Labor Market Dynamics: Demand, Supply, and Unemployment

Posted on Feb 3, 2025 in Economy

Labor Demand and Supply

Workers offer their services to perform jobs.

Entrepreneurs demand labor for their businesses.

Full Employment and the Natural Rate of Unemployment

Full employment is defined as the optimal use of resources and has an associated level of unemployment, known as the “natural rate of unemployment”.

Natural unemployment rate = Frictional unemployment + Structural unemployment

Actual unemployment rate = Natural unemployment + Cyclical unemployment

Types of Unemployment

  • Seasonal unemployment
  • Frictional unemployment
  • Structural unemployment
  • Cyclical unemployment

Seasonal Unemployment

This type of unemployment occurs in activities with production characteristics that require labor only during certain times of the year.

Frictional Unemployment

Frictional unemployment occurs when an employee leaves or loses their job and is unemployed for a period while searching for a new job.

This type of unemployment is short-term because it takes time for workers to find the job that best suits their skills and preferences.

There are two reasons why a certain amount of frictional unemployment is inevitable:

  • The process of job creation and destruction
  • The constant entry of new workers into the labor market

A solution is to improve employment information systems to more quickly match labor supply and demand.

Structural Unemployment

Structural unemployment is a chronic type of unemployment that persists over time and exists even when the economy is producing at a normal pace.

Factors contributing to structural unemployment:

  • The existence of declining productive activities: This is unemployment due to the decline of a particular industry or because an industry is migrating to another region.
  • Changes in the structure of labor demand, reducing the demand for certain skills while increasing demand for other qualifications.
  • Wages are set above the level that balances labor supply and demand.

Factors that lead to wages above equilibrium:

Several factors can lead to wages exceeding equilibrium, causing structural unemployment:

  1. Minimum Wage: Industrialized countries have minimum wage laws, which establish the lowest wage that companies can pay their workers. When this wage is higher than the equilibrium wage, there is an excess supply of labor, resulting in unemployment.
  2. The Power of Unions: When companies agree to employment conditions, workers tend to demand and receive higher wages.
  3. Efficiency Wage: Companies may choose to pay “efficiency wages” as an incentive for increased productivity, which can also contribute to structural unemployment.
  4. Side Effects of Public Policy: Unemployment insurance, while helping the unemployed maintain a decent living while looking for work, can also contribute to unemployment.

Cyclical Unemployment

Cyclical unemployment is caused by inadequate aggregate demand and is linked to economic downturns. It is temporary.

This type of unemployment fluctuates with the economic cycle: the deeper and longer a recession lasts, the higher the unemployment. As the economy recovers and begins to grow, unemployment will decrease.

Solution: Apply demand-side policies, primarily monetary and fiscal policies.