Unemployment and Its Natural Rate

Overview of Unemployment

Unemployment is a key macroeconomic indicator that reflects the health of the labour market. Economists typically divide the problem of unemployment into two categories: the long-run problem and the short-run problem.

• Natural Rate of Unemployment: The amount of unemployment the economy normally experiences in the long run.

• Cyclical Unemployment: Year-to-year fluctuations in unemployment around the natural rate, closely associated with short-run ups and downs of economic activity.

Example: During recessions, cyclical unemployment rises above the natural rate due to decreased economic activity.

Observed vs. Natural Unemployment Rates

Unemployment rates fluctuate over time. The observed unemployment rate may differ from the natural unemployment rate due to economic cycles.

• Natural rate is relatively stable, while observed rate varies with economic conditions.

Figure: A graph of observed and natural unemployment rates (1966–2020) shows cyclical deviations from the natural rate.

Identifying and Measuring Unemployment

Labour Force Survey (LFS)

Statistics Canada conducts the Labour Force Survey (LFS) monthly, surveying about 54,000 households to gather labour market data.

• Data collected includes unemployment, types of employment, average workweek length, and duration of unemployment.

Categories of Labour Force Participation

Each adult (aged 15+) is classified into one of three categories:

• In the labour force:

  • Employed: Worked for pay (full-time or part-time) during the previous week.

  • Unemployed: Did not work but actively searched for work in the last four weeks.

• Not in the labour force: Includes full-time students, homemakers, retirees, etc.

Example: A person who spent the previous week looking for a job is classified as unemployed.

Population Breakdown Example (2020)

Key Labour Market Statistics

• Labour Force (LF): Total number of workers (employed + unemployed).

• Unemployment Rate (U): Percentage of the labour force that is unemployed.

• Labour Force Participation Rate (LFPR): Percentage of the adult population in the labour force.

Example Calculation: If Canada has 18,055,000 employed, 1,346,000 unemployed, and 10,145,000 not in the labour force:

• Labour force:

• Unemployment rate:

• Adult population:

• Labour force participation rate:

Labour-Market Experiences by Demographic Group (2020)

Limitations of Unemployment Statistics

Interpretation Challenges

Unemployment statistics can be difficult to interpret due to frequent movement in and out of the labour force.

• Discouraged searchers: Individuals who want to work but have stopped looking are not counted as unemployed, leading to underestimation.

• Overestimation: Some may claim unemployment to qualify for benefits but are not actively seeking work.

• Underemployment: Part-time workers who want full-time jobs are not counted as unemployed.

Alternative Measures of Labour Underutilization (2020)

Duration and Causes of Unemployment

Duration of Unemployment

Policymakers are concerned with how long individuals remain unemployed.

• In 2020, the average spell of unemployment lasted 15.2 weeks.

• One-third of unemployed are out of work for a month or less; two-thirds for less than three months.

• Policy should focus on those with prolonged unemployment.

Why Is There Always Some Unemployment?

The unemployment rate is never zero, even in a healthy economy. It fluctuates around the natural rate (typically 6–7%).

• Natural unemployment rate: The rate to which the economy tends to return in the long run.

Types of Unemployment

Frictional Unemployment

Frictional unemployment arises because it takes time for workers to search for jobs that best suit their skills and preferences.

• Job search: The process by which workers find appropriate jobs.

• Sectoral shifts and innovation mean some unemployment is inevitable.

• Examples: Declining industries lose jobs, growing industries seek new workers.

Additional info: Frictional unemployment is a sign of a dynamic, innovative economy.

Public Policy and Job Search

Government policies can reduce frictional unemployment by helping workers find jobs faster.

• Employment agencies provide job information.

• Training programs help workers transition between industries.

• Employment Insurance (EI) partially protects incomes but may affect job search incentives.

Additional info: EI eligibility depends on hours worked and local unemployment rates.

Structural Unemployment

Structural unemployment occurs when the quantity of labour supplied exceeds the quantity demanded at the prevailing wage rate.

• Results from insufficient jobs in some labour markets.

• Caused by wages set above equilibrium due to minimum-wage laws, unions, or efficiency wages.

Example: If minimum wage is set above the market-clearing level, some workers cannot find jobs.

Quick Quiz: Review Questions

• How is the number of unemployed calculated in a population?

• What is the size of the labour force given employed and unemployed numbers?

• What is the main policy goal of employment insurance?

• What is an unintended consequence of employment insurance?

Additional info: Employment insurance may reduce the search effort of the unemployed, potentially increasing frictional unemployment.