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Labor Market

Introduction

An important macroeconomic variable is the total amount of labor that is used in a certain time period. The amount of labor and the amount of capital are important explanatory variables for total production and GDP. Another reason for the importance of the amount of labor is that it is related to the unemployment rate - a macroeconomic variable which is clearly important.

Unemployment Classification

Economists sometimes distinguish between different types of unemployment. There are many different ways of classifying unemployment but the following is quite common.

• Frictional unemployment. Individuals that are temporarily unemployed while transiting between jobs or just entering the labour market. This kind is typically short in duration but always present in a market economy.

• Structural unemployment. Individuals that are unemployed because their skills are no longer in demand where they live. This kind typically leads to longer spells and may require the unemployed to acquire training or to move.

• Cyclical unemployment. Unemployment due to a recession.

• Classical unemployment. Unemployment due to real wages being too high (for example through minimum wage laws).

All unemployed individuals are assumed to belong to exactly one of these categories, so that if we sum the unemployment from each category we will get the total unemployment. We define the unemployment rate for the above categories e.g. we define the frictional unemployment rate as the frictional unemployment divided by the total labor force, and similarly for the other categories.

Obviously, it is often difficult to determine exactly which category an unemployed individual belongs to and official measures of the unemployment in each category do not exist.

Notwithstanding, this classification is very useful in economics. If unemployment increases in a particular city due to a firm relocating production, it is structural unemployment that increases (initially, part of it is frictional), and if unemployment increases due to a recession, it is the cyclical unemployment that has increased. Knowing what type of unemployment is currently present is important when considering what type of measures to take to lower unemployment.

Full employment

The natural rate of unemployment is defined as the sum of the rates of frictional, structural, and classical unemployment (excluding cyclical unemployment). The natural rate of unemployment is sometimes called voluntary unemployment and is assumed to be much more stable than the total unemployment rate.

Since the cyclical unemployment is zero in a boom, the natural rate of unemployment is equal to the observed unemployment rate in a boom. In a recession, the observed unemployment rate exceeds the natural rate by the cyclical unemployment rate.

We say that we have full employment when the unemployment rate is equal to the natural rate (and cyclical unemployment is zero). Remember that full employment does not imply that the unemployment rate is zero.

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