How does the Unemployment Rate Effect the Economy?

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Updated: May 16, 2022
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The rate of unemployment is more than a percentage of unemployed people, it is used as key a macroeconomic indicator when determining the health of an economy. The unemployment rate is found by taking the labor force and dividing it by the number of people who are currently searching for a job, also know as the number of unemployed people. The unemployment rate is composed from three types of unemployment: frictional, cyclical, and structural. This could create a potentially serious problem for policy makers because high unemployment rates don’t necessarily mean that the economy is slacking.

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Economists refer to the unemployment rate as a lagging indicator of the economy because the economy usually heals itself before unemployment rates can drop again. When someone loses their job, their steady income disappears, causing them to pay less taxes to the state and federal government. As more people become unemployed the government will have to make up for the tax revenue loss by raising taxes for both employed and unemployed, in turn giving tax payers even less money to spend freely. Since almost everyone who is unemployed will eventually become eligible for unemployment insurance and will slowly take money out of the economy rather than contribute to it with taxes, the government will again have to raise taxes if unemployment were to rise more. With more unemployed workers, there is less money to go around, causing overall demand of goods and services to fall. Economists say that unemployment imposes a ripple effect on the economy because of small-scale effects it has on individuals as well as the larger-scale effects it has in the markets. In addition, the U.S. Department of Labor’s Bureau of Labor Statistics releases an employment situation summary once a month, giving investors something to think about the first week of trading.

Being fired or quitting are not the only ways people lose their job. With a competitive moving U.S. economy constantly evolving, shifts in markets will naturally happen. In a capitalist market some companies will strive while others will fail. This makes judging the overall health of the economy more difficult with just one number. In turn policy makers will look at other statistics to help them come to more accurate conclusions. One of the three main rates that is looked at is the frictional unemployment rate.”Frictional unemployment arises as a result of the normal labor turnover that occurs in a healthy dynamic economy. At any given time employed workers change jobs, lose jobs, or leave the labor force. Similarly, unemployed workers may find employment or may decide to stop seeking employment, while still others may enter or reenter the labor force. Even in the best often times there is some unemployment that arises from this dynamic friction in the economy” (Rissman). For example, to put this in to perspective, worker A builds computers for Apple. Eventually the consumer demand for Apple computers declines and worker A is fired from his position due to Apple having to cut their wage cap. He then goes and takes his skill set and transfers it to another company that builds computers. He applies and lands a position there. Since worker A can take his skills and apply them else where he is said to be frictionally unemployed in the time he is looking for a new job. This percentage can be found by taking the civilian labor force and dividing it by the number of people who are frictionally unemployed.

The second kind of unemployment that is looked at is the cyclical unemployment. Cyclical unemployment similarly coincides with the economic output. Economic output is the amount of goods and services that are being produced or serviced within the US. When the economy has a low output cyclical unemployment will rise due to less demand from businesses for labor. Let’s say that restaurant A is the most popular place in town to eat. Eventually people grow old of the food and restaurant A starts getting less and less customers. The demand for labor then decreases causing cyclical unemployment to rise. Since Minimum wage or real wages do not fall as aggregate demand for labor does, businesses will have to save money in order to make profit. One way they can do this is by cutting their wage cap. In other terms they will reduce employee hours then move to firing workers to save money. Those workers are then said be called cyclically unemployed because the demand for their work is not needed. Cyclical unemployment is temporary, as the name suggests, businesses will cycle through employees over time, jobs open in one place and close in another.

In a similar manner you can find the structural unemployment rate by dividing the civilian labor force by the number of people structurally unemployed. When someone becomes structurally unemployed they are either forced to take a lower level job (underemployed) or to choose to not have a job at all which at that point they wouldn’t be considered unemployed. “Structural unemployment is the result of shifts in the relative demand for different types of labor” (Rissman). Whether the shift comes from changes in prices, technological advancements, or taste and preference, the point is that the labor demand for one type of job falls as the labor demand rises for another. For instance Linda the secretary, 30 years ago used paper to write everything down and filing cabinets to store files. As the years pass and the turn of the 21st century nears, computers are being introduced more and more into daily life. The need for keeping things in physical form is less important. Since Linda is old and cant adjust to using a computer for administrative work she becomes less and less capable at completing basic tasks that other young secretaries can do. She eventually is marginalized due to her incapabilities. Linda is now structurally unemployed because her skill set is out dated and wont be able to find the same position with her skill level anywhere else. A real life example of this would be the hundred of thousands of manufacturing jobs the US has been lost to China due to substantially cheaper production costs.

What is the difference between actual unemployment rate and natural unemployment rate? When determining the overall health of an economy unemployment plays a huge roll. The rate of unemployment and all the factors that go in to it effects everyone that contributes to society. When changes are made to fiscal and monetary policies, government policy makers must look past the actual unemployment rate and deeper in to what is contributing to unemployment itself. Policy makers must take into account not only the unemployment rate but the how the unemployment rate correlates with business cycles. “The natural rate of unemployment is defined simply as the rate of unemployment that is compatible with a steady inflation rate. The natural rate can therefore be thought of as the rate of unemployment that would occur in the absence of cyclical fluctuations. In other words the natural rate is essentially the sum of structural and frictional unemployment. Because structural and institutional factors change over time, the natural rate of unemployment will also vary” (Rissman). Essentially the natural unemployment rate is the unemployment rate without the down sides of the business cycle (people leaving their jobs). The natural unemployment isn’t something that can be observed, it is an estimate. The natural rate of unemployment moves slow over time as the actual unemployment rate fluctuates above and below it. But why does this matter? Under some economic conditions, economists feel that modifications to fiscal and monetary policies can reduce cyclical unemployment. As the unemployment rate nears the natural unemployment rate, the need for fiscal and monetary policy diminishes. However, such polices can not change structural and frictional unemployment, hence why it is important to know the difference between actual and natural unemployment when altering policies.

In turn, the United States government created unemployment insurance programs as part of the Social Security Act of 1935. These programs provide fixed cash amounts to eligible workers who become unemployed through no fault of their own, while they look for a new job. The unemployment insurance is a joined program between the federal government and individual state governments. The funds that benefit the unemployed are acquired through FUTA or the Federal Unemployment Tax Act. FUTA is a federal provision that oversees as well as allocates the costs of administering the unemployment insurance and job service programs in all states. As a result, if employers have paid more than $1,500 in wages to employees during any calendar quarter, they are required to pay federal unemployment taxes. Most states already have an unemployment tax of their own in place. These unemployment taxes are then used to fund the unemployment account of the government. “The FUTA tax rate is 6.0%. The tax applies to the first $7,000 paid to each employee as wages during the year. The $7,000 is often referred to as the federal or FUTA wage base”(IRS). To put this into perspective, if you had five employees and paid each of them $7,000 in wages, you would pay $420 per employee in FUTA taxes, [6% x ($7,000 x 5 employees)]. Once someone earns more than $7,000 then their employer will stop paying FUTA on them. These funds are then distributed to those who are eligible that are without jobs. There are fifty unemployment programs, one for each state and one for every U.S. territory outside the states. Though each program is separate from each other, all programs have to follow specific guidelines set by the federal law. The U.S. Department of Labor watches over the programs and frequently checks in with each state to ensure that the guidelines are being followed.

When applying for unemployment insurance there are two main requirements that applicants must meet before they can receive benefits. They must either meet the state threshold for wages earned or time worked in said based period. They also must be at no-fault for losing their job, which is determined by the state and may require proof, but usually the state does their research before requesting any. Unemployed workers can submit applications by phone, in their state unemployment website, or in the unemployment office itself. Claims usually take two to three weeks to process and get approved. Once approved Unemployed workers can receive up to twenty six weeks of benefits a year. These weekly cash benefits aim to replace half the individuals regular wage. In addition to getting benefits weekly, those who who receive them must file weekly or bi-weekly reports that shows their employment status. While the eligible unemployed are receiving benefits, there are a few rules they must follow. One of which being that you can not deny work, meaning that if someone offers you a job, side-job, chore, anything that gives you the opportunity (within the law) to earn money, you can not deny it. With that being said, you also have to report any money you’ve earned on weekly or bi-weekly reports.

The best way I can explain this is with the weather, the actual temperature vs what it feels like outside. You wake up in the morning and check the weather, it is 25 degrees, but then you walk outside and it is so cold you can’t breathe. With the actual temperature, wind chill, UV index, humidity

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How does the unemployment rate effect the economy?. (2019, May 08). Retrieved from