Cambridge Syllabus Notes

Employment & Unemployment – Natural Rate of Unemployment (NRU)

Learning Objectives

Define the natural rate of unemployment (NRU) and explain why it can never be zero.
Identify and distinguish all the main types of unemployment recognised in the Cambridge IGCSE/A‑Level syllabus.
Explain how the overall unemployment rate is measured and how the NRU is estimated.
Illustrate the NRU in a labour‑market diagram and relate it to the Phillips‑curve (NAIRU) framework.
Analyse the policy implications of the NRU, evaluate supply‑side measures and the limits of demand‑side policy.

1. Measuring Unemployment (the official rate)

The unemployment rate that appears in the news and on exam questions is derived from a labour‑force survey (e.g., the UK’s Labour Force Survey, US CPS, World Bank data). The standard definition (U‑3) is:

Unemployed: people aged 16+ who are without work, are available for work, and have actively looked for a job in the last four weeks.
Labour force: the sum of employed + unemployed persons.
Unemployment rate (u): u = (Unemployed ÷ Labour force) × 100%.

More expansive measures (U‑6) also count discouraged workers, part‑time workers who want full‑time work, and those marginally attached to the labour market. These broader measures are useful when discussing hidden unemployment, but the exam‑level definition is the U‑3 rate.

2. Types of Unemployment (Cambridge syllabus)

Type	Definition	Typical Causes
Frictional	Short‑run unemployment while workers search for a new job, enter the labour market for the first time, or re‑enter after a break.	Job switching, graduate entry, geographic relocation, time needed for matching vacancies.
Structural	Long‑run unemployment caused by a mismatch between workers’ skills or location and the requirements of employers.	Technological change, decline of old industries, regional disparities, inadequate education or training.
Cyclical	Unemployment that rises when aggregate demand falls (a recession) and falls when the economy expands.	Business‑cycle fluctuations, insufficient aggregate demand, negative output gap.
Seasonal	Regular, predictable unemployment linked to seasonal patterns in certain industries.	Agriculture, tourism, construction, retail during holidays.
Technological (a subset of structural)	Unemployment caused specifically by new technologies that render some skills obsolete.	Automation, computerisation, robotics.
Institutional (optional)	Unemployment arising from labour‑market institutions that affect hiring costs or incentives.	High minimum wages, strong trade‑union bargaining power, generous unemployment benefits.

3. Natural Rate of Unemployment (NRU)

The natural rate of unemployment (NRU) is the rate of unemployment that would prevail when the economy is producing at its potential (full‑capacity) output. At this point the labour market is in long‑run equilibrium: the quantity of labour supplied equals the quantity of labour demanded at the prevailing real wage, and only the “normal” frictions remain.

3.1 Why the NRU is never zero

Frictional unemployment – workers always need time to move between jobs or to enter the labour market.
Structural unemployment – skill and location mismatches persist even in a well‑functioning economy.
Institutional friction (if included) – minimum‑wage laws, union power, or benefit systems can create a baseline level of unemployment.

These components are considered “normal” and together form the baseline NRU.

3.2 Formal expression

\(u_{N}=u_{F}+u_{S}\;(+u_{I})\)

\(u_{N}\) – natural rate of unemployment (percentage of the labour force)
\(u_{F}\) – frictional unemployment rate
\(u_{S}\) – structural unemployment rate
\(u_{I}\) – institutional unemployment rate (optional)

3.3 Estimating the NRU

Obtain the official unemployment rate \(u\) from the latest labour‑force survey.
Use the vacancy‑unemployment ratio (VUR), job‑search duration data, or labour‑market flow statistics to estimate the frictional component \(u_{F}\).
If institutional friction is being measured, estimate \(u_{I}\) from policy‑related statistics (e.g., minimum‑wage coverage).
Subtract the estimated frictional (and institutional) components from the total rate to obtain structural unemployment: \(u_{S}=u-u_{F}(-u_{I})\).
Combine the components to give the NRU.

Illustrative example (rounded figures):
Overall unemployment \(u = 6.0\%\)
Frictional estimate \(u_{F}=1.5\%\)
Institutional estimate \(u_{I}=0.5\%\)
Then \(u_{S}=6.0-1.5-0.5 = 4.0\%\) and \(u_{N}=1.5+0.5+4.0 = 6.0\%\).

4. Labour‑Market Diagram (Long‑run equilibrium)

Labour‑market diagram showing LS, LD, equilibrium real wage W*, and natural rate of unemployment uN — **Labour‑market diagram**
• Horizontal axis – *Employment (E)* (or number of workers)
• Vertical axis – *Real wage (W)*
• \(L_S\) = labour‑supply curve, \(L_D\) = labour‑demand curve
• Equilibrium real wage \(W^{*}\) where \(L_S\) meets \(L_D\)
• The vertical distance between the total labour‑force line (LF) and the equilibrium employment point (E*) represents the natural rate of unemployment \(u_{N}\).
• Any short‑run shift of \(L_D\) creates cyclical unemployment, but the long‑run position returns to the point shown.

5. NRU and Inflation – the NAIRU Concept

In many A‑Level papers the NRU is identified with the non‑accelerating inflation rate of unemployment (NAIRU). The subtle difference is:

NRU – a purely labour‑market concept (long‑run equilibrium, no cyclical component).
NAIRU – the NRU plus the condition that unemployment must be low enough to keep inflation from accelerating.

5.1 Phillips‑curve illustration

Short‑run and long‑run Phillips curves showing NAIRU — **Phillips‑curve diagram**
• Horizontal axis – unemployment rate (u).
• Vertical axis – inflation rate (π).
• Short‑run Phillips curve (SRPC) is downward‑sloping.
• Long‑run Phillips curve (LRPC) is vertical at the NAIRU (= NRU).
• When \(u • When \(u>u_{N}\) the economy is to the right → inflation falls or stabilises.

6. Policy Implications

6.1 Limits of Demand‑side Policy

Expansionary fiscal or monetary policy can lower the actual unemployment rate temporarily (moving the economy leftward along the SRPC).
If unemployment is pushed below the NRU/NAIRU, wages rise faster than productivity, creating demand‑pull inflation.
Persistently keeping \(u\) below the NRU forces the central bank to tighten policy, potentially causing a recession.

6.2 Supply‑side Policies – how they shift the NRU

Policy	Targeted NRU component	Pros (expected impact)	Cons / Unintended effects
Vocational training and retraining programmes	Structural (\(u_{S}\))	Reduces skill mismatches; improves productivity; long‑run growth boost.	Time lag before workers acquire new skills; costly; effectiveness depends on employer‑industry coordination.
Geographic mobility incentives (relocation grants, improved transport, housing subsidies)	Structural & frictional (\(u_{S},u_{F}\))	Enables workers to move to vacancy‑rich regions; lowers regional unemployment differentials.	Housing market constraints; may create “brain‑drain” in depressed areas; fiscal cost.
Job‑search assistance, online matching platforms, public employment services	Frictional (\(u_{F}\))	Shortens average job‑search duration; low implementation cost; quick impact.	May be less effective for workers with low skills or in remote areas; risk of “matching” on superficial criteria.
Reform of minimum‑wage or unemployment‑benefit levels	Institutional (\(u_{I}\)) – can also affect frictional.	Lowering an excessively high minimum wage can reduce structural unemployment; tightening benefits can shorten job‑search periods.	Risk of increasing poverty or low‑skill job turnover; political resistance; may raise inequality.
Investment in education (STEM, lifelong‑learning schemes)	Structural (\(u_{S}\))	Pre‑emptively equips future workforce for technological change; supports long‑run adaptability.	Long time‑horizon before benefits appear; requires sustained funding.

6.3 Overall Evaluation (AO3)

Supply‑side measures can permanently lower the NRU, but most have long implementation lags and budgetary implications.
Demand‑side stimulus is useful for tackling cyclical unemployment, yet it cannot sustain unemployment below the NRU without igniting inflation.
Policymakers must therefore balance short‑run stabilisation (monetary/fiscal) with long‑run structural reforms to keep the NRU as low as feasible while avoiding inflationary pressure.

7. Summary Table – Components of the Natural Rate

Component	Definition	Typical Causes
Frictional	Unemployment while workers search for a new job or enter the labour market.	Job switching, graduate entry, geographic relocation, time needed to match vacancies.
Structural	Unemployment caused by a mismatch between workers’ skills/locations and employer requirements.	Technological change, decline of old industries, regional disparities, inadequate education.
Institutional (optional)	Unemployment arising from labour‑market institutions that affect hiring costs or incentives.	High minimum wages, strong trade‑union bargaining power, generous unemployment benefits.

Key Take‑away

The natural rate of unemployment is the baseline, long‑run level of unemployment that an economy experiences when it is producing at its potential output. It reflects the inevitable frictional, structural (and, where relevant, institutional) frictions in the labour market. Only supply‑side policies can shift the NRU; demand‑side policies can move the actual unemployment rate temporarily but cannot sustain a level below the NRU without generating inflation, as shown by the NAIRU/Phillips‑curve framework.

natural rate of unemployment: definition