Last Updated 07 Apr 2020

Economic Cost of Unemployment

Category Employment
Essay type Research
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In the recent economic downturn, many companies collapsed, resulting in many jobless workers. Corporations, in order to survive the downturn reduced their head counts by retrenching. The unemployed couldn't find jobs as companies are not hiring due to the pessimism of the economy. This hence attributes to the unemployment rate which has reached the highest in n the United States since 1983. Unemployment rate has always been one of the key economic indicator that investors and traders look at for direction of the market.The reason being that unemployment may bring about serious consequences to the economy.

This essay will discuss the two types of unemployment and the economic cost of unemployment to a country. Frictional unemployment arises because people changing jobs will go through a period of unemployment. They include people who change job voluntarily, fired workers seeking re-employment, people being laid off temporarily due to seasonal demand and also young workers looking for their first job. Whilst these people get employed, new job seekers and laid off workers will replace them in unemployment pool.As the economy gets better, the unemployment pool grows as well. While unemployment may be waste of resource, on the contrary, frictional unemployment allows for a better reallocation of resources by moving people from low paying, low productivity job to a higher paying, higher productivity job thus resulting in a larger real GDP for the economy. Frictional unemployment is inevitable due to the imperfect functioning of the labor market.

Structural unemployment arises when there is a change in the demand for labor, both occupationally and geographically.Occupationally, when the labor force do not respond immediately to the demand for new skills, workers will realize that their skill does not match the jobs opportunities available. Their skills become obsolete and they find it increasingly hard to find a job as employers demand new skills. They will need to undergo retraining and upgrading to fit into the new jobs. During this period of retraining or upgrading, they are structurally unemployed. The demand for new skills is usually caused by technological advancement. Geographically, the demand for labor changes due to the migration of a industry.

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As the job opportunities move away, the workers become structurally unemployed. International competitiveness is one of the main reasons that an industry will relocate. The key difference between frictional unemployment and structural unemployment is that the skills of frictionally unemployed workers are still in demand thus they are able to find a job faster while structurally unemployed workers take a longer time to find a job as they need to undergo retraining and relocating henceforth is a bigger issue then frictional unemployment. (McConnell, C. Brue, S. and Flynn, S. (2009): Economics - Eighteen Edition) Economic Cost of Unemployment In this section, lets consider the economic cost of unemployment.

When a country unemployment rate is consistent with the natural unemployment rate(NRU), the economy is deemed to be producing its potential Gross Domestic Product(GDP) while an unemployment rate that is above the NRU will bring about economics costs which economist called GDP Gap. It is the difference between the actual and potential GDP. GDP Gap can either be negative or positive.In the case of an unemployment rate that is above the NRU, a negative GDP Gap signals that the economy is not functioning at its full potential and is sacrificing output. The following example illustrate the forgone output. Assuming that the average output per person in Country A is $10,000, a total of 2 million unemployed will result in a loss of $20 billion worth of services and products to Country A's economy. Okun's Law which quantifies the relationships between unemployment rate and GDP Gap indicates that for every 1 percentage point by which the actual unemployment rate exceeds the NRU, a negative GDP Gap of 2 percent occurs.

Okun's Law, www. investopedia. com)[14 Nov 09]. Lets calculate the GDP Gap for the United States using the Okun's Law. On Nov 6, 2009, the United States Bureau of Labor Statistics release unemployment rate for Oct 09 to be at 10. 2% while the US labor force stands at 154 million. (2009, Employment Situation Summary, www.

bls. gov)[14 Nov 09].NRU is around 5% hence excess unemployment stands at 5. 2% thus the GDP Gap is -10. 4%. Using 2008 GDP of around $14. 44 trillion (CIA World Fact Book, www.

cia. gov)[14 Nov 09], the GDP Gap worth approximately $1. trillion which is the equivalent of the sum of several developing countries' GDP . Conclusion From the above discussions, we understand that there are various types of unemployment and they are inevitable. While frictional unemployment is more persistent, structural unemployment is consequently more serious. Any economy with unemployment rate higher than the NRU will be sacrificing output thus capping the growth of a economy. Government will be putting a lot of effort to upgrade and educate their workers in order to prepare them for the ever changing consumer demand which in turns will bring in economical benefits to the country.

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Economic Cost of Unemployment. (2019, Feb 23). Retrieved from

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