Types of Unemployment

Frictional unemployment is the unemployment that arises from normal labor turnover. These workers are searching for jobs. The unemployment related to this search process is a permanent phenomenon in a dynamic, growing economy. Frictional unemployment increases when more people enter the labor market or when unemployment compensation payments increase.

Structural unemployment is the unemployment that arises when changes in technology or international competition change the skills needed to perform jobs or change the locations of jobs. Sometimes there is a mismatch between skills demanded by firms and skills provided by workers, especially when there are great technological changes in an industry. Structural unemployment generally lasts longer than frictional unemployment. Minimum wages and efficiency wages create structural unemployment.

Cyclical unemployment is the fluctuating unemployment over the business cycle. Cyclical unemployment increases during a recession and decreases during an expansion.

“Natural” Unemployment

Natural unemployment is the unemployment that arises from frictions and structural change when there is no cyclical unemployment—when all the unemployment is frictional and structural. Natural unemployment as a percentage of the labor force is called the natural unemployment rate.

Full employment is defined as a situation in which the unemployment rate equals the natural unemployment rate.

What Determines the Natural Unemployment Rate?

The Age Distribution of the Population An economy with a young population has a large number of new job seekers every year and has a high level of frictional unemployment.

The Scale of Structural Change The scale of structural change is sometimes small but sometimes there is a technological upheaval. When the pace and volume of technological change and when the change driven by international competition increase, natural unemployment rises.

The Real Wage Rate The natural unemployment rate increases if minimum wage is raised to exceed the equilibrium wage rate or if more firms use an efficiency wage (a wage set above the equilibrium real wage to enable the firm to attract the most productive workers and motivate them to work hard and discourage them from quitting).

Unemployment Benefits Unemployment benefits increase the natural unemployment rate by lowering the opportunity cost of job search.

Real GDP and Unemployment Over the Business Cycle

When the economy is at full employment, the unemployment rate equals the natural unemployment rate and real GDP equals potential GDP. When the unemployment rate is greater than the natural unemployment rate, real GDP is less than potential GDP. And when the unemployment rate is less than the natural unemployment rate, real GDP is greater than potential GDP. The gap between real GDP and potential GDP is called the output gap.

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