Full employment and the natural rate of unemployment - YouTube

In this video you’ll learn about the terms unemployment, the unemployment rate, full

employment and the natural rate of unemployment.

We’ll also use diagrams to demonstrate full employment and the natural rate of unemployment.

Unemployment includes the number of people in the labour force who do not currently have

a job and are (a) currently seeking a job and (b) available to work.

The unemployment rate measures unemployment as a percentage of the labour force, not the

population.

Full employment occurs when there is only frictional unemployment.

It can be represented diagrammatically on the PPC as any point along the production

possibilities curve.

This then means, it also corresponds to the LRAS curve at maximum output.

Full employment is sometimes used interchangeably with the natural rate of unemployment but

the two concepts are not necessarily the same.

The International Labour Organisation describes it as “…the situation where all people

who are available and searching for work can find a job at the prevailing remuneration

rates and conditions.”

They place the range of full employment between 3-6% in modern advanced economies.

This is seen here on the Keynesian aggregate supply curve at the portion of the curve that

is vertical.

Hence the label, Yfe or output at full employment.

Second is the natural rate of unemployment.

 It is a concept put forward by Milton Friedman from the monetarist school of economics.

The natural rate of unemployment is the level of unemployment that corresponds to the level

of unemployment that would exist if the economy were at its long run level of production.

At this point, inflation is stable.

If unemployment were to decrease, the inflation rate would rise.

The natural rate includes both frictional and structural unemployment, but not cyclical

and therefore cannot be reduced by using monetary and fiscal policy.

It can only be reduced by using supply-side policies.

The natural rate of unemployment will occur when the economy is operating at its potential

level of output in the long-run, shown here by Y*. 

Also, when the economy is in long run and short run equilibrium at Y*, the expected

inflation rate is equal to the actual inflation rate.

This will not be the case when actual output is above or below potential output which is

at Y*.

To take it a step further, let’s diagram the natural rate of unemployment specifically.

The labour force is represented by the first supply curve aptly labeled labour force.

Given the demand for labour DL, the actual number of workers taking up jobs is less than

what we would expect given this information.

In actuality, the workers who are able, willing and do take up employment are represented

by SL.

The two supply curves SL and Labour Force converge because at higher wage rates we would

anticipate more workers accepting jobs.

As it stands, the wage rate will be equal to W* and the quantity employed is Q1.

The distance from Q1 to Q2 represents the natural rate of unemployment.

This is because at any given time in an economy, there will be some workers who do not accept

jobs and are waiting for something better.

Additionally, some workers cannot take certain jobs due to the immobility of labour.

This may be either geographic or occupational.

There are various other reasons to explain this, but the unemployment that exists from

Q1 to Q2 is frictional and structural.

Given this information, what can a government do in order to reduce its natural rate of

unemployment?

It could pursue a variety of supply side policies that would increase the incentive to work.

They could also consider policies that help reduce the geographical and occupational immobility

of labour.

Several potential policies are listed here.

By now you should have a better understanding of the terms unemployment, the unemployment

rate, full employment and the natural rate of unemployment.

You should also now be able to use some diagrams to demonstrate both full employment and the

natural rate of unemployment.

There are some complicated parts to these concepts, so feel free to leave a question

or comment if you have one and let’s try and answer them together.

That’s us done for now and I will see you in the next one!