What is Unemployment?

Unemployment occurs when a person who is actively searching for employment is unable to find work. Unemployment is often used as a measure of the health of the economy. The most frequent measure of unemployment is the unemployment rate, which is the number of unemployed people divided by the number of people in the labor force.

Key Takeaways

  • Unemployment occurs when workers who want to work are unable to find jobs, which means lower economic output, while still requiring subsistence.
  • High rates of unemployment are a signal of economic distress, but extremely low rates of unemployment may signal an overheated economy.
  • Unemployment can be classified as frictional, cyclical, structural, or institutional.
  • Unemployment data are collected and published by government agencies in a variety of ways.

How is Unemployment Defined?

Understanding Unemployment

Unemployment is a key economic indicator because it signals the (in)ability of workers to readily obtain gainful work to contribute to the productive output of the economy. More unemployed workers mean less total economic production will take place than might have otherwise. And unlike idle capital, unemployed workers will still need to maintain at least subsistence consumption during their period of unemployment. This means the economy with high unemployment has lower output without a proportional decline in the need for basic consumption. High, persistent unemployment can signal serious distress in an economy and even lead to social and political upheaval.

On the other hand, a low unemployment rate means that the economy is more likely to be producing near its full capacity, maximizing output, and driving wage growth and rising living standards over time. However, extremely low unemployment can also be a cautionary sign of an overheating economy, inflationary pressures, and tight conditions for businesses in need of additional workers.

While the definition of unemployment is clear, economists divide unemployment into many different categories. The two broadest categories of unemployment are voluntary and involuntary unemployment. When unemployment is voluntary, it means that a person has left his job willingly in search of other employment. When it is involuntary, it means that a person has been fired or laid off and must now look for another job. Digging deeper, unemployment — both voluntary and involuntary — can be broken down into four types.

Frictional Unemployment

Frictional unemployment arises when a person is in between jobs. After a person leaves a company, it naturally takes time to find another job, making this type of unemployment short-lived. It is also the least problematic from an economic standpoint. Frictional unemployment is a natural result of the fact that market processes take time and information can be costly. Searching for a new job, recruiting new workers, and matching the right workers to the right jobs all take time and effort to do, resulting in frictional unemployment.

Cyclical Unemployment

Cyclical unemployment is the variation in the number of unemployed workers over the course of economic upturns and downturns. Unemployment rises during recessionary periods and declines during periods of economic growth. Preventing and alleviating cyclical unemployment during recessions is a major concern behind the study of economics and the purpose of the various policy tools that governments employ on the downside of business cycles to stimulate the economy.

Structural Unemployment

Structural unemployment comes about through technological change in the structure of the economy in which labor markets operate. Technological change such as automation of manufacturing or the replacement of horse-drawn transport by automobiles, lead to unemployment among workers displaced from jobs that are no longer needed. Retraining these workers can be difficult, costly, and time consuming, and displaced workers often end up either unemployed for extended periods or leaving the labor force entirely.

Institutional Unemployment

Institutional unemployment is unemployment that results from long term or permanent institutional factors and incentives in the economy. Government polices such as high minimum wage floors, generous social benefits programs, and restricive occupational licensing laws; labor market phenomena such as efficiency wages and discriminatory hiring; and labor market institutions such as high rates of unionization can all contribute to institutional unemployment.

Measuring Unemployment

In the United States, the government uses surveys, census counts, and the number of unemployment insurance claims to track unemployment.

The US Census conducts a monthly survey on behalf of the Bureau of Labor Statistics called the Current Population Survey (CPS) in order to produce the primary estimate of nation’s unemployment rate. This survey has been done every month since 1940. The sample consists of about 60,000 eligible households, translating to about 110,000 people each month. The survey changes one-fourth of the households in the sample so that no household is represented for more than four consecutive months in order to strengthen the reliability of the estimates.

Many variations of the unemployment rate exist with different definitions concerning who is an "unemployed person" and who is in the "labor force." For example, the Bureau of Labor Statistics (BLS) commonly cites the "U-3" unemployment rate as the official unemployment rate, but this definition of unemployment does not include unemployed workers who have become discouraged by a tough labor market and are no longer looking for work.