut the wage rate. However, not only might this be difficult, with workers and trade unions resisting cuts in wage rates, but there is also a significant chance that it would lead to a downward, deflationary spiral. The cut in wages would reduce A.D, which in turn would lower A.D.L, leading to a further cut in wages, and so on.
Unemployment can also arise due to problems with the supply of labour. Some people may be unemployed because they are unaware of vacancies, unsuited to take up vacancies or are unwilling to take up the vacancies. In other words, they are experiencing voluntary, frictional and structural unemployment. Some economists argue that people experiencing these types of unemployment are all voluntarily unemployed because they could put more effort into finding out about job vacancies, could be more prepared to find employment and be more prepared to accept (for a short period of time at least) a lower-paid job than ideally they would like.
In such a situation, there will be a gap between the aggregate labour force (A.L.F) and those prepared to work at the going wage rate, the aggregate supply of labour (A.S.L). The graph below shows this difference and unemployment of Q-Q1. The gap between A.S.L. and A.L.F. narrows as the wage rises, as more of the labour force is prepared to work the higher the wage rate.
The unemployment that exists when the A.D.L. equals the A.S.L. at the going wage rate is sometimes referred to as EQUILIBRIUM UNEMPLOYMENT or the NON-ACCELERATING INFLATION RATE OF UNEMPLOYMENT (N.A.I.R.U). As the name suggests, it is consistent with the level of unemployment at which there is no upward pressure on the wage rate and inflation. If unemployment falls below the level, perhaps because a government raises A.D. in an attempt to reduce unemployment, the rate of inflation increases. In contrast, if unemployment rises above N.A.I.R.U, perhaps because the government is seeking to reduce inflation, (eg higher taxes) then the wage rate and inflation will fall.
In the 1980s, it was estimated that the UK’s N.A.I.R.U. was 8%. In 2008, the figure was estimated at 5%. The fall is attributed mainly to government supply-side policies. Whilst in the 1980s, 50% of the unemployed were long-term unemployed, the figure is now closer to 20%. It is thought that the higher the proportion of long-term unemployed in the jobless total, then the higher the N.A.I.R.U. This is because those people out of work for a long time exert less influence on wage bargaining. They are, in effect, not competing with those in work for the jobs.