Some terms to be familiar with while we’re discussing employment:

Labour force – the working population of an economy, i.e. all people of working age who are willing and able to work.
Dependent population – people not in the labour force and thus depend on the labour force to supply them with goods and services to fulfill their needs and wants. This includes students in education, retired people, stay at home parents, prisoners or similar institutions as well as those choosing not to work.

Employment is defined as an engagement of a person in the labour force in some occupation, business, trade, or profession.

Unemployment is a situation where people in the labour force are actively looking for jobs but are currently unemployed.

All governments have a macroeconomic objective of maintaining a low unemployment rate.

Full Employment is the situation where the entire labour force is employed. That is, all the people who are able and willing to work are employed – unemployment rate is 0%.

Changing patterns and level of employment

Over time, patterns and levels of employment change. It could be due to the effects of the business cycle that every economy goes through from time to time (growth and recession). It could be due to the changes to the demographics (population- age and gender) of the country. It could also be due to structural changes (dramatic shifts in how an economy operates). Let’s look at some ways in which this happens:

As an economy develops, it undergoes a structural change as output and employment shifts from primary sector to manufacturing and then to the tertiary (services) sectors. This can be seen in rapidly developing countries like India where there employment in agriculture and allied industries are rapidly falling and people are moving towards the fast-growing service sector, especially IT and retail.

In the same way, employment moves from the informal sector (formally unrecognised trades such as street vending- output is not included in GDP and incomes are not taxed) to the formal sector (recognised – included in GDP and taxes) as economies develops. People who previously worked as street vendors may work in registered firms, as the economy develops.

Overtime, as an economy develops, the labour force also sees an increase in the proportion of female labour. As social attitudes become progressive and women are encouraged to work, more women will enter the labour force and contribute to growth.

Similarly, as the country develops, the proportion of old people may increase in proportion to young and working people (because death and birth rates fall). This will cause the labour force to shrink and cause a huge burden on the economy. Japan is now facing this problem as their birth rates are falling and it is up to a shrinking labour force to support a growing dependent senior population.

As economies become more market-oriented (government enterprises and interventions decline), the economy will naturally see a large proportion of the labour force shift to the private sector.

Measuring unemployment

Economies periodically calculate the number of people unemployed in their economies, to check the unemployment rate and see what policies they should implement to reduce it if it is too high. They can do this in two ways:

  • Claimant count: unemployed people can file for unemployment claims (benefits/allowances provided to the unemployed job seekers) by the government. The government can count the total number of unemployment claims made in the economy to measure unemployment.
  • Labour surveys: economies conduct surveys among the entire labour force to collect data about it. This will include data on the number of people unemployed.


Unemployment rate = number of people unemployed / total no. of people in the labour force

There are some problems with measuring employment.

Under-employment: people may be officially classed as employed but they may be working fewer hours than they would like. For example, they may have a part-time job, but want a full-time job. This is considered as unemployment because they may not fulfil the working hours needed to be considered employed.

Inactivity rates: the long-term unemployed may become discouraged and leave the labour market completely. In effect they are not working, but they are classed as economically inactive rather than unemployed. So, the unemployment rate can be understated.

The causes/types of unemployment
  • Frictional unemployment: this occurs as a result of workers leaving one job and spending time looking for a new one. This type of unemployment is short-lived.
  • Cyclical unemployment: this occurs as a result of fall in aggregate demand due to an economic recession. When demand falls, firms will cut their production and workers will lose their jobs. There will be a nation-wide rise in unemployment.
  • Structural unemployment: this occurs due to the long-term change in the structure of an economy. Workers end up having the wrong skills in the wrong place – causing them to be unfit for employment. This can be explained by dividing it further:
    • Technological unemployment: this has rose in recent times as industrial robots, machinery and other technology are being substituted for labour, leaving people jobless.
    • Sectoral unemployment: unemployed caused as a sector/industry declines and leave its workers unemployed.
  • Seasonal unemployment: this occurs as a result of the demand for a product being seasonal. For example, the demand for umbrellas will fall in non-monsoon seasons, and so workers in umbrella manufacturing firms will become unemployed over those seasons.
  • Voluntary unemployment: when people choose not to work for various reasons – they want to pursue higher education, would like to take a break etc. Because they’re not actively looking for work, voluntarily unemployed people do not belong to the labour force!
The consequences of unemployment
  • People will lose their working skills if they remain unemployed for a long time and may find it even harder to find suitable jobs. As people remain unemployed, their incomes will be low, and living standards will fall.
  • Unemployment will also lead to poverty, homelessness and ill health and encourage people to steal and commit other crimes to make money– crime rates will rise.
  • People losing skills is not just detrimental to the unemployed individuals but also to firms who may employ these people in the future. They will have to retrain these workers.
  • Firms will have to pay redundancy payments to workers they lay off.
  • Workers will be demotivated as they fear they could lose their jobs, especially in a recession.
  • As firms lay off workers, they will be left with spare capacity- unutilised machinery, tools and factory spaces, leading to higher average costs.
  • Due to low incomes, people’s purchasing power/consumption will fall, causing demand to fall.
  • People will need to rely on charity or government unemployment benefits to support themselves. These benefits are provided from tax revenue. But now, as incomes have fallen tax revenue will also fall. This might mean that people remaining in work will have to pay more of their income as tax, so that it can be distributed as unemployment benefits to the unemployed. The burden on tax-payers will rise.
  • Public expenditure on other projects such as schools, roads etc. will have to be cut down to make way for benefits. There is opportunity cost involved here.
  • The economy doesn’t reach its maximum productive capacity, i.e., they are economically inefficient on the PPC. The economy loses output.
Policies to reduce unemployment

Both demand-side policies and supply-side policies help reduce unemployment. Demand-side policies will address the unemployment caused by demand deficiency (cyclical) while the supply-side measures will curtail structural and frictional unemployment.

  • Expansionary policies to increase demand: expansionary fiscal policies like cutting down taxes and increasing government spending (which also creates jobs) and expansionary monetary policies like cutting interest rates will help boost demand in the economy, to keep production and employment high. However these will take effect only with a time lag. Cutting tax rates won’t help if people don’t have confidence in the economy and prefer to save. Similarly, cutting interest rates will also be ineffective if banks are unwilling to lend to businesses, due to low confidence in the economy.
  • Depreciate the exchange rate: as the currency depreciates, the country’s exports will become cheaper and so export demand from abroad will increase, helping boost production and employment in the export industries.
  • Control inflation: higher inflation causes firms to lay off workers to reduce costs. So if the government tries to control inflation via monetary tools, it will help reduce firm costs and increase employment. But there is also the argument that as unemployment rises, incomes will also rise, driving up prices again.
  • Cutting unemployment benefits to provide incentive to work: many people don’t work because they are comfortable living off the unemployment benefits provided by the government. Cutting down on these benefits, will persuade them to look for work and earn. But this would of course, go against the welfare principle of the government.
  • Restricting imports and encourage exports: a lot of unemployment occurs when good quality and cheaper foreign products put domestic industries out of business. Controlling imports using import tariffs and quotas will encourage domestic firms to emerge and increase production and thus increase employment. Similarly, easing controls on labour-intensive export industries will open up new job opportunities. However such protectionist measures can harm the country in the long-run as efficient competition from abroad reduces.
  • Cutting down minimum wages: minimum wages increase firms’ labour costs and so they will lay off workers. Lowering the minimum wages will encourage firms to employ more labour.
  • Remove labour market regulations: letting the market have a free hand in the labour market – abolishing maximum working weeks, minimum wages, making it easier to hire and fire workers – will improve the labour market flexibility, can improve imperfections in the labour market. However, this can cause temporary unemployment and cause greater job insecurity.
  • Training/Retraining: structural employment issues can be eliminated by retraining the unemployed in skills required in modern industries. This will also improve occupational mobility. This is very expensive when done on a large scale across the economy, requiring training centres to be built, and trainers to be employed. The benefits of providing skills and training will only be reaped in the long-term.
  • Promote industries in unemployed areas: a lot of employment is created when government provide subsidies and tax breaks for new industries which set up shop in certain backward regions.
  • Increase geographical mobility of labour: frictional unemployment is caused because people can’t move around to find good jobs. The government can improve labour mobility by investing in transport and housing services.
  • Provide information: frictional unemployment can be eliminated to an extent by making information available about job vacancies to the unemployed through job centres, newspapers, government websites etc.

Notes submitted by Lintha

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7 thoughts on “4.7 – Employment and Unemployment

    1. They are included in the labour force! For example, in India about 92% of the labour force work in the informal sector.
      The informal sector itself isn’t included in official GDP statistics because they’re unregulated and don’t pay taxes, and as a result are off-record. But the number of people working in the informal sector (usually self-employed) is measured.
      For more info. on how informal labour is defined and measured, check out this ILO page:


  1. Hi, you said that people that choose to pursue higher education are considered as voluntary unemployed, but if they do not have the willingness to work, shouldn’t they be not included in the labor force?


    1. Yes, they aren’t included in the labour force. To be classified as unemployed, one has to be actively looking for work but not be finding any. I shall explicitly mention that!

      Liked by 1 person

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