Unit 5: Full Employment

Full Employment and Measures of Unemployment

We’ve looked at two of society’s four major goals for it’s macro economy, which means we have two goals left.  Those two goals,  stable and predictable growth and full employment of labor, are closely related, so we will study both in this unit. The issue of the stability and predictability of growth in an economy is described as the “business cycle”.

Learning Objectives for the Unit:

  • Calculate and explain measures of  …  unemployment and the business cycle.
  • Calculate an unemployment rate using the simple formula.
  • Describe ways in which changes in the unemployment rate might be deceptive.
  • Describe the types of unemployment and identify examples of each.

Goal:  Full Employment

There is still one major goals left: full employment of our resources.  Typically, we measure how well a society achieves its goal of full employment of resources by looking at how well it is using its labor resources.  Part of the reason for this goal is humanitarian:  if some people are unemployed, it’s hard for them to live.  But there’s a broader, more macro-oriented rationale as well: the economic problem.  As a society, we have unlimited wants, but we have limited, scarce resources.  Doing “the best we can” means making the best use of all our resources.  The most important resource any society has is its available labor.  For a society to reach its production possibilities, it must use all he available labor, and ideally, use that labor efficiently.

To measure how well society is using the available labor would seem to be an easy issue.  It would appear that a simple percentage number could tell us how what portion of our available labor force is not being used, or is not “employed”.  Indeed, this is the concept behind the most commonly used employment measure:  the unemployment rate.

At its simplest, the unemployment rate is the  “number of unemployed workers” divided by the “total labor force – the number of available workers.  Of course we typically convert this division into a percentage number.  This unemployment rate gets tremendous publicity.  It is published for the previous month by the Bureau of Labor Statistics of the U.S. Government on the first Friday of each month, along with a slew of other employment related data in the “Monthly Employment Report”.   Unfortunately, like GDP, the unemployment rate is not a perfect measure.  It may be the best we have, but it has flaws.  It shouldn’t be regarded as a precise measurement.  It’s only an approximation.  It is subject to errors.  More importantly, the way it is calculated leads to the potential for changes in the unemployment rate to give deceptive feedback about how the economy is doing.

In concept, the unemployment rate should tell us how well we are using our available labor resources.  A low and decreasing unemployment rate should indicate a growing economy that’s creating opportunities for all workers.  A high and increasing unemployment rate should indicate a slowing economy that’s entering a contraction and not providing opportunities.  In general, over the long haul, the unemployment rate tends to do this.  But changes in the unemployment rate can also provide distorted signals.  It is possible that a contracting economy would actually show a decreasing unemployment rate for a while.  Likewise, an economy that suddenly starts growing may show an unemployment rate that is increasing for a while.  To better understand how this can happen, see the Closer Look on Unemployment Measures.

Economists do follow and use the unemployment rate statistics closely, particularly when looking at longer-term trends.  However, in the very short-term, most economists also look closely at the absolute number of new jobs being created each month.  In other words, while unemployment rate is important, the month-to-month increases in the total number of employed workers is also very important.  Often the change in total employment will help identify when the unemployment rate is giving a distorted signal about the economy.

Types of Unemployment:  Why are people unemployed?

Not all unemployed workers have the same effect on the macroeconomy.  A lot depends on why the workers are unemployed.  For this, economists identify four types or groups of unemployed workers based on why or how they became unemployed.  There are no official statistics published about these different types of unemployment.  Instead, these are analytical categories that economists use when doing small surveys or when theorizing about the dynamics of the economy.  Nonetheless, it is important to understand the four types.

  1.  Seasonal Unemployment – Some workers become unemployed because their jobs are seasonal.  For example, ski resort workers are often unemployed in the summer.  Summer camp workers are unemployed in winter.  Many outdoor construction jobs disappear in the winter months, also.  Seasonal unemployment tends to be predictable, and conceptually, isn’t a real macro economic policy worry.  The jobs will return next year when the season returns.  Fortunately, advanced statistical techniques allow economists to remove much of the effects of seasonal unemployment from reported unemployment and employment data. This is what is meant by “seasonally adjusted data”.
  2. Structural Unemployment – Some workers are unemployed because of long-term changes in the structure or technology of the economy. For example, at one time, the economy needed large numbers of railway workers.  But as the economy increasingly shifted towards shipping goods by trucks and people by airplanes, we didn’t need as many railway workers.  They became unemployed.  Some of them had specialized skills that could only be used with railroads.  Even if the economy was booming, these specialized workers would be unemployed until they developed other skills. Macro economic policy cannot change structural unemployment.   Only job retraining, education for other jobs, and moving of workers can remedy structural unemployment.
  3. Frictional Unemployment – On any particular day some people are unemployed because they are looking for jobs AND there are open jobs for them.  The job-seeker and the employer simply haven’t found each other yet.  As most of you know, finding a job isn’t an easy process. There’s a lot of searching and interviewing going on.  At a macro-economic level, these “workers-between-jobs” are good.  It’s part of the process of the economy finding the right job for the right workers.  Ideally, we do no want to eliminate frictional unemployment.  If there were no frictional unemployment, then that would mean there were no workers looking for and being interviewed for better jobs.  The economy would be stagnant.  From a macro economic policy standpoint, frictional unemployment is OK.
  4. Cyclical Unemployment – This is the type of unemployment we want to avoid.  Cyclical unemployment happens when the business cycle is either contracting or just starting to recover.  We fully expect the economy to have need for workers with these skills, but right now the employers aren’t doing enough business to employ them.  Workers who get laid off during a recession are the classical example of cyclical unemployment.  We want macro economic policy to eliminate cyclical unemployment.

How Can 4 or 5% Unemployment Be “Full Employment”?

Understanding these four types of unemployment helps to explain why economists can say an economy that has reported unemployment of perhaps 4.5% is actually at full employment.  The economists are not saying that 4% is close enough and that these unemployed workers don’t matter. Economists describe 4% to 4.5% unemployment as being full employment because it estimated that frictional unemployment is approximately 4%.  So, if the reported actual rate is 4% and we estimate that frictional unemployment tends to run around 4%, it stands to reason that there is 0% cyclical unemployment.  It should always be kept in mind that we only have estimates of how much unemployment is frictional – there is now way to formally measure it.   Throughout the rest of the course we will often refer to the economy either being at “full employment” or “having substantial unemployment”.  What we will mean in practical terms is that an economy at “full employment” is reporting approximately 4-4.5% unemployment.  Anything greater than a reported 4% unemployment rate is likely to be cyclical or structural unemployment.

What’s Next?

This unit wraps up our units on structure, goals, and measurement of the macroeconomy.  Next, we will start a new part of the course where we look at models/theories of the real sector of the economy. An important part of the next section will be the centuries old debate about whether government can or should manage the economy.  It’s a debate that is still very much alive among both today’s economists and today’s politicians.