Labor Market, Unemployment, and Microeconomics Explained

Defining Unemployment, the Labor Market, and Microeconomics

There is always some level of unemployment in any economy, which is not automatically a bad thing, as many people assume. The presence of unemployment—usually expressed as a percentage—indicates that at any given point in that economy, there are people looking for work and employers looking for better employees. In economics, the key factor when determining the level of unemployment is the number of workers who are eager to work but cannot find work. Unemployment refers to circumstances involving unwanted job losses and willing workers without jobs. The unemployed are those individuals who are currently without work but actively seeking it. A person cannot be classified as unemployed when they are not looking for a job. Consequently, in economics, not everyone who is not employed is considered unemployed (Romer, 2011).

The market in which employers search for employees, determine wages, and workers seek employment opportunities is referred to as the labor market. Smaller, interrelated markets with different skills, training requirements, and locations make up local and international labor markets. Labor markets exchange information about employment conditions, wage rates, levels of competition, and working location between the workforce and job seekers. Generally, more common jobs—such as those held by drivers, secretaries, and clerks—serve as the starting point from which general wage levels are established in a labor market (Romer, 2011).

The branch of economics that examines how companies, individuals, and households allocate scarce resources in society is referred to as microeconomics. Macroeconomics, by contrast, analyzes the mechanisms of the national economy as a whole—including output, income, and growth—by developing, testing, and employing models and hypotheses about how the national economy functions. The theories developed in macroeconomics are used both to determine how economic policies should be applied and to forecast events that may affect the national economy positively or negatively (Romer, 2011).

Many people view economics as a complex study of tables, statistics, charts, and numbers. In actuality, economics simply studies human behavior in satisfying needs and wants, on the assumption that this behavior is rational (Romer, 2011).

Types of Unemployment and Their Causes

Unemployment is beneficial for any economy in that it helps keep inflation in check. Even in very healthy economies, some level of unemployment must be present. It is for this reason that a natural rate of unemployment was established. The natural rate of unemployment was articulated by two renowned American economists, Edmund Phelps and Milton Friedman, both of whom won the Nobel Prize in economics. The natural rate of unemployment in the United States currently stands at around five percent (Acocella et al., 2008).

There are several distinct types of unemployment that together account for the level of unemployment present in any economy. They include frictional, structural, seasonal, cyclical, and surplus unemployment. Frictional unemployment takes place when skilled workers leave their current job and begin searching—or waiting—for a position that better fits their skills. Workers may seek a job that pays more or offers greater fulfillment compared to their current role (Acocella et al., 2008).

Structural unemployment is generally considered more serious than frictional unemployment. It occurs when willing workers lack the skills required for available jobs. Structural unemployment is influenced by changes in consumer demand and technology, both occupationally and geographically. Geographically, certain skills are in greater demand in some regions than others; occupationally, certain skills are more sought after than others (Acocella et al., 2008).

Cyclical unemployment is caused by changes in total expenditure. It occurs when businesses do not have sufficient demand to require all available workers. When business cycles are at their peak, unemployment tends to be low; when cycles contract, unemployment rises (Acocella et al., 2008).

Seasonal unemployment occurs at certain times of the year, as the name suggests. A classic example involves fishermen, who can only fish during the fishing season. If fishing is their sole occupation, they remain unemployed until the next season. Other examples include forestry and construction workers, whose employment is affected by seasonal and weather conditions. Workers can avoid such joblessness by planning ahead and holding part-time jobs during the off-season (Acocella et al., 2008).

Neoclassical and Other Economic Theories of the Labor Market

The neoclassical labor philosophy proposes that the labor market functions like any other market in which goods are bought and sold at a price. The primary good within the labor market is labor itself. In economic theory, labor is regarded as one of the four factors of production—a view held by both neoclassical and Keynesian theorists. The neoclassical approach analyzes the labor market at the microeconomic level, employing microeconomic tools to determine how much to pay for a given level of work (Acocella et al., 2008).

The neoclassical philosophy views unemployment as voluntary. It argues that voluntary unemployment arises when a person chooses to remain unemployed rather than accept low wages currently on offer, hoping a better-paying position will emerge. Deliberate unemployment also results when an employer refuses to hire a qualified worker because wages cannot be lowered due to government agreements. Both situations reflect the inability of the labor market to function under perfect competition—whether because workers lack sufficient information about vacancies or because of market inflexibilities. The resulting imbalance produces a persistent labor market disequilibrium. The neoclassical solution is to create conditions that promote perfect competition, allowing wages to bring the labor market into stable equilibrium and thereby eliminating unemployment (Acocella et al., 2008).

In line with the implicit contracts paradigm (Azariadis, 1975; Barlevi, 2001), wage inflexibility is analyzed at the micro level. In most cases, money wages are negotiated between firms and employees in an environment characterized by uncertainty. During periods of economic hardship, employees may be required to agree to lower wages (Acocella et al., 2008).

The efficient wages theory proposes that when determining the salary to pay an employee, both the quantity and quality of the work expected should be considered. Quality is assessed through the level of labor intensity, labor productivity, and related factors (Acocella et al., 2008).

The classical view holds that wage rates always adjust to clear unemployment because wages are treated as variable. Classical economists therefore consider unemployment to be virtually non-existent. They illustrate this through the labor supply curve—showing the amount of labor households wish to supply—and the labor demand curve—showing the amount of labor firms wish to employ at given wages. If firms require fewer workers, the labor demand curve shifts to the left, and the wage rate eventually declines. Classical economists believe the labor market will reach its optimal level if left to regulate itself, meaning that those who are unemployed are those unwilling to work at prevailing wages, rather than those unable to find jobs (Acocella et al., 2008).

The bargaining theory is another attempt by neoclassical economists to explain why labor markets deviate from perfect competition and why trade unions and collective bargaining have developed in capitalist economies. According to this theory, negotiations between union members and employers lead to unemployment, as unions protect members from employer exploitation, creating inflexibility in wages and employment levels (Blundell and MaCurdy, 2008).

The theory of labor market imperfections holds that the labor market is not unique in its structure and form. Institutional factors within the labor market led neoclassical economists to link unemployment to the dual nature of the market. Two sectors exist: the primary labor market and the secondary labor market. When workers in the primary labor market refuse to accept positions in the secondary labor market, unemployment results (Blundell and MaCurdy, 2008).

The insider-outsider theory offers another perspective on this duality. Workers already in the labor market (insiders) make it difficult for those outside it (outsiders) to gain employment by securing and defending high wages through their unions (Blundell and MaCurdy, 2008).

According to the traditional neoclassical theory, the primary cause of unemployment is the absence of perfect competition within the labor market. This theory treats unemployment as an independent phenomenon, unconnected to economic growth and development, attributing it instead to external factors such as wage rigidity or market imperfections. The theory holds that if flexibility and perfect competition are achieved in the labor market, the problems of unemployment can be resolved (Blundell and MaCurdy, 2008).

Conclusion: Neoclassical vs. Keynesian Employment Policy

Both current and projected employment policies are linked to an understanding of the factors that cause unemployment. Therefore, when examining both active and passive employment strategies, this connection must be kept in mind (Head, 2005).

Both the Keynesian and the neoclassical theories propose that employment policy is linked to the optimal allocation of productive resources, particularly labor. The neoclassical approach holds that employment policy must identify and correct flaws in the labor market, such as the absence of perfect competition. The Keynesian theory, by contrast, assumes that the labor market is inherently imperfect and therefore treats employment policy as a direct response to this market failure. The state acts as an external agent, intervening to achieve the best possible distribution of labor. Both active and passive labor policies seek to improve the distribution of labor within the labor market (Head, 2005).

Both the neoclassical and Keynesian theories conclude that full employment can be achieved through the optimal allocation of labor in the labor market. The most fundamental question that can be asked about employment policy is whether such a policy is one component of broader social change, or whether this distinction is ultimately artificial insofar as any coherent policy affecting human welfare must be understood in social terms (Head, 2005).

References

Acocella, N., Bartolomeo, D., and Hibbs, D. A. (2008). Labor market regimes and the effects of monetary policy. Journal of Macroeconomics, 30, 134–156.

Arestis, P. (1986). Wages and prices in the UK: The post-Keynesian view. Journal of Post Keynesian Economics, 8(3), 339.

Azariadis, C. (1975). Implicit contracts and unemployment equilibria. Journal of Political Economy, 83(6), 1183–1202.

Barlevi, G. (2001). Why are the wages of job changers so procyclical? Journal of Labor Economics, 19, 837–878.

Blundell, R., and MaCurdy, T. (2008). Labor supply. In The New Palgrave Dictionary of Economics (2nd ed.).

Head, S. (2005). The new ruthless economy: Work and power in the digital age. Oxford University Press.

Romer, D. (2011). Unemployment. In Advanced macroeconomics (4th ed., pp. 456–512). McGraw-Hill.