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