The Government has a strong incentive to maximise the size of the labour force and ensure that as many people are working as possible. Fiscally it is more beneficial because tax revenues increase during periods of high employment, as the Government has more people earning and therefore it receives more tax receipts. Low levels of unemployment would result in reduced social security payments which can be more beneficially spent elsewhere in the economy.
If there are more people working then the economy is closer to the production possibility frontier, which results in people earnings increasing and there being and there possibly being a wider range of goods available in the economy. These factors may also result in higher rates of growth in the economy over time, as the higher levels of demand in the economy may encourage firms to innovate to maximise their profit potential in the larger economy.
Frictional and structural unemployment and hysteresis can result in huge social problems. People out of work encounter huge stresses in attempting to find new employment, as they feel worse about themselves and are concerned about their declining standard of living. This can also result in crime because some people may consider it an easier option. This can be especially true for individual areas, with the decline in an industry or service predominantly effecting the same social classes or skills groups. In some cases if they live close to each other in an area such an economic decline could increase crime levels significantly.
Employment is usually considered on a macroeconomic rather than a microeconomic level to deal with unemployment. It is considered more cost and time effective to alleviate structural and frictional problems with job centres and work schemes or tackle persistent unemployment through the whole economy. The microeconomic response would have to address individual markets and it would probably be a lot more difficult and inefficient to correct than a more general macroeconomic policy.
This article was written by Jonathan McHugh in June 2005
6/1/05
What Is Meant By Full Employment?
Full employment exists when all firms in the economy are able to hire all the labour that they want at the equilibrium wage rate and all the workers are prepared to accept jobs at that wage rate are employed. It also takes into account structural and frictional unemployment, discouraged workers and the effect of technology on employment. However, there are ways dynamically to adjust the level of employment through addressing problems with involuntary and voluntary unemployment.
In figure 1 the equilibrium of full employment is represented on point A (labour size N*, wage rate W*), as it is the intersection between line NS, the aggregate of workers desires to accept jobs at particular real wage rates and line ND, the aggregate of firms desires to employ labour at particular wage rates.
Any other level of employment would not be regarded as full employment and any wage above the equilibrium’s wage rate of W* would create unemployment. For example, trade unions may be able to ask for a minimum wage, say W1. At W1 the higher wage rates would create an incentive for more of the labour force to seek employment, as they would be financially better off. Similarly, the higher wages would create a disincentive for firms to employ as many workers, as their revenues would decrease. As a consequence there will be a move from full employment to unemployment, with the size of unemployment being between N2 and N3. This is created as a result of the W1 wage rate creating a greater desire for labours to supply their services than for the firms to employ them. The only way to reduce these effects and bring back full employment would be to reduce the wage rate from W1 to W*
Trade unions may also be able to put training requirements on working in a market, which would shift the NS curve to the left to NSu. In this example the size of unemployment created would be between N2 and N3 as a result of these employment barriers.
There are people who are unable to find work despite their desire to, as structural and frictional problems prevent them. Many people are unable to find work because there aren’t jobs available in their area or their professions are in decline. For example, a coal miner could be unemployed in his hometown as a result of the local pit which hired the majority of the village closing down, despite the fact that he has the desire to work. In such a case he may have to work elsewhere, even abroad to match his skills with a company, at possibly huge emotional distress.
Frictional unemployment exists because of the inefficiencies involved in matching up the right employee to the right job, which normally takes significant time and results in people being unemployed in the interim. The size of these unemployed workers for both structural and frictional problems is the difference between N*, the aggregate of workers prepared to accept jobs and N1, the aggregate of people willing to accept jobs at the correct price but are unable to find the right ones. They are not classified as disrupting full employment in the labour market, as they are unable to initiate the decision to accept or refuse an employers offer in the short run. However, over time these will erode individual reasons for lack of employment but will be replaced by similar circumstances elsewhere in the economy. If the government was able to reduce these effects then the NS curve would shift to the right, closer to the LF curve, the curve representing the aggregate of the willing to work labour market. As a result, the level of full employment would increase.
There are people who are able to work in the economy but choose not to as they do not have the inclination and find the opportunity cost of employment too great. For example, they may consider the cost of finding a job too strong to justify the benefits of working and so they remain economically inactive. The size of this hysteresis in an economy is the difference between N1, the level of the labour force offering their services and NT, the total size of the labour force population in the short run. These people are not classed as effecting the labour market as they have chosen to stay out of the economic bargaining for employment or to make the effort to approach firms. However, reducing the subsidies given to the unemployed or improving the skills for these people to give them higher earning potential would increase their incentives to work and it should shift the NS curve (and possibly the LF curve) to the right and increase the level of full employment.
Advances in technology can have bearings on the level of employment in an economy as firms realise that they are able to employ less employees with the same amount of output with new capital. Figure 2 shows a set of production possibility frontiers. If there was an improvement in technology there would be a shift in the PPF curve from y=f(N) to y=f’(N). Consequentially, the output level Y1 can be produced using only N2 levels of labour, a reduction of labour in the economy. However, the reduction in labour should reduce output costs which should lower market price and then stimulate market demand so that output may increase to Y2, an increase in employment to N3.
This piece was written by Jonathan McHugh in June 2005
In figure 1 the equilibrium of full employment is represented on point A (labour size N*, wage rate W*), as it is the intersection between line NS, the aggregate of workers desires to accept jobs at particular real wage rates and line ND, the aggregate of firms desires to employ labour at particular wage rates.
Any other level of employment would not be regarded as full employment and any wage above the equilibrium’s wage rate of W* would create unemployment. For example, trade unions may be able to ask for a minimum wage, say W1. At W1 the higher wage rates would create an incentive for more of the labour force to seek employment, as they would be financially better off. Similarly, the higher wages would create a disincentive for firms to employ as many workers, as their revenues would decrease. As a consequence there will be a move from full employment to unemployment, with the size of unemployment being between N2 and N3. This is created as a result of the W1 wage rate creating a greater desire for labours to supply their services than for the firms to employ them. The only way to reduce these effects and bring back full employment would be to reduce the wage rate from W1 to W*
Trade unions may also be able to put training requirements on working in a market, which would shift the NS curve to the left to NSu. In this example the size of unemployment created would be between N2 and N3 as a result of these employment barriers.
There are people who are unable to find work despite their desire to, as structural and frictional problems prevent them. Many people are unable to find work because there aren’t jobs available in their area or their professions are in decline. For example, a coal miner could be unemployed in his hometown as a result of the local pit which hired the majority of the village closing down, despite the fact that he has the desire to work. In such a case he may have to work elsewhere, even abroad to match his skills with a company, at possibly huge emotional distress.
Frictional unemployment exists because of the inefficiencies involved in matching up the right employee to the right job, which normally takes significant time and results in people being unemployed in the interim. The size of these unemployed workers for both structural and frictional problems is the difference between N*, the aggregate of workers prepared to accept jobs and N1, the aggregate of people willing to accept jobs at the correct price but are unable to find the right ones. They are not classified as disrupting full employment in the labour market, as they are unable to initiate the decision to accept or refuse an employers offer in the short run. However, over time these will erode individual reasons for lack of employment but will be replaced by similar circumstances elsewhere in the economy. If the government was able to reduce these effects then the NS curve would shift to the right, closer to the LF curve, the curve representing the aggregate of the willing to work labour market. As a result, the level of full employment would increase.
There are people who are able to work in the economy but choose not to as they do not have the inclination and find the opportunity cost of employment too great. For example, they may consider the cost of finding a job too strong to justify the benefits of working and so they remain economically inactive. The size of this hysteresis in an economy is the difference between N1, the level of the labour force offering their services and NT, the total size of the labour force population in the short run. These people are not classed as effecting the labour market as they have chosen to stay out of the economic bargaining for employment or to make the effort to approach firms. However, reducing the subsidies given to the unemployed or improving the skills for these people to give them higher earning potential would increase their incentives to work and it should shift the NS curve (and possibly the LF curve) to the right and increase the level of full employment.
Advances in technology can have bearings on the level of employment in an economy as firms realise that they are able to employ less employees with the same amount of output with new capital. Figure 2 shows a set of production possibility frontiers. If there was an improvement in technology there would be a shift in the PPF curve from y=f(N) to y=f’(N). Consequentially, the output level Y1 can be produced using only N2 levels of labour, a reduction of labour in the economy. However, the reduction in labour should reduce output costs which should lower market price and then stimulate market demand so that output may increase to Y2, an increase in employment to N3.
This piece was written by Jonathan McHugh in June 2005
How Might Unemployment Be Above The Natural Rate?
Prior to the drop in demand the economy was resting at point A, wage level W* and employment level N* in figure 4. There is a shift in the demand for labour by the firms from P0 to P1 as a result of less profitability in the economy. If the employees as a result of trade unions encourage wage stability (or sticky wages) then the price level would remain at W*. This has the effect of creating voluntary employment between N1 and N* as the real wage has been forced up as the price level has lowered and the wages have remained the same. If employees do not perceive a price level fall but supply to their expected real wage not money wage, then NS0 remains the supply curve as they haven’t perceived the fall in the price level. They will then accept a lower monetary wage as the real wage has increased as a result of the price level falling faster than their wages. This is still voluntary, as a further fall in money wages would reduce real wages back to the equilibrium level. In the long run the stickiness of wages should erode following contract negotiations over time, which should shift the labour supply curve from NS0 to NS1, resulting in full employment at N* but a lower wage rate of W2.
Voluntary unemployment occurs when a decline in the output of the economy from Y* to Y1 (shown by figure 3) prevents firms from selling as many goods as before. As a consequence there will be a shift in the labour demand curve from ND0 to ND1 in figure 4 and the firms will not hire beyond N1 as any extra employment would reduce their profits. As a result the labour demand curve B C N1 is kinked at C on figure 4. If the money wage stays at W* then D will not be anywhere near the unconstrained supply or demand curves, creating involuntary employment as a result. Consequentially, because workers cant price themselves in being employed at lower wages there will not be a reduction in the level of unemployment in the economy.
Returning to figure 1, with NC (the constrained labour demand) being the total level of employment and W* being the wage rate there would be cyclical unemployment between NC and N* and structural and frictional unemployment between N* and N1. At wage rate W1 cyclical unemployment would be between NC and N2, classical unemployment between N2 and N3 and frictional and cyclical unemployment between N3 and N4. Such demand deficient unemployment can add to hysteresis and result in increased structural unemployment and a shift of the labour force and labour supply curves to the left as a result of discouraged people not being able to find positions and loosing their skills.
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