99 Cyclical Unemployment
What you’ll learn to do: examine causes and types of unemployment, including cyclical, frictional, structural, and natural unemployment
Workers become unemployed for different reasons, some of which are more problematic than others. Consider the following two examples, neither of which is considered a “layoff”: a college student quits her part time job when she graduates from college to look for a career and a steel worker becomes replaced by an industrial robot. We typically don’t see the former as a major social problem, but we often see the latter that way. What causes different types of unemployment and what government policies, if any, can help get those individuals back to work? These questions are what we’ll consider next.
Learning Objectives
- Analyze cyclical unemployment
- Explain the relationship between sticky wages and employment using various economic arguments
Cyclical Unemployment
When people think of unemployment, most of the time they imagine a situation where the economy slows down and businesses respond to the decrease in demand for their products by reducing production and laying off workers. Let’s explore this “cyclical” unemployment in more detail by considering the market for labor.
Firms hire labor because they need workers to produce their products. Workers supply labor in order to earn income. Together, these represent the demand for and supply of labor, as we explained briefly earlier in the module on supply and demand. Equilibrium in the labor market occurs at the wage rate where the quantity of labor demanded equals the quantity of labor supplied. The equilibrium wage rate and employment level are shown in Figure 1.
One primary determinant of the demand for labor from firms is how they perceive the state of the macro economy. If firms believe that business is expanding, then at any given wage they will desire to hire a greater quantity of labor, and the labor demand curve shifts to the right. (We assume that there is no substantial change in the age structure of the labor force, institutions and laws affecting the labor market, or other factors that might shift the supply curve for labor.)
Conversely, if firms perceive that the economy is slowing down or entering a recession, then they will wish to hire a lower quantity of labor at any given wage, and the labor demand curve will shift to the left. The variation in unemployment caused by the economy moving from expansion to recession or from recession to expansion (i.e. the business cycle) is known as cyclical unemployment.
From the standpoint of the supply-and-demand model of competitive and flexible labor markets, unemployment represents something of a puzzle. In a supply-and-demand model of a labor market, as illustrated in Figure 1, the labor market should move toward an equilibrium wage and quantity. At the equilibrium wage (We), the equilibrium quantity (Qe) of labor supplied by workers should be equal to the quantity of labor demanded b