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Lesson 27: Types of Unemployment & The Unemployment Rate

Module 1: Macro Fundamental Analysis

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Video Transcript

in this module we’re going to look at unemployment which is the fourth of the macroeconomic objectives that we looked at after growth inflation and the balance of payments so as you can see the unemployment rate is important in the economic calendar and unemployment is defined as individuals who are actively seeking employment but unable to find work so they are actively searching for employment and actively searching for employment is defined as someone who has actively searched for work in the past four weeks and is currently available to work unemployment is an important economic indicator as it shows the ability of workers to gain employment and in turn contribute to the economic output of an economy so gdp economic output

the first type of unemployment we’re going to look at is cyclical unemployment so cyclical unemployment is unemployment caused by changes in the business cycle this is what traders are mostly focused with and this is what shows up in the economic calendar so as economies expand and contract this has a direct effect on unemployment rates due to increased and decreased aggregate demand so remember we talked about this in previous videos unemployment being a derived demand so when there is economic growth there is lower levels of unemployment or there is more employment to look at it in a different way and when there is economic contraction people get laid off there is less employment unemployment actually goes up the unemployment rate increases so when economies expand aggregate demand increases and businesses employ more people to increase business productivity to meet the increased demand when economies contract aggregate demand decreases and businesses lay off workers and they decrease their business productivity to meet the decreased demand the primary measure of unemployment used by traders and investors is the unemployment rate and this measures cyclical unemployment so what we just discussed there is the main focus for traders and investors this is the primary type of unemployment that central banks and governments are attempting to prevent through the use of fiscal and monetary policies so the unemployment rate is defined as unemployed individuals divided by the total number of individuals in the labor force and we’re going to look at that in a bit more detail in a second

the second type of unemployment is frictional unemployment and this is unemployment caused by the voluntary changing of jobs so although some people may move from one job straight into another generally speaking this is not the case and many people leave their employment and enter a period of time when they are seeking another job people leaving higher education to enter the workforce are also considered to be frictionally unemployed so frictional unemployment is that unemployment between it’s a transitionary unemployment so moving between jobs or going from higher education into the workforce frictional unemployment therefore can be thought of as the natural time lag it takes moving from one job or higher education into a new job

and the third type of unemployment we’re going to look at is structural unemployment now this is probably the worst one because it takes a lot longer and it takes more effort to overcome but this is unemployment caused by structural changes in an economy such as technological advancements a commonly used example of structural unemployment in economics is automobiles or cars replacing the horse and cart so this was a structural change within the economy demand for cart makers and horse related services dropped as the invention of cars happened and demand for those services disappeared completely so this means that any workers in those industries lost their jobs and it’s very very hard to go and find a new job if you are skilled and you are trained and educated your whole life in the horse and cart industry you have to actually go and learn a new skill in order to re-enter the workforce this can often lead to longer periods of unemployment because it’s much harder to go out and learn a whole new skill especially if you’ve been doing it all your life you may be in your 50s at this point and long-term skills can be rendered completely useless and entire industries can disappear when you have these structural changes in in an economy so another example of this would be robotics people are talking about now rather than in the past with the horse and carts a more recent example is the use of robotics in factories replacing factory workers so workers need to be retrained and learn new skills which takes time and as a result of this many workers will end up leaving the labor force completely if they become structurally unemployed again think of this if you’re in your late 50s for example are you going to go want to try and learn a whole new skill and take all the education and training it takes to actually utilize that skill when you’ve been doing one thing your whole life you’re probably just going to end up not working

so the natural rate of unemployment is defined as unemployment within an economy which occurs naturally and which is not linked to economic performance so economic performance cyclical unemployment this is what comes up in the unemployment rate in the economic calendar the natural rate of unemployment is made up of frictional and structural unemployment and represents a long-term unemployment rate by filtering out unemployment linked to the business cycle so cyclical unemployment so when you hear people talking about the natural rate of unemployment or the long-term unemployment rate they’re talking about the structural and frictional unemployment within an economy which has to be expected i mean you cannot try and eradicate unemployment when it’s just simply people moving between jobs or from higher education into work

so frictional unemployment plus structural unemployment equals the natural rate of unemployment so the long-term unemployment rate

the natural rate of unemployment also includes other factors such as surplus unemployment however we’ve added this equation for illustrative purposes and for memory retention so all you really need to know is the natural rate of unemployment is the frictional and mainly structural unemployment that occurs naturally quote unquote within the economy so please download the attach spreadsheet for unemployment and we’re going to jump over to the spreadsheet now and have a look at these concepts in a little bit more detail so let’s have a look at the unemployment rates tab and just have a look at how the unemployment rate is actually obtained you can see on the left-hand side we have total population so this is the total number of people within an economy say now if you had 100 000 people obviously this would be a very small economy the numbers are much larger but just for ease we’re using these numbers here so the total population of a hundred thousand people and then out of that there is a filter put in place to look for the working age population so people age 16 years or more you cannot obviously expect somebody who is one years old or six months old or even four years old to go and work so from the total population you extract the working population this is people over the age of 16. now out of the working age population you have the labor force and the labor force are people of working age so people from the working age population who are employed and unemployed so people who have a job and people who do not have a job but are able to work and have been actively searching for a job in the last four weeks and then out of the labor force you get the unemployed which is just simply this part of the labor force it’s the unemployed part so you’re looking at for example out of the whole labor force you have 50 000 people and the unemployed in the labor force equates to 2 000 people so then you have 48 000 people in this case who are actually employed and then all you simply do is you find the percentage of the unemployed compared to the labor force so in this case two thousand and fifty thousand so you can see that equates to four percent if we just find that as a percentage so unemployment has a very specific meaning and because of that there can actually be some inaccuracies so if ten 000 people either joined the labor force as the economy picked up or 10 000 people left the labor force that the economy was bad and their prospects were bad and they may be discouraged so perhaps even that they have been continuously going to job interviews and they can’t get one so they just give up this would cause a bit of inaccuracy because they would leave the labor force but they would still be able to work and therefore they should technically be registered as unemployed but they won’t be under the current system of unemployment so there can be some inaccuracies and this is also something which is done via surveys and they survey just a small sample of the population so very often there is also a margin of error in the unemployment rate and it can even be up to around three percent which when you think about it if you’re looking at unemployment of say two percent or three percent or four percent two would be very low it’s actually quite a large margin of error compared to the overall unemployment rate we also have on the right here some alternative unemployment tools that you can look at and you can look at the population ratio to employment the labor force participation rate which is what we discussed over here so when you look at the labor force participation rate this is the c column that this piece of data would be showing and you can click on all of these and go straight through to the data in the spreadsheet you have non-farm payrolls and you also have job seekers per job openings these are all analytical tools that you can look at to show you a deeper insight into the unemployment of an economy and importantly as well we actually have leading unemployment data so you can see non-farm payrolls this is not a piece of leading economic data this is well touted in many many outlets which deal with trading but actually it’s a pretty non-event piece of data because a lot of the times traders will actually know in advance what non-farm payrolls will be because they will look at the leading unemployment data such as initial job loss claims and also continuing jobless claims so the jobless claims because they are issued weekly and non-farm payrolls is every month so the first friday of every month is non-farm payrolls the jobless claims week on week give you a picture of what the non-farm payroll data will be at the end of the month so considering how much non-farm payrolls is actually discussed and advertised it’s really a non-piece of data and generally speaking it’s not something you’d want to be trading