The official definitions
Statistical agencies survey households and sort every adult (aged 16 and over, not in an institution or the military) into one of three groups:
- Employed: did any paid work in the survey week.
- Unemployed: without a job, available for work and actively looking in recent weeks.
- Not in the labour force: students, retirees, full-time carers, and others not looking.
The labour force = employed + unemployed.
- Unemployment rate = unemployed ÷ labour force × 100
- Labour force participation rate = labour force ÷ adult population × 100
Worked example
In a town: 90 people are employed, 10 are unemployed, and 60 are not in the labour force.
- Labour force = 90 + 10 = 100.
- Unemployment rate = 10 ÷ 100 = 10%.
- Adult population = 160, so participation = 100 ÷ 160 = 62.5%.
Now suppose 2 of the unemployed give up and stop searching. They become discouraged workers, outside the labour force. Unemployed falls to 8 and the labour force to 98, so the rate is 8 ÷ 98 ≈ 8.2%. The rate fell, yet nobody found a job. This is why the headline rate can understate hardship.
Types of unemployment
- Frictional: short spells while people search and move between jobs. Present even in healthy economies.
- Structural: a mismatch between workers' skills or location and the jobs available, for example after an industry declines.
- Cyclical: unemployment caused by a recession, when demand for goods and labour falls.
The natural rate of unemployment is the rate with no cyclical unemployment, that is, frictional plus structural. When the economy is at full employment, the actual rate equals the natural rate. Estimates of the natural rate vary and change over time.
Costs
For individuals, lost income and skills. For the economy, lost output: when cyclical unemployment is high, real GDP falls below its potential, the output that full employment would give. Okun's law is an observed rule of thumb that an extra point of cyclical unemployment goes with a few percent lower GDP relative to potential.
Policy
Cyclical unemployment is addressed by stimulating demand. Frictional unemployment can be reduced by better job-matching services. Structural unemployment calls for retraining and help with moving. Unemployment insurance cushions income, though it can lengthen search time slightly.