9.3 Employment / Unemployment

1. Full Employment

What does "full employment" mean?

When economists talk about full employment, they do not mean that every single person in the country has a job. That would be almost impossible in any real economy. Instead, full employment means that all workers who want to work at the current wage rate are able to find a job.

In practice, there will always be a small number of people temporarily between jobs — for example, someone who just quit one job and is looking for another. This is considered normal and acceptable. Full employment is therefore said to exist when the only unemployment that remains is this kind of short-term, unavoidable unemployment.

2. Equilibrium and Disequilibrium Unemployment (Including Hysteresis)

Equilibrium Unemployment

Equilibrium unemployment occurs when the labour market is in balance — but some workers are still unemployed because they choose not to work at the going wage rate, or because they are in the process of searching for jobs that match their skills. This type of unemployment is consistent with the labour market working normally. It includes:

• Workers who are between jobs (searching for a better match)
• Workers who find the current wage too low and prefer not to work

This is sometimes called the natural rate of unemployment, and it exists even when the economy is healthy.

Disequilibrium Unemployment

Disequilibrium unemployment occurs when the labour market is not in balance — there are more people who want to work than there are jobs available, even at the current wage rate. This happens when something has gone wrong in the economy. For example:

• A recession (when the economy shrinks) leads to firms cutting jobs
• Wages may be "stuck" above the market-clearing level because of minimum wage laws or trade unions, meaning firms hire fewer workers than they would otherwise

In disequilibrium unemployment, unemployment is higher than the natural rate and is not being corrected automatically.

Hysteresis

Hysteresis is a concept that explains why unemployment can stay high even after the original cause has gone away. The word comes from science and means "lagging behind."

Imagine a recession hits and many people lose their jobs. Even after the recession ends and the economy recovers, some of those workers may remain unemployed for a long time. Why? Because:

• Long periods out of work cause workers to lose their skills — they become less attractive to employers
• Workers may lose confidence and stop actively searching for jobs
• Employers may distrust long-term unemployed workers and prefer to hire people who are currently in work
• Workers may have become used to receiving benefits and reduce their effort to find jobs

The result is that a temporary shock to the economy can cause permanently higher unemployment — the economy does not return to where it was before. This is hysteresis.