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WA5. Unemployment Rate

Statement

Suppose an economy has 10,000 people who are not working but looking and available for work and 90,000 people who are working. What is its unemployment rate?

Now suppose 4,000 of the people looking for work get discouraged and give up their searches. What happens to the unemployment rate? Would you interpret this as good news for the economy or bad news? Explain.

Answer

In the first estimation, the labor force is the sum of the employed and unemployed people, which is 100,000. The unemployment rate is the number of unemployed people divided by the labor force, which is 10,000/100,000 = 0.1 or 10%.

In the second estimation, the labor force is the sum of the employed and unemployed people, which is 96,000; excluding the discouraged workers. The unemployment rate is the number of unemployed people divided by the labor force, which is 6,000/96,000 = 0.0625 or 6.25%.

In nominal terms, the unemployment rate has decreased from 10% to 6.25%, which is apparently a good news for the economy. However, the decrease was not due to people finding jobs, but rather due to people giving up as there is no hope for them to find a job. This is called discouraged workers. Discouraged workers are not considered as unemployed nor in the labor force. The decrease in the unemployment rate is not due to the economy’s improvement, but rather due to playing with the numbers of the unemployment statistics.

Some might argue that spreading good news about unemployment rates actually helps the economy as companies may predict an increase in demand due to the more purchasing power of the newly employed people; companies at this point may want to increase their output and thus they need to hire more people. This is not a sustainable way to increase employment, and some real solutions should take place (Rittenberg & Tregarthen, 2009).

This situation highlights the limitations of the unemployment rate as a measure of the economy’s health. The exclusion of discouraged workers and part time workers considered as employed despite them looking for full-time jobs may mislead the statistic and yield a false sense of improvement in the economy, despite the same number of people being unemployed.

To summarize, the unemployment rate decreased from 10% to 6.25% due to discouraged workers being excluded from the labor force. This is not a sign of economic improvement, but rather a misleading statistic; although, some might argue that publishing positive statistics can help the economy as a side effect.

Summary

  • In the first estimation, the unemployment rate is 10%.
  • In the second estimation, the unemployment rate is 6.25%.
  • Unemployment rate decreased from 10% to 6.25% due to discouraged workers being excluded from the labor force.
  • This is not a sign of economic improvement, but rather a misleading statistic.

References