Unemployment

Causes of Unemployment

Frictional unemployment. This is unemployment caused by people moving between jobs, e.g. graduates or people changing jobs. There will always be some frictional unemployment as it takes time to find a job.

Structural unemployment. This is unemployment due to a mismatch of skills in the labour market. It can be caused by:

Classical or Real Wage Unemployment. This occurs when wages in a competitive labour market are pushed above the equilibrium. This could be caused by minimum wages or trades unions.

Demand deficient or ‘cyclical unemployment.’ This occurs when there is a fall in AD, leading to a decline in national income. For example, a European recession would cause less demand for UK exports – therefore UK firms will employ less workers 


Voluntary unemployment. Generous unemployment benefits may encourage people to stay on benefits rather than get work; this is sometimes known as “voluntary unemployment”.

Policies to reduce Unemployment

Fiscal and Monetary Policy (demand side)

If there is demand deficient unemployment, the government could try expansionary fiscal policy which involves cutting income tax to boost consumer spending and aggregate demand. Or the Bank of England could cut interest rates to reduce the cost of borrowing and encourage spending. Higher AD would lead to higher output and should encourage firms to take on more workers.

However, demand side policies may cause higher rates of inflation and will not reduce supply side unemployment, like structural unemployment.

Education and training. Structural unemployment could be solved by offering retraining and new skills for the long-term unemployed. This gives a better opportunity for the unemployed to find work in new industries.

However, it would cost money, and it may prove difficult for some older workers to retrain in new industries and develop new skills.

Better job information and interview practice. This could help reduce frictional unemployment by giving the unemployed better information about available job vacancies, and also offering tips for the unemployed to get work.

Lower benefits and taxes. Lower benefits and income tax may increase the incentive for the unemployed to look for work rather than stay on benefits. This could reduce frictional unemployment.

However, benefits in the UK are already quite low; reducing benefits may increase poverty but will not create any jobs.

Reduce minimum wages. If the minimum wage is above the equilibrium, reducing it to the equilibrium will enable firms to employ more workers, which reduces real wage unemployment.

However, demand for labour may be quite inelastic; cutting wages may just make firms more profitable.

Regional grants. These can help overcome geographical unemployment by encouraging firms to set up in depressed areas or helping workers to move to areas of high demand.

However, subsidies may prove ineffective for encouraging workers to move because they may be attached to their local community. Firms may have a similar reluctance to set up in depressed areas because of a lack of infrastructure.