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Defining and Measuring the Unemployment Rate

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  • 0:11 What is Unemployment?
  • 1:12 Who is Included in the…
  • 3:32 How to Measure Unemployment
  • 5:20 Calculating the…
  • 9:01 Lesson Summary
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Lesson Transcript
Instructor: Jon Nash

Jon has taught Economics and Finance and has an MBA in Finance

You've probably heard about the unemployment rate, especially given how high it was in the 2008 recession. Find out how economists define unemployment, what the unemployment rate is, and how to calculate it in this lesson.

What is Unemployment?

Let's talk about who's considered unemployed, how we measure the labor force, and how we calculate the unemployment rate (with the help of some real-world examples).

The Bureau of Labor Statistics defines a person as unemployed if they are not working but are willing and able to work. More precisely, unemployment is when the labor force is seeking employment but cannot find it. Unemployment is a cost to the economy in terms of the deficiency in production. In other words, when people don't have jobs those employees aren't able to produce, and therefore the economy produces less. The number of unemployed persons includes people age 16 and older who are without a job but looking for work. The number of people out of work is the focus of this lesson; however, in order to accurately measure this, we need to define the labor force and talk about who's included in it.

Who's Included in the Labor Force?

The labor force includes the total number of people who are working or unemployed. It's an important measurement of who is willing and able to work. For example, when Melanie loses her job at the local jewelry store, she scans the newspapers and internet job sites for job postings; however, Melanie's sister Hannah still works at the jewelry store. Both Melanie and Hannah would be counted in the labor force - it's both people who are working and people who are unemployed.

Who's Not Included in the Labor Force?

We've talked about who's included; let's talk about who's not included. Some people are not counted in the labor force.

Melanie's daughter Melinda goes to college full-time. Full-time college students are neither employed nor unemployed, and so they are not included in the labor force.

Another example: Melanie's cousin Marvin lost his job at the auto plant. He was looking for work for nine months but finally gave up and is no longer seeking a job, even though he's willing to work. Marvin is what we call a discouraged worker. Discouraged workers are not included in the labor force even though they're able to work because they're not looking for work. They really want a job, but they've given up on the whole job search process, and because of this, they don't get counted in the unemployment statistics. Why is this important? If discouraged workers were included in the unemployment rate, it would be a lot higher. Economists believe that the unemployment rate underestimates the level of unemployment in the economy.

Finally, if we want to know how much of the population is participating in the labor force, we have a number for that. The labor force participation rate is the percentage of the population that is in the labor force. The formula is as follows: labor force participation rate = labor force / adult population. We can use this information to measure unemployment and draw some important conclusions as well. The way we measure unemployment is by calculating the unemployment rate.

Using this formula will allow you to calculate the labor force participation rate.
Labor Force Participation Rate Formula

How To Measure Unemployment

The unemployment rate is the percentage of the labor force that is unemployed. It's reported by the Department of Labor on the first Friday of each month. It's one of the most widely followed economic indicators, and it frequently affects the direction of investment markets. During the Great Depression, the unemployment rate surged as high as 25%. That means one out of every four people were willing and able to work but could not find work! A recession in 2008 was the worst since the Great Depression (because the unemployment rate was higher for longer than any other time since the Great Depression), and during this time the unemployment rate peaked at 10.2%.

Let's find out how this rate is calculated, and we'll start in a small town, far, far away. To calculate the unemployment rate, you need to know two things: first, you need to know the number of unemployed persons, and second, you need to know the number of people that are in the labor force. The unemployment rate represents the number of unemployed persons as a percentage of the labor force.

So let's calculate the unemployment rate in the small town of Ceelo. As you can see, here are the statistics from the town government regarding the labor market in the town of Ceelo. In 2010, 80 adults lived in Ceelo, of which 40 had a job. Then a lot of residents talked to their friends around the country, and another 80 adults moved to town. In 2011, there were 160 adults, 90 of whom had jobs.

Calculating the Unemployment Rate

The formula for calculating the unemployment rate is unemployment rate = number of unemployed persons / labor force. Remember that the labor force includes those who are employed and those who are unemployed.

So let's start with 2010. In 2010, Ceelo had a labor force of 40 + 10, which is 50 workers. When we plug in the 10 unemployed people into the formula, we get 10 / 50 = 20%. So that's the unemployment rate for 2010 in the town of Ceelo. If the unemployment rate is 20%, that doesn't mean that 20% of the adult population is unemployed. It means that (10/50), or 20% of the labor force, is unemployed - a very important distinction. Another way to say this is that (40/50), or 80% of the labor force, is employed.

In the following year, 2011, Ceelo had a labor force of 90 + 10, or 100, workers. That's the labor force. That means the unemployment rate was 10 / 100 = 10%. This means that 90% of the labor force is employed during that year.

The formula for calculating the unemployment rate
Unemployment Rate Formula

Now we can draw a conclusion about the trends in the labor force in the small town of Ceelo. From 2010 to 2011, the population increased and the labor force grew, while the unemployment rate fell from 20% down to 10%.

But what if we want to know how much of Ceelo's population is willing and able to work? Then we'd use the labor force participation rate. Remember, the labor force participation rate is the percentage of the population that is in the labor force. The formula is labor force participation rate = labor force / adult population.

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