The classical economic model of labor market relies on supply-demand analysis for studying the wage rate and the level of employment in an economy. And for showing how these variables are linked to output and productivity. The employment model is based on the assumption that all workers who are willing to work at the prevailing wage rate are able to find jobs. In reality, of course, not everyone who is wants to work finds a job. There’s always some unemployment. It implies that, at any point of time, there’s always under-utilization of society’s labor.
Who are employed and who are not:
- Employed: If a person worked full-time or part-time during the past week (or was on sick leave or vacation from a job).
- Unemployed: If a person didn’t work during the past week but looked for work during the past four weeks and
- Not in the labor force: If the person didn’t work during the past week and didn’t look for a work during the past four weeks. Ex: full-time students, homemakers and retirees.
There’s always unemployment. Why?
Even the economy is growing vigorously and many new jobs are being created, some people remain unemployed. Why unemployment has become a permanent feature in any economy. Here, we need to the kinds of unemployment. There are two kinds, one is frictional and the other is structural.
The labor market is characterized by a great deal of searching by both workers and firms. Unemployed workers search for suitable jobs, and firms with vacancies search for suitable workers. If all workers were identical and all jobs were identical, these searches would be short and easy. The problem is that neither the jobs nor workers are identical. Workers vary in their talent, skills, experience, goals and geographic location and the amount of time and energy they are willing to spend on the job. Similarly, jobs vary in skills and experience required, working conditions, locations, hours and pay. Because of these differences, an unemployed worker may search for several weeks before finding a suitable job. Similarly, a firm may search for a considerable time before It is able to hire a suitable worker. The unemployment that arises as workers and firms search for jobs and workers respectively is called frictional unemployment. Because, the economy is dynamic, with jobs continually being created and destroyed and workers continually entering and exiting the labor force, there’s always some frictional unemployment.
The workers who are not able to find jobs for a long time are called as chronically unemployed. This is not due to the matching process, but due to many other factors. People in these situations don’t seem to search for a work very intensively and don’t find a stable job. Structural employment can be of two reasons. First, unskilled or low-skilled workers often are unable to find suitable and long-term jobs. Second, is the reallocation of labor from industries that are shrinking, or regions that are depressed, to areas that are growing. If one industry is failing and another industry is prospering then the labor from the failing industry can be shifted to the prospering industry. But, the transition will take time and there will be unemployment until the workers are hired by the new industry and/or skilled enough to find a job.
According to Okun’s law, a one percentage point in the increase in the rate of cyclical unemployment reduces the output by 2.5 percentage points.
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