Employment / Unemployment – Full Employment
Learning objectives
- Define full employment and explain why it does not mean “zero unemployment”.
- State the official formulas used to measure unemployment, labour‑force participation and hidden unemployment.
- Distinguish between the natural rate of unemployment (NRU) and the NAIRU, and relate both to the Phillips curve.
- Identify the three types of unemployment, the determinants of the NRU and the concept of hysteresis.
- Draw and interpret the AD‑AS diagram for full‑employment output and the short‑run/long‑run Phillips‑curve diagram.
- Explain the policy implications of full employment and link them to the macro‑policy objectives set out in the Cambridge IGCSE/A‑Level syllabus.
1. What is full employment?
Full employment is the macro‑economic condition in which the economy is producing its potential (full‑employment) output and the only unemployment that remains is the unavoidable component – the natural rate of unemployment. It is therefore defined formally as:
u = u*
where u is the actual unemployment rate and u* is the natural rate. At this point:
- The economy operates at YFE (the LRAS output).
- Cyclical unemployment is zero.
- Inflation is stable (the NAIRU condition, see section 3).
2. Measuring unemployment – the three key concepts
| Concept |
Formula / definition |
Typical use in the syllabus |
| Unemployment rate (U) |
\[
U = \frac{\text{Number of unemployed (U)}}{\text{Labour force (LF)}}\times 100
\]
(Labour force = employed + unemployed) |
Core indicator of labour‑market health; used to compare actual unemployment with the NRU. |
| Labour‑force participation rate (LFPR) |
\[
LFPR = \frac{\text{Labour force (LF)}}{\text{Working‑age population (WAP)}}\times 100
\] |
Shows the proportion of the working‑age population that is either working or looking for work. |
| Under‑employment / hidden unemployment |
People who are employed part‑time but would like full‑time work, or who are marginally attached (not actively seeking work but would take a job). |
Highlights labour‑market slack that the headline unemployment rate may miss. |
Note: Different countries use slightly different definitions. For example, the UK Office for National Statistics (ONS) counts anyone who has been job‑seeking in the last four weeks, whereas the US Bureau of Labour Statistics (BLS) requires a more recent job‑search activity. These differences can affect the measured rate of unemployment.
3. Natural rate of unemployment (NRU) and NAIRU
| Term |
Definition (Cambridge syllabus) |
Key features |
| Natural rate of unemployment (NRU, u*) |
The rate of unemployment that prevails when the labour market is in equilibrium – it consists of frictional + structural unemployment. |
It is a *structural* concept; does not include cyclical unemployment. |
| Non‑Accelerating Inflation Rate of Unemployment (NAIRU) |
The specific unemployment level at which inflation is neither accelerating nor decelerating. |
In practice the syllabus treats NAIRU ≈ NRU for policy analysis, but theoretically NAIRU incorporates expectations about future inflation. |
Thus, for most A‑Level examinations you can write: NAIRU ≈ NRU = u*, while recognising that NAIRU adds the expectations‑augmented element needed for the Phillips‑curve discussion.
4. Types of unemployment
| Type |
Primary cause |
Persists at full employment? |
| Frictional |
Job‑search and matching processes; workers voluntarily move between jobs. |
Yes – unavoidable. |
| Structural |
Skill mismatches, geographic immobility, technological change, institutional factors. |
Yes – unavoidable. |
| Cyclical |
Insufficient aggregate demand (a downturn in the business cycle). |
No – disappears when u = u*. |
Voluntary unemployment (people who choose not to work at the prevailing wage) is not counted as a failure of the labour market and is excluded from the NRU.
5. Determinants of the natural rate of unemployment
| Determinant |
Effect on u* |
| Demographics (age structure, labour‑force participation) |
Higher participation can raise u* if matching becomes harder; ageing populations may lower it. |
| Skills and education |
Better alignment of skills with industry needs reduces structural unemployment → lower u*. |
| Geographic mobility |
Improved transport and housing policies lower structural unemployment → lower u*. |
| Labour‑market institutions (minimum wages, EPL, unions) |
Stringent regulations tend to raise frictional/structural unemployment; flexibility tends to lower u*. |
| Technological change |
Creates new skill demands; if the workforce cannot adapt, structural unemployment rises → higher u*. |
| Hysteresis |
Long periods of high cyclical unemployment erode skills and raise the long‑run u*. |
6. Hysteresis – why past unemployment matters
A deep recession can leave a legacy of higher structural unemployment because long‑term unemployed workers may lose skills, become demotivated, or suffer health problems. Even after aggregate demand recovers, the NRU may settle at a higher level than before the recession.
7. Diagrammatic representation
- AD‑AS diagram – Draw a vertical LRAS at YFE. The intersection of AD with LRAS gives the full‑employment point where u = u*. If AD shifts left, the economy moves to a point below YFE and cyclical unemployment appears.
- Phillips‑curve diagram – Sketch a short‑run downward‑sloping curve (SRPC) and a vertical long‑run curve (LRPC) at the NAIRU. The economy is at full employment when the equilibrium point lies on the LRPC; moving left of the LRPC (lower u) puts the economy on the upward‑sloping part of the SRPC, indicating accelerating inflation.
8. The Phillips curve – detailed view
- Short‑run Phillips curve (SRPC) – Shows an inverse relationship between unemployment and inflation when expectations are fixed.
- Long‑run Phillips curve (LRPC) – Vertical at the NAIRU; in the long run there is no trade‑off between inflation and unemployment.
- Expectations‑augmented Phillips curve – Incorporates adaptive or rational expectations:
\[
\pi_t = \pi_{t}^{e} - \beta (u_t - u^{*})\,
\]
where \(\pi_{t}^{e}\) is expected inflation. If policy pushes u below u*, expectations adjust upward and inflation accelerates.
- Policy trade‑offs – In the short run a government can reduce unemployment by accepting higher inflation (expansionary fiscal/monetary policy). In the long run any attempt to keep u below the NAIRU merely raises inflation without lasting gains in employment.
9. Policy implications and link to macro‑policy objectives
Cambridge A‑Level expects students to connect full employment with the four main macro‑policy objectives: price stability, full employment, economic growth, and balance of payments.
- Demand‑side policies (monetary & fiscal)
- Goal: keep actual output close to YFE without driving u below u* (avoids inflationary pressure).
- Tools: interest‑rate cuts, quantitative easing, expansionary fiscal spending, tax cuts.
- Short‑run effect: reduces cyclical unemployment, moves AD rightward.
- Supply‑side policies
- Goal: lower the NRU (and hence the NAIRU) and shift LRAS rightward, raising potential output.
- Examples: vocational training, lifelong‑learning schemes, R&D subsidies, transport infrastructure, deregulation of labour markets.
- Long‑run effect: higher YFE, lower structural unemployment, reduced inflationary pressure for any given level of demand.
- Institutional reforms
- Adjust minimum‑wage levels, reform employment protection legislation, promote flexible working hours.
- These affect frictional and structural unemployment directly.
- Link to the four objectives
- Price stability – Achieved by keeping unemployment at the NAIRU.
- Full employment – Defined as u = u* (no cyclical unemployment).
- Economic growth – Supply‑side reforms raise YFE, allowing higher real GDP without inflation.
- Balance of payments – A stable domestic price level helps maintain competitiveness; demand‑side stimulus that overheats the economy can worsen the current account.
10. Worked example (calculating the unemployment rate)
Suppose a country’s labour‑force survey gives the following figures:
- Working‑age population (WAP): 30 million
- Employed: 24 million
- Unemployed (actively seeking work): 2 million
- Marginally attached (not actively seeking): 1 million
Calculate the three key measures:
- Labour‑force participation rate:
\[
LFPR = \frac{24+2}{30}\times100 = \frac{26}{30}\times100 \approx 86.7\%
\]
- Unemployment rate:
\[
U = \frac{2}{26}\times100 \approx 7.7\%
\]
- Hidden unemployment (under‑employment):
Includes the 1 million marginally attached, giving a broader “U‑plus” rate of \(\frac{2+1}{30}\times100 \approx 10\%\).
If the estimated NRU for this economy is 7.5 %, the economy is very close to full employment (actual U ≈ NRU). Policy would therefore focus on maintaining stability rather than aggressive stimulus.
11. Summary
- Full employment ⇔ actual unemployment = natural rate (u = u*). Only frictional and structural unemployment remain; cyclical unemployment is eliminated.
- The NRU is a structural concept; the NAIRU adds the expectations element needed for the Phillips‑curve analysis. In practice the two are treated as equal for policy discussion.
- Unemployment is measured by three related indicators: the unemployment rate, the labour‑force participation rate, and hidden/under‑employment.
- Determinants such as demographics, skills, mobility, institutions, technology and hysteresis shift the NRU.
- AD‑AS and Phillips‑curve diagrams are essential tools: the LRAS vertical line marks full‑employment output, while the vertical LRPC marks the NAIRU.
- Policy aims to keep the economy at the full‑employment point (price stability) and, in the longer run, to shift the NRU downwards through supply‑side reforms, thereby raising potential output and supporting sustainable growth.