Causes/types of unemployment: cyclical unemployment

Government and the Macro‑economy – Employment and Unemployment

Objective

Understand the causes and characteristics of cyclical unemployment and how government policy can influence it.

What is Cyclical Unemployment?

Cyclical unemployment occurs when the overall demand for goods and services in the economy falls, leading to a reduction in production and a corresponding fall in the demand for labour.

Key Features

• Linked to the business cycle – rises during a recession and falls during an expansion.
• Temporary – workers are unemployed because firms are producing less, not because of a mismatch of skills.
• Often concentrated in sectors that are sensitive to changes in aggregate demand (e.g., manufacturing, construction).

Relationship with the Business Cycle

The level of cyclical unemployment can be illustrated with the aggregate‑demand/aggregate‑supply (AD‑AS) model.

Measuring Unemployment

The unemployment rate is calculated as:

\$\text{Unemployment Rate} = \frac{U}{L}\times 100\$

where \$U\$ = number of unemployed people and \$L\$ = labour force.

Causes of Cyclical Unemployment

1. Insufficient aggregate demand.
2. Contractionary fiscal or monetary policy.
3. External shocks (e.g., oil price spikes, financial crises).
4. Reduced consumer confidence leading to lower consumption.

Government Policies to Reduce Cyclical Unemployment

Fiscal Policy

• Increase government spending (\$G\$) – shifts AD right.
• Reduce taxes – increases disposable income and consumption (\$C\$).

Monetary Policy

• Lower interest rates (\$i\$) – encourages investment (\$I\$) and consumption.
• Quantitative easing to increase the money supply (\$M\$) and stimulate spending.

Supply‑side Measures (to complement demand management)

• Training programmes to improve worker flexibility.
• Incentives for firms to retain staff during downturns.

Comparison with Other Types of Unemployment

Summary

1. Cyclical unemployment is demand‑driven and varies with the business cycle.
2. It can be reduced by policies that boost aggregate demand, such as increased government spending or lower interest rates.
3. Understanding the distinction between cyclical and other forms of unemployment helps policymakers target the appropriate tools.