MACROECONOMICS

LECTURE NOTES NO 04
UNEMPLOYMENT AND LABOUR MARKETS
2024
 DEFINITION OF UNEMPLOYMENT
• According to International Labour Organisation (ILO), unemployment
(or being unemployed) refers to those of a working age, who in a
specified period, are without work, and are both available for, and
have taken specific steps to find work.
• The unemployed rate is then obtained by expressing the number of
people who are willing and able to work but who do not have jobs as
a percentage of the total number of people who are willing and able
to work.
 Unemployment (cont…)
• The total number of people who are willing and able to work is called
the LABOUR FORCE or economically active population (EAP).
• The EAP consists of workers in the formal sector of the economy plus
self-employed persons and employers plus informal sector workers
plus unemployed persons.
• The EAP thus includes all people who are in work or unemployed.
• It is derived from the total population figure.
 Unemployment (cont…)
• Given the total population, the EAP depends on factors such as:
- the age distribution of the population – the greater the proportion of
the population in the 15 to 64 age group (i.e. working age
population), the greater the labour force will be.
- Retirement rules and the availability of social security.
- Compulsory retirement and the availability of social pensions and
other forms of social security tend to reduce the labour force.
- Social, cultural, religious or other conventions about the role of
women in society.
 Unemployment (cont…)
- the availability of childcare centres and other institutions which
enable women to take up paid jobs outside the home.
- the level of development structure of the economy

• The fraction, proportion or percentage of the population of working

age (i.e. 15-64 years) who are economically active is called the labour
force participation rate (LFPR).
 Unemployment (cont…)
• Thus:
LFPR =
𝐿𝑎𝑏𝑜𝑢𝑟 𝑓𝑜𝑟𝑐𝑒 (𝑜𝑟 𝑒𝑐𝑜𝑛𝑜𝑚𝑖𝑐𝑎𝑙𝑙𝑦 𝑎𝑐𝑡𝑖𝑣𝑒 𝑝𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛)
𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛 𝑜𝑓 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑎𝑔𝑒 (15 𝑡𝑜 64 𝑦𝑒𝑎𝑟𝑠)

• The LFPR can be expressed as a percentage by multiplying the above

fraction or ratio by 100.
 TYPES OF UNEMPLOYMENT
• Two definitions of unemployment are used to generate statistics on
unemployment: a strict definition, formulated by ILO and generally
used in international comparisons of unemployment in developed
countries, and an expanded definition which is more suitable to
developing countries and which was used from 1994 to 1998 to
officially estimate unemployment in South Africa.
 Types of Unemployment (cont…)
• According to the strict definition: unemployed persons are those
people within the economically active population (i.e. aged 15 to 64)
who:
a. did not work during the seven days prior to the survey interview
(the reference week),
b. were available to start a business in the four weeks prior to the
survey interview,
c. Actively looked for work or tried to start a business in the four
weeks prior to the survey interview.
 Types of Unemployment (cont…)
• The three conditions are thus: without work, currently available for
work and seeking work.
• Note, however, that if the person has worked for at least an hour
during the reference week, he/she is not classified as unemployed.
• The requirement for being classified as employed is therefore not
particularly strict.
 Types of Unemployment (cont…)
• The expanded definition of unemployment excludes criterion ( c) above.
• In other words, whereas a person had (according to the strict definition) to
have taken steps recently to find a job, the expanded definition only
requires a desire to find employment.
• The expanded definition thus includes discouraged work-seekers.
• A discouraged work-seeker is defined as a person who was not employed
during the reference period, was available to work or start a business but
did not take active steps to find work during the last four weeks because of
any of the following: no jobs were available in the area, the person had
been unable to find work requiring his/her skills or had lost hope of finding
any work.
 Types of Unemployment (cont…)
• Cyclical – unemployment caused by a drop in aggregate demand of a
country e.g. recession period – drop in real GDP in SA, some workers
may be laid off as the economy slows down.
• These workers possess the necessary skills, but there is simply not
enough demand for their firms to continue to employ them.
 Types of Unemployment (cont…)
• Structural – unemployment caused as a result of the decline in
industries and the inability of former employees move into jobs being
created in new industries.
• Other workers have a mismatch of skills for the job or geographic area
that they want to work.
• If a welder is replaced by a robot or if a nuclear engineer is simply no
longer needed in a lab, these workers become unemployed.
• This type of unemployment is called structural unemployment
because the structure of the job is incompatible with the skills offered
by the worker.
 Types of Unemployment (cont…)
• Seasonal – unemployment caused because of the seasonal nature of
employment e.g. tourism, skiing, beach lifeguards, etc
• Disguised/Hidden – exists if people who were previously fully
employed, have had their hours reduced because of poor business
performance.
• Frictional – unemployment caused when people move from job to
job to claim benefits in the meantime (includes people who
temporarily move between jobs).
 CAUSES OF UNEMPLOYMENT
• There are four basic causes of unemployment in a healthy, working
economy:
1. Minimum wage laws;
2. Labour unions;
3. Efficiency wages; and
4. Job search
• In the real world economy all four of these forces work together to
create the unemployment that is reflected in the unemployment rate.
 1. Minimum Wage Laws
• In microeconomics, we learned that in an efficient market, the price of a
good changes to equilibrate the quantity demanded and the quantity
supplied.
• The labour market, in its natural form, is just like any other market.
• If there are unemployed workers who want jobs, the price of labour or the
wage rate will simply drop until all of the labour force is employed.
• That is, this would happen if there were not government intervention into
the labour market.
• In order to help maintain a certain standard of living among all workers,
the government implements a minimum wage, which artificially inflates
the wages of the workers at the bottom of the wage scale above what the
firm would normally pay at equilibrium.
 Minimum Wage Laws (cont…)
• This in turn causes the people above the minimum wage to demand
more pay and for the people above them to do the same.
• Eventually, the minimum wage causes the wages of all workers to
increase above the market-clearing level.
• When the wage demanded is greater than the wage offered, workers
earn more; but in response firms will cut jobs to recoup the money
they are losing, increasing unemployed workers.
• Raising the minimum wage therefore also increases unemployment.
 2. Labour Unions
• A second and closely related, cause of unemployment, lies with the
actions of labour unions.
• Labour unions are collectives of workers who rally together for higher
wages, better working conditions, and more benefits.
• These unions force firms to spend more money on each worker, some
in the form of wage and some in the form of benefits.
• Overall, this has an effect similar to the minimum wage law, where
workers are demanding wages greater than the firms are willing to
pay.
 Labour Unions (cont…)
• Again, this raises the wages of workers above the market clearing
level and creates a situation in which there are more people who
want to work at the wage than there are firms who want to hire at
the wage.
• In this way, labour unions increase the wages and benefits of workers
who are employed, but may simultaneously increase the number of
workers who are unemployed.
 3. Efficient Wages
• A third reason for unemployment is based on the theory of efficient wages.
• The basic idea behind efficient wages is that firms benefit by paying their
workers above the equilibrium wage, since higher wages produce happier,
healthier, and more productive workers, and may even increase worker
loyalty.
• But when the firms pay efficiency wages that are above the equilibrium
level, they also create an excess in the labour supply: more people want to
work for the wage than there are positions.
• Efficiency wages, like the minimum wage and labour unions, therefore
increase the wages for workers who are employed but also increase overall
unemployment.
 4. Job Search
• The fourth cause of unemployment, job search, is unrelated to the labour
market.
• Instead, it is based on ideas similar to the frictional, structural, and cyclical
unemployment discussed earlier.
• When a person decides that he want to work, he cannot simply become
employed. Instead he must find a job.
• This job search often takes a bit of time.
• During the process of looking for the right job, the person is considered as
an unemployed member of the labour force.
• Simply looking for a job or moving from one job to the next causes
unemployment.
 Job Search (cont…)
• Unemployment is in reality much more complex than the average
consumer appreciates.
• For this reason, most people do not understand that some
unemployment in the economy is not a problem.
• In fact, unemployment of certain low levels indicate that the economy
is functioning neither above nor below its potential output level, at a
sustainable level.
 ECONOMIC AND SOCIAL COSTS OF
UNEMPLOYMENT
• The private costs for the unemployed:
- Loss of income
- Fall in real living standards
- Increased health risks
- Stress
- Reduction in quality of diet
- Social exclusion because of loss of work or income

- Loss of marketable skills (human capital) and motivation

- The longer the duration of unemployment, the lower the chances of finding
fresh employment – the unemployed becomes less attractive to potential
employers.
 CONSEQUENCES OF UNEMPLOYMENT (2)
• Economic consequences for Businesses
• Negative consequences
• Fall in demand for goods and services
• Fall in demand for businesses further down the supply chain
• Consider the negative multiplier effects from the closure of a major employer in a
town or city
• Consequences for the Government (Fiscal Policy)
- Increased spending on unemployment benefits and other income – related state
welfare payments
- Fall in revenue from income tax and taxes on consumer spending
- Fall in profits – reduction in revenue from corporation tax
- May lead to rise in government borrowing (i.e. a budget deficit
 CONSEQUENCES OF UNEMPLOYMENT (3)
• Consequences for the economy as a whole
- Lost output (real GDP) from people being out of work – the economy
will be operating well within its production frontier.
- Unemployment seen as an inefficient way of allocating resources-
labour market failure?
- Some of the long term unemployed may leave the labour force
permanently – fall in potential GDP
- Increase in the inequality – rise in relative poverty.
 POLICIES TO COMBAT UNEMPLOYMENT
1. Training and retraining
2. Wage subsidies or employment subsidies
3. Lower minimum wages
4. Promotion of small business and informal sector
5. Special public works programmes
6. Government as employer of last resort.