Unemployment and the Phillips curve
Unemployment means people willing and able to work cannot find jobs. The Phillips curve shows a short-run trade-off between inflation and unemployment.
Key concepts
The labour force is everyone of working age who is either employed or unemployed. A person is unemployed if they have no job but are available for and actively seeking work. People who are not looking (full-time students, homemakers, retired people) are outside the labour force. The unemployment rate = unemployed ÷ labour force × 100. The labour force participation rate = labour force ÷ working-age population × 100. In Sri Lanka, these figures come from the Labour Force Survey of the Department of Census and Statistics. Underemployment means people work fewer hours than they want, or in jobs below their skills.
Worked example: unemployment and participation rates
An economy (illustrative figures) has a working-age population of 8,000,000. The labour force is 4,000,000, of whom 3,800,000 are employed. Find the number unemployed, the unemployment rate and the labour force participation rate.
- Unemployed = labour force − employed = 4,000,000 − 3,800,000 = 200,000.
- Unemployment rate = 200,000 ÷ 4,000,000 × 100 = 5%.
- Participation rate = 4,000,000 ÷ 8,000,000 × 100 = 50%.
200,000 unemployed; unemployment rate 5%; participation rate 50%.
Types of unemployment
| Type | Cause | Remedy |
|---|---|---|
| Frictional | People between jobs or searching for their first job | Better job information, online job portals |
| Structural | Mismatch between workers' skills or location and the jobs available, as industries change | Retraining, vocational education, help to relocate |
| Cyclical (demand-deficient) | Too little aggregate demand in a recession | Expansionary fiscal and monetary policy |
| Seasonal | Work that depends on seasons: harvests, tourist seasons, festivals | Diversify activities across the year |
| Disguised | More people work than needed, so their marginal product is near zero (e.g. on small family farms) | Create jobs in industry and services |
| Technological | Machines and software replace some jobs | Upskilling for new types of work |
Costs of unemployment
- Lost output: the economy produces inside its production possibility curve.
- Lower tax revenue and higher welfare spending for the government.
- Poverty, debt and stress for families; skills fade the longer people are out of work.
- Social problems such as crime and unrest.
- Loss of skilled workers who migrate abroad for jobs.
The Phillips curve
In 1958, A. W. Phillips found, using long-run UK data, that years of low unemployment came with fast wage inflation, and years of high unemployment with slow wage growth. The short-run Phillips curve therefore shows a trade-off: policy could buy lower unemployment at the price of higher inflation. In the 1970s, many countries had high inflation and high unemployment together (stagflation), which the simple curve could not explain. Milton Friedman and Edmund Phelps argued that once workers expect higher inflation, they demand higher wages, so the short-run curve shifts up. In the long run, unemployment returns to its natural rate, and the long-run Phillips curve is vertical: there is no lasting trade-off.
Why the long-run Phillips curve is vertical
End result: the same unemployment as before, but with higher inflation.
Seasonal unemployment is common in tourism and agriculture, where hotels and paddy work need more hands at certain times. Structural unemployment appears when graduates' skills do not match what employers such as IT and apparel firms need, which is why many firms run their own training programmes.
Short answer: “What is frictional unemployment?” Short-term unemployment of people moving between jobs or searching for their first job.
Structured question: “Explain the different types of unemployment and a remedy for each.” Frictional (job information), structural (retraining), cyclical (demand management), seasonal (diversification), disguised (new jobs outside agriculture).
Essay: “Explain the relationship between inflation and unemployment using the Phillips curve. Is there a trade-off in the long run?” Define unemployment and the natural rate, draw the short-run Phillips curve trade-off, explain 1970s stagflation and expectations (Friedman-Phelps), and show the vertical long-run curve.
Short run: a trade-off. Long run: no trade-off (vertical at the natural rate). Types of unemployment: F-S-C-S-D (Frictional, Structural, Cyclical, Seasonal, Disguised).