Natural Unemployment

What is Natural Unemployment?

Natural unemployment, or natural rate of unemployment, is the unemployment rate that persists in a well-functioning, healthy economy that is considered to be at “full employment.” It is a hypothetical rate of unemployment and suggests that there is never zero unemployment in an economy.

Natural unemployment refers to the unemployment that exists when the labor market is in perfect equilibrium.

The theory behind natural unemployment suggests that there is never zero unemployment even in a healthy economy due to the presence of frictional, structural, and cyclical unemployment. When the economy is at the natural rate of unemployment, it is said to be at the “full employment” level and to have reached its potential real GDP.

Components of Natural Unemployment

1. Frictional Unemployment

Frictional unemployment occurs when workers are “in-between jobs,” i.e., when people in the workforce are looking for jobs but are unable to find one yet. It includes recent graduates and employees facing unexpected layoffs that are actively searching. To reduce frictional unemployment, the government must focus its resources on decreasing information costs so that there is a higher amount of job market information present in the economy.

2. Structural Unemployment

Structural unemployment refers to unemployment that is caused due to a mismatch between the skills that a worker offers and those that employers demand. An example of structural unemployment is a scenario where a software engineer is skilled at a coding language that is outdated, which results in unemployment. Offering training programs and subsidized education for skill-building is a way to reduce structural unemployment.

3. Surplus Unemployment

Surplus unemployment is caused by wage rigidity and changes in minimum wage laws. For example, if authorities decide to increase the minimum wage by $2 at any given time, some workers are likely to be laid off due to lowering labor demands. This contributes to natural unemployment in the economy.

What Affects Natural Unemployment?

1. Productivity and Technological Advancements

Shifts in the productivity of workers determine the demand for labor, which, in turn, impacts the natural rate of unemployment. Unexpected increases in productivity can lead to a higher demand for labor at a given wage rate, and if the change persists in the long term, it can decrease the natural rate of unemployment.

2. Public Policies

Governments and public policy can significantly affect the natural rate of unemployment. By reducing information costs, governments can make the job market more accessible to potential candidates, which may reduce frictional unemployment and the time spent searching for jobs.

Similarly, subsidizing training programs at corporations and supporting the learning of important practical skills is another step a government can take to reduce the structural unemployment in an economy, thereby reducing the natural rate of unemployment.

On the other hand, the government may also increase the natural rate of unemployment if unemployment benefits are good enough for workers. If unemployment benefits provide workers with goods and services that are sufficient, the opportunity cost of not being employed is likely to be low, and workers are unlikely to be motivated to search for jobs.

More Resources

CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

• Cyclical Unemployment
• Employee Turnover Rate
• Economic Indicators
• Labor Force KPIs
• See all economics resources