APMacro: Unemployment Rate

GDP image
The Bureau of Labor Statistics (BLS) conducts a nationwide random survey each month to determine who is employed and who is not employed. In a series of questions it asks which members of the household are working, unemployed and looking for work, not looking for work, and so on. From the answers it determines an unemployment rate for the entire nation.

The BLS divides the total population into three groups. One group is made up of people under 16 years of age and people who are institutionalized. Such people are not considered potential members of the labor force. They are in mental hospitals or correctional institutions. A second group, labeled not in the work force is composed of adults who are potential workers but are not employed and are not seeking work. They are homemakers, full-time students, or retirees. The third group is the labor force. The labor force consists of people who are able and willing to work. Both those who are employed and those who are unemployed but actively seeking work are counted as being in the labor force.

Labor Force = employed workers + unemployed workers

The unemployment rate is the percentage of the labor force unemployed:

Unemployment Rate = (unemployed / labor force) x 100

Unemployment that is excessive involves great economic and social costs. The basic cost of unemployment is forgone output. When the economy fails to create enough jobs for all who are able and willing to work, potential production of goods and services is irretrievably lost. Unemployment above the natural rate means that society is operating at some point inside its production possibilities curve. Economists call this sacrifice of output a GDP gap, the difference between actual and potential GDP.

GDP gap = actual GDP – potential GDP

The GDP gap can be either negative, actual GDP < potential GDP, or positive, actual GDP > potential GDP. In the case of unemployment above the natural rate, it is negative because actual GDP falls short of potential GDP. Potential GDP is determined by assuming that the natural rate of unemployment prevails. The growth of potential GDP is simply projected forward on the basis of the economy’s normal growth rate of real GDP.  The higher the unemployment rate, the larger the GDP gap.

Economist Arthur Okun was the first to quantify the relationship between the unemployment rate and the GDP gap.

Okun’s law indicates that for every 1 percentage point by which the actual unemployment rate exceeds the natural rate, a negative GDP gap of 2 percent occurs.

With this information, we can calculate the absolute loss of output associated with any above natural unemployment rate.



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