Natural Unemployment Formula

Introduction

Is it possible for an economy to have no or zero unemployment? Is it possible that all the workers in an economy are on jobs and not even a single worker is jobless? Economists believe that this is not possible in real life scenarios and in a healthy economy; there is always a minimum level of unemployment, which is called natural unemployment. So, one of the macroeconomic objectives of government is to have full employment, that is, unemployment at the natural rate of unemployment.  In this article, we will explain the concept of natural unemployment in detail.

Natural Unemployment Definition

The minimum unemployment rate that would occur in a well-functioning economy if there were no cyclical unemployment is called the natural unemployment. In other words, it is unemployment resulting from real or voluntary economic forces in a healthy and growing economy. It explains how workers are moving from job to job; the number of unemployed is replaced by technology or automation, and those who lack the skills to gain employment. It is an unemployment which includes only the structural and frictional unemployment and not the cyclical unemployment.

Significance

The significance of natural unemployment is that the natural rate of unemployment is considered the lowest acceptable level that a healthy economy can sustain without causing inflation. Economists are of the view that government can reduce cyclical unemployment by using fiscal policy, monetary policy or supply side policies, however, these policies are unlikely to change natural unemployment.

Natural Unemployment Formula

Here is the formula to calculate the natural rate of unemployment: 

Natural Unemployment Rate = [(FU + SU)/LF] x 100%

Here

FU = Frictional Unemployment

SU = Structural Unemployment

LF = Labour Force

Unemployment Terms

The following are some unemployment terms:

Dependent Age Group

The dependent age group is the population of age below 15 and above 64 years. Here, 15 years is the school leaving age and 64 is the retirement age according to the World Bank and the United Nations Organisation (UNO) criteria.

Working Age Group

The working age group is the population of age from 15 to 64 years. It is assumed here that the school leaving age is 15 years and the retirement age is 64 years. It must be kept in mind that different countries have different value of the school leaving age and the retirement age.

Labour Force (LF)

The labour force or workforce of a country is composed of the people in the working age group (from 15 to 64 years) who are willing to work and able to work. This is equal to a combination of the number of employed individuals (E) and the number of unemployed individuals (U) seeking work.

Labour Force = E + U

Not in the Labour Force (NLF)

NLF is equal to those individuals who are neither employed nor unemployed and not seeking work.

Adult Population

The adult population is the sum of the labor force and not in the labor force.

Adult Population = LF + NLF

Unemployment Rate

The unemployment rate is the number of employed people calculated as a percentage of the size of total labor force. It changes when the number of employed individuals and the number of unemployed individuals change.

Unemployment Rate = (U/LF) x 100%

Natural Unemployment Graph

Natural unemployment occurs when there is equilibrium in the labour market and there is no shortage or surplus. This happens when the forces of demand for labour and supply of labour intersect. The following graph illustrates this phenomenon: 

In this graph, the quantity of labour is taken on the horizontal axis (x-axis) and the wage rate is taken on the vertical axis (y-axis). S1 is the supply curve of labour which shows the willingness and ability of the households to sell labour at various wage rates. S0 is the supply of labour which is composed of those workers who actually take jobs. The equilibrium point of the labour market is E0 where the demand for labour D0 and the actual supply of labour S0 intersect. W0 is the equilibrium wage rate and L0 is the equilibrium level of employment or full employment level. At W0, some workers are still unemployed due to frictional and structural reasons and E0A is the natural unemployment. This is the minimum level of unemployment which will prevail in an economy at any given point in time.

Full Employment

The term full employment means a situation of an economy when there is no cyclical unemployment or demand-deficient unemployment. It is shown by L0 in the above graph. This full employment L0 is a target to achieve when an economy is performing well. At L0, there exists the natural unemployment, which means the minimum level of unemployment prevailing in the economy because there are always workers looking for a job, including fresh graduates or those who are replaced by technology. Therefore, in an economy, there is always a momentum of labour that represents natural unemployment.

Hysteresis

If the unemployment is cyclic, institutional, or policy-based, then it is not considered as natural unemployment. However, structural unemployment is part of natural unemployment. A rise in structural unemployment can lead to an increase in natural unemployment. This is called hysteresis by economists. Steep recessions or economic downturns can increase the rate of natural unemployment if workers lose the skills to find full-time jobs or if particular businesses close and is unable to reopen due to excessive loss of revenue. 

Causes of Natural Unemployment

The following are some causes of natural unemployment:

Less Demand for Labour

Economists revealed that if unemployment existed in an economy, it was mainly due to the lack of demand for labour or workers. This economy would need to be stimulated through effective fiscal or monetary measures. Therefore, history reveals that the natural flow of workers continues back and forth between companies even during robust economic periods.

Institutional Factors

According to the general equilibrium model of economics, at perfect equilibrium, the natural unemployment is equal to the rate of unemployment in a labour market. This is mainly the difference between the workers who are willing and able to do a job at the current wage rate and those who take the jobs. According to this definition of natural unemployment, it is possible for institutional factors, like minimum wage or high degree of unionisation, in order to increase the natural rate over the long-run.

Effects of Inflation on Unemployment

Many economists believed that there is a direct relation between the level of unemployment and the level of inflation. John Maynard Keynes wrote a book named The General Theory of Employment, Interest, and Money in 1936. In his book, he explained the relationship between unemployment and inflation.

The Phillips curve systematised this relationship, which explained that unemployment moved in the opposite direction of inflation. If the economy were fully employed, then there would be inflation for sure, and with periods of low inflation, the unemployment rate must rise or persist.

The Phillips curve defamed after the great stagflation of the 1970s. Inflation and unemployment both rise during stagflation, arising a question on the correlation between strong economic activity and inflation, or between unemployment and deflation.

Classical Theory of Unemployment

Many theories have been formed to explain and understand the concept of unemployment. Advocates of the classical theory of unemployment believed that full employment exists in an economy. They consider full employment as normal because economies automatically incline towards full employment when the supply and demand for labour in the market are at equilibrium.

Types of Unemployment

The following are some types of unemployment:

Frictional Unemployment

A type of unemployment that is caused by workers seeking, switching or searching for jobs and firms searching for workers is called frictional unemployment.

Structural Unemployment

A long-term chronic unemployment that happens when the economy is not in recession is called a structural unemployment. This happens when there is a mismatch between the skills of workers available for jobs and the requirements of vacant jobs. The main cause of structural unemployment is the growth or decline in some industries leading to the creation of jobs for which suitable skilled workers are not available or the redundant workers for which suitable jobs are not available. 

Cyclic Unemployment

The unemployment created by economic recessions is called cyclic unemployment. According to the U.S. Bureau of Labor Statistics, the difference between the natural rate of unemployment and the current rate of unemployment is called the cyclical rate of unemployment. 

Cyclic Unemployment= Actual Unemployment - Natural Unemployment

Actual Unemployment Rate

The natural rate and cyclic rate of unemployment are collectively known as the actual rate of unemployment.

Actual Unemployment = Natural Unemployment + Cyclical Unemployment

NAIRU

NAIRU stands for non-accelerating inflation rate of unemployment. This is the rate of unemployment that exists when the inflation rate is not accelerating; that is, it is neither increasing nor decreasing. Milton Friedman, Edmund Phelps, and Friedrich Hayek, all Nobel Prize winners in the field of economics, have contributed significantly to the theory of natural unemployment.

Conclusion

In conclusion, the natural unemployment rate is the lowest unemployment rate that arises from real or voluntary economic forces. It is a common phenomenon in a labour market where labour or workers move in and out of companies or jobs. Because of natural unemployment, full employment is impossible to attain in an economy. The unemployment is not considered natural if it is cyclic, institutional, or policy-based unemployment.