Employment and Unemployment

Aims of this chapter-

- Define the workforce, the unemployment rate, the economic activity rate
- Describe the sources of unemployment, its duration, the groups most
affected by it, and how it fluctuates over a business cycle
- Explain how we measure the price level and the inflation rate using the RPI
and CPI

How will COVID-19 affect the world of work?

- COVID-19 will have far-reaching impacts on labour market outcomes. Beyond
the urgent concerns about the health of workers and their families, the virus and
the subsequent economic shocks will impact the world of work across three key
dimensions, as per ILO:
● The number of jobs (both unemployment and underemployment)
● The quality of work (e.g. wages and access to social protection)
● Effects on specific groups who are more vulnerable to adverse labour
market outcomes.
An ILO report of growth of unemployment is shown in the graph below:

There is more of a time lag on the

UK's official unemployment data
than some other nations. Its main
statistics office shows employment
at a record high and unemployment
at around 4%. However, KPMG
forecasts this will rise to just under
9% during the lockdown period.

The unemployment rate in Canada in April was 13% up 5.2 percentage points in ● The working-age population i.e. the number of people aged between 16
March, according to data from the country’s official statistics bureau. So far in the years and retirement who are not in jail, hospital, or some other form of
covid-19 crisis, more than 7.2 million people have applied for emergency institutional care.
unemployment assistance. ● Others

The working-age population is in turn divided into two groups:

● The economically active or workforce
● The economically inactive

Workforce- It is the sum of employed and unemployed workers.

To be considered unemployed (according to the LFS), a person must be:

1) Without work but having made specific efforts to find a job within the past
four weeks
2) Waiting to be called back to a job from which he or she has been laid off
3) Waiting to start a new job within 30 days.

How do we measure unemployment and what other data do we use to monitor

the labour market? Figure 21.1 shows the population categories

- Having a good job that pays a decent wage is important. But the cost of living used by the ONS and the relationships among

also matters them.

How do we measure the cost of living and its rate of change?

Note that "workforce" and "economically active"

Labour force survey are two names for the same group of people.

The Office for National Statistics conducts a continuous survey to determine the
changing state of the UK labour market.
The survey divides the population into two groups:
Three Labour Market Indicators Exercise
Three labour market indicators are calculated using the data from the Labour
Force Survey. They are:
● The unemployment rate
The unemployment rate is the percentage of the workforce that is
unemployed. The unemployment rate is-
UR = (Number of people unemployed/Workforce) x 100. Based on the information in the above table, what is the unemployment rate?
The unemployment rate reaches its peaks during recessions. What is the economic activity rate?
● The economic activity rate
The economic activity rate is the percentage of the working-age population - The unemployment rate=
that is in the workforce. The economic activity rate is- (6 million unemployed) + (139 million workforce)x100 = 4.3%
(Workforce/Working-age population) x 100. The economic activity rate=
The economic activity rate has hovered just under 80 per cent for the last (139 million workforce) + (207 million working-age population)x100 = 67.1%
30 years, sometimes higher, sometimes lower, but not by much. The
economic activity rate falls during recessions as discouraged workers i.e.
people available and willing to work but who have not made an effort to
find work within the last four weeks and thus leaves the workforce.
● The employment rate
The employment rate is the percentage of working-age people who have
jobs. The employment rate is-
(Number of people employed/Working-age population) x 100
The employment rate was around 75 per cent in 1971 and was still around
75 per cent in 2007. But during that time the employment rate has risen
and fallen with the cycle (lower in recessions)

Figure 22.3 shows the changing face of the Unemployment, Full Employment and Price Level
UK labour market. The female economic The Anatomy of Unemployment
activity rate has risen and the male economic People become unemployed if they:
activity rate has fallen. The female 1) Lose their jobs
employment rate has risen and the male 2) Leave their jobs
employment rate has fallen. 3) Enter or re-enter the workforce.

People end a spell of unemployment if they:

1) Are hired or recalled
Aggregate hours- These are the total number of hours worked by all workers 2) Withdraw from the workforce
during a year. Aggregate hours have fluctuated with the business cycle but have
no clear trend. But as the number of workers The figure shows labour market flows between different states.
has increased, the average workweek has
shortened. The graph shows aggregate hours
in UK from 193 to 2003.
● This graph shows UK unemployment by
reason in the 1980’s and 1990’s. Job leavers
are the smallest group while job losers are
the largest group.

Real wage rate- It is the number of goods and services that an hour's work will
buy. The real wage rate equals the money wage rate divided by the price level
(the GDP deflator). Three measures of the real wage rate are-
● Average hourly earnings of adult manual workers ● The duration of unemployment increases
● Total wages and salaries per hour during a recession. This figure shows
● Total labour compensation per hour unemployment by duration close to a
business cycle trough in 1992 and close to a
peak in 1989.
Types of Unemployment
Classification of unemployment helps us to understand what causes
unemployment. Unemployment can be classified into three types-
● Frictional unemployment
Frictional unemployment is unemployment that arises from normal labour
market turnover. The creation and destruction of jobs require that
unemployed workers search for new jobs. Increases in the number of ● The figures show real GDP and the
young people entering the workforce and increases in unemployment unemployment rate and estimates of potential
benefit payments raise frictional unemployment. GDP and the natural unemployment rate from
● Structural unemployment 1980-2010
Structural unemployment is unemployment created by changes in
technology and foreign competition that change the skills and location
match between jobs and workers. This is mainly caused by skills mismatch
and/or spatial mismatch. The Output Gap and Unemployment Rate
● Cyclical unemployment The quantity of real GDP at full employment is
Cyclical unemployment is the fluctuation in unemployment caused by the potential GDP Over the business cycle, real GDP
business cycle. fluctuates around potential GDP. The gap between
Full employment- Full employment occurs when there is no cyclical real GDP and potential GDP is called the output gap.
unemployment or, equivalently, when all unemployment is frictional and/or As the output gap fluctuates over the business cycle,
structural. The unemployment rate at full employment is called the natural rate of the unemployment rate fluctuates around the natural
unemployment. The natural rate of unemployment cannot be measured unemployment rate. The 3rd figure shows us the
accurately and estimates of its size vary. output gap in the US. 2nd figure shows the
unemployment and natural unemployment rate in the
Real GDP and Unemployment Over the Cycle US.
Reflecting back at the definition of potential GDP, we can restate it as the
quantity of real GDP produced at full employment. It corresponds to the When the economy is at full employment, the unemployment rate equals the
capacity of the economy to produce output on a sustained basis; actual GDP natural unemployment rate and real GDP equals potential GDP, so the output
fluctuates around potential GOP with the business cycle. gap is zero.

When the unemployment rate is less than the natural unemployment rate, real Reading the RPI and CPI numbers
GDP is greater than potential GDP and the output gap is positive. The RPI is defined to equal 100 for the reference base period. Currently, the
reference base period is July 2015. That is, the CPI/RPI is defined to have a
And when the unemployment rate exceeds the natural unemployment rate, real value of 100 in July 2015. In July 2016, the CPI was 100.63, which means that
GOP is less than potential GDP and the output gap is negative. the prices measured by the CPI were 0.63 per cent higher in July 2016 than in
July 2015.
Price Level, Inflation and Deflation The CPI & RPI work in a similar way
What will it really cost you to pay off your student loan? What will your parents'
life savings buy when they retire? Constructing the RPI and CPI
The answers depend on what happens to the price level, the average level of Constructing the RPI and CPI involves three stages:
prices and the value of money. A persistently rising price level is called inflation; ● Selecting and updating the basket
a persistently falling price level is called deflation. ● Conducting a monthly price survey
● Calculating the price index
Low, steady and anticipated inflation or deflation is not a problem, but an The different indices have slightly different 'baskets'.
unexpected burst of inflation or a period of deflation brings four big problems and
costs. It:
● Redistributes income
● Redistributes wealth Selecting and updating the basket
● Lowers real GDP and employment The figure represents the CPI basket. The basket
● Diverts resources from production is selected to cover all expenditure on consumer
Price Indices goods and services in the United States by
The price level is the "average" level of prices and is measured by using a price households, residents of institutions and tourists.
index. The Office for National Statistics calculates two indexes every month.
They are: The Retail Prices Index, or RPI and The Consumer Prices Index or
CPI
Conducting a Monthly Price Survey Measuring Inflation
Each month, ONS employees check 180,000 prices of more than 7000 types of The main purpose of the RPI is to measure inflation. The inflation rate is the
goods and services in 150 places throughout the United Kingdom. The RPI and percentage change in the price level from one year to the next. The inflation
CPI are calculated using the prices and the contents of the baskets. formula is:
Inflation rate = [(RPI this year — RPI last year)/RPI last year] x 100.
Calculation
We calculate the RPI (or CPI) for an economy that consumes only oranges and
haircuts. The RPI (or CPI) basket is 10 oranges and 5 haircuts. This table shows Figures in the side show us the CPI and Inflation
us the prices of the base period. The cost of RPI/CPI basket in the base period rate of the United States from 1970 to 2010.
was £50.

Biased Price Indices

The main sources of bias in a price index are:
● New goods bias
New goods that were not available in the
This table shows us the prices in the current period. The cost of the RPI/CPI base year appear and, if they are more
basket in the current period was £70. expensive than the goods they replace, the
We use- (2x10)+(10x5)= 70 price level may actually be higher than that
suggested by the RPI. Similarly, if the new
goods are Cheaper than the goods they
replace, but not yet in the RPI basket, they
bias the RPI upwards (the price level may
actually be lower).
The RPI is calculated using the formula:
● Quality change bias
RPI= (Cost of basket in current period/Cost of basket in base period)x100
Quality improvements generally are neglected, so quality improvements
Using the numbers for this example the RPI is:
that lead to price increases are considered purely inflationary.
RPI= (£70/£50)x100= 140
The RPI is 40% higher in the current period than in the base period.

● Substitution bias
The basket used to calculate the RPI is fixed and does not take into
account consumers' substitutions away from goods whose relative prices
increase.

Some Consequences of Bias in the RPI and CPI

Pensions and other government outlays are linked to the RPI so bias upwards
could end up swelling government spending. The Bank of England uses the CPI
as the target of monetary policy and biases in the index could lead to
inappropriate monetary policy decisions.

CPI and GDP deflator

The CPI is an index of the prices of consumption goods and services. For some
purposes, we need a price index that has broader coverage. One such price
index is the GDP deflator, which is an index of the prices of all the items in GDP.
So the GDP deflator is an index of the prices not only of the items in consumption
expenditure but also the prices of items in investment, government expenditure
and net exports.
The CPI measures only the prices of consumption goods and services, so it
covers a narrower range of items than does the GDP deflator.
The GDP deflator is calculated using two numbers that we have already met:
Nominal GDP and real GDP. The formula for the GDP deflator is:

GDP deflator = (Nominal GDP/Real GDP)x100