2.3 Macroeconomic objectives – Low Unemployment

Definition: Unemployment – situation when people who are willing, able and available for work are unable to find work.

Unemployment rate formula: (Number of unemployed people / Labour force) * 100%

Difficulties in measuring unemployment:

  • Hidden unemployment (working people who are excluded from the measure of unemployment because of the definition of unemployment)
  • Underemployment (people want full-time jobs, yet are only able to get part-time jobs)
  • Regional, gender, age and ethnic disparities are not taken into account as it is an average

Consequences of unemployment:

  • Loss of GDP
  • Loss of government revenue (tax)
  • Cost to the government in the form of unemployment benefits
  • Greater disparities in income distribution
  • Various social problems (growing unemployment-related crime rates; higher stress levels; homelessness)

Types of unemployment:

  • Frictional – people are switching jobs
  • Structural – people are out of job because their skills are no longer required (e.g. technology improved and machinery replaced humans or consumer preferences changed and a service/good is no longer produced)
  • Seasonal – people are out of job because their workplace only operates seasonally (e.g. skiing resorts)
  • Cyclical (also known as Demand Deficient) – because of weak demand for various goods and services, firms decrease their output and fire workers
  • (Real-wage unemployment)

Cyclical unemployment can be seen here:

Cyclical unemployment


As aggregate demand falls from AD1 to AD2, unemployment increases by the amount Y1-Y2. That is demand deficient unemployment.

On the Labour force diagram, cyclical (demand deficient) unemployment can be shown as follows:

Labour force diagram - Cyclical

As individual firm’s demand falls, the firm decreases its output. Hence, the demand for labour decreases D1 -> D2. Because wages do not fall, there appears an unemployment of amount Q1-Q2 (the distance between D1 and D2 at wage W1).

Cures for frictional and seasonal unemployments:

  • Cutting unemployment benefits – becomes less beneficial to stay unemployed
  • Improving information – making it easier to find jobs

Cures for structural unemployment:

  • Training schemes and education – help people re-specialise and gain skills which are demanded
  • Relocation – providing incentives to move to places where person’s skills are required

Cures for cyclical unemployment:

  • Expansionary fiscal and/or monetary policies aimed at increasing aggregate demand


There is also Natural Rate of Unemployment – it is also known as the equilibrium rate. Mainly used by Monetarists and is referred to as the rate which exists at the full employment level of income where the AS is vertical. Cure: Supply-Side Policies which would shift the LRAS (Monetarist view) and the vertical AS part (Keynesian view) to the right.

LF diagram


The diagram above illustrates the Natural Rate of Unemployment, it is the Q2-Q1 (distance between S and LF at wage W1). LF in this diagram is the Labour Force – people who are able to work, however are unwilling at a given wage. It is converging to the Supply of labour, because as wage increases people will eventually start to work. In theory, there must be a wage at which everyone who is able to work will be willing to work.