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Why the Unemployment Rate Decreases and Increases

Why the Unemployment Rate Decreases and Increases
Coming up next: Three Types of Unemployment: Cyclical, Frictional & Structural

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  • 0:04 Why the Unemployment…
  • 0:37 Calculating Unemployment
  • 2:41 Understanding Unemployment
  • 4:48 Three Types of Unemployment
  • 8:28 Lesson Summary
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Lesson Transcript
Instructor: Dr. Douglas Hawks

Douglas has two master's degrees (MPA & MBA) and is currently working on his PhD in Higher Education Administration.

Policymakers, investors, and consumers watch the monthly unemployment rate with great interest. In this lesson, you'll learn what factors influence the unemployment rate and why the rate can change rapidly from month to month.

Why the Unemployment Rate Changes

If you watch the news or read the paper, you've probably seen or read news reports about the unemployment rate. Sometimes the news is reporting concern over the increasing unemployment rate, and other times its good news - the unemployment rate is falling. While the unemployment rate can be reported quickly, and most people understand why it is an important barometer for the economy, economists have discovered that the unemployment rate is much more complex than simply the percentage of people that are out of work.

Calculating Unemployment

Each month, the federal government calculates the unemployment rate using data collected from the Current Population Survey (CPS). The CPS is like a mini-Census survey, conducted by Census workers. Each month, 60,000 households - consisting of about 110,000 people - are called and asked about their employment situations, among other things. This data becomes the basis for the unemployment rate reported each month.

Now, coming up with the national unemployment rate isn't as simple as just taking the unemployment rate for that group of people and extrapolating that to the entire population. Statisticians have taken great care to make sure they analyze demographic and regional characteristics of the sampled individuals and adjust the survey results to reflect the actual profile of the U.S. economy. After all that hard work, the Bureau of Labor and Statistics (BLS) reports the unemployment rate on the first Friday of each month.

As an example, let's take the numbers that were reported on March 7, 2014. On March 7, the BLS reported that the economy had added 175,000 new jobs, but the unemployment rate increased from 6.6% in February 2014 to 6.7% in March. How could the unemployment rate increase when the number of jobs available also increased? To understand that and be able to put other changes in the unemployment rate in context, we need to become familiar with all the factors that contribute to the unemployment rate. We'll be using some terms and concepts from your algebra days, but don't worry; it will all make sense in just a few more minutes!

Understanding Unemployment

To understand why the unemployment rate can change from month to month, we first must clearly define 'unemployment.' To be classified as unemployed, an individual must meet three criteria:

  1. They don't have a job
  2. They are looking for jobs
  3. They are available for work

If someone meets all of those criteria, they are unemployed.

Anyone that has a job is considered employed. Simple enough. The total labor force is the sum of unemployed people and employed people. The unemployment rate can then be calculated as the percentage of the labor force that is unemployed. Note: the unemployment rate is based on the labor force, not the total population.

Remember our early example when the economy added 175,000 new jobs but the unemployment rate went up? That's a very possible scenario, and it is due, in large part, to the second criteria in the definition of unemployment: they are looking for jobs. That means if someone doesn't have a job - they are able to work, but they just aren't looking for a job right now - they are not considered unemployed. But, if they change their mind and start looking for a job, now they are counted in the unemployment numbers.

When we see changes in unemployment, we often assume those changes are due to the number of people that are unemployed, or in the formula for the unemployment rate, the numerator, or the top number in a fraction. But remember, in the unemployment calculation, the denominator, the bottom number of a fraction, is the total labor market, which can also change each month. So, changes to the unemployment rate can be due to changes to the number of people working, or it can be due to the number of people that say they are looking for work.

Three Types of Unemployment

Okay, so now that we know how unemployment is calculated, what it means, and when it is reported, we can start talking about why the number changes so often. To analyze and understand unemployment trends, economists have defined three types of unemployment: structural unemployment, cyclical unemployment, and frictional unemployment. Understanding what causes these three types of unemployment will make the fluctuations in the unemployment rate all make sense.

First, structural unemployment occurs when the labor force cannot provide workers with the skills and abilities employers need. For example, when tech companies are not able to fill positions because they can't find qualified applicants, the unemployment rate would increase. If you read an article in your local newspaper about a big tech company opening up an office with 500 employees in your town, your first thought might be, 'Great! That'll bring the unemployment rate down!'

You may be right, but if those jobs require special skills and there aren't many people in your town that can fill those jobs, then the impact on unemployment won't be significant. In fact, job openings that can't be filled because of a lack of skilled workers actually increases the unemployment rate because they can bring more job seekers to the labor market, so there are more people looking for work - one of the three criteria to be considered unemployed - but they can't get the job, leaving them in the ranks of unemployed.

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