 the growth process of an economy isn’t necessarily smooth  there are booms & slumps along the way

 these booms & slumps could have serious consequences

For example: Botswana’s real GDP increased by a massive 8,400% during 1961-2017

 but… this growth as not an

entirely smooth process

In analysing changes in GDP or GDP per capita over time, it’s useful to distinguish b/w short-run & long-run
movements this can be done by decomposing GDP movement into a trend

LONG-RUN & SHORT RUN MOVEMENTS:

the long run movement: trend

 when economists talk about long-run growth, they refer to the trend

short-run movement: fluctuations around the trend

 when economists talk about business cycles, they refer to movements of GDP around the trend

the neoclassical model aims

to explain the long-term trend
of GDP not fluctuations
around the trend

TREND OF GDP:
 Not necessarily a smooth curve (like example)
 Economists have a very specific way to define the long-run trend of GDP

POTENTIAL GDP:
 a country’s long-run trend GDP value is called potential GDP
 potential GDP is NOT its max. GDP
 you can imagine it as the output that a country can produce when firms operate on their normal hours using a
normal workforce
 can be defined as level of output that keeps inflation stable
PRODUCING MORE THAN POTENTIAL GDP:
 If firms overuse the labour & capital (i.e. work their machines & workers overtime)  the economy will
produce more than its potential GDP
 this isn’t sustainable in the long run

PRODUCING LESS THAN POTENTIAL GDP:

 if firms underutilise their labour & capital (i.e. some workers & machines are idle)  the economy will produce
less than its potential GDP

Actual GDP can be bigger or

smaller than potential GDP

OUTPUT GAP:
 difference b/w actual GDP & potential GDP is called output gap
 expressed as percentage of potential GDP

(actual GDP−potential GDP)

output gap ( % ) = ×100
potential GDP

POSITIVE OUTPUT GAP:

When actual GDP > potential
GDP  output gap is +ve
Since the economy is producing above its normal capacity…

 higher demand for workers & materials

 if firms hire more workers, then it may cause unemployment to ↓
 higher demand for workers & materials may cause wages, material prices & eventually output process to rise
faster  meaning higher inflation

NEGATIVE OUTPUT GAP:

When actual GDP < potential
GDP  output gap is -ve
Since the economy is producing below its normal capacity…

 lower demand for workers  may cause laying off workers  leading to higher unemployment
 weaker demand for workers will put downward pressure on prices  lower inflation

If GDP = potential level 

inflation rate will be stable
(not pushed up or down) since unemployment & inflation typically respond to the output gap with a
substantial time lag, policymakers & economist keep a close eye on output gap as
a forward indicator of where the economy is heading

Example:
 if there’s a large +ve output gap implying higher inflation to come then the central bank may ↑interest rates to
prevent an inflation outbreak

CHALLENGES WITH MEASURING OUTPUT GAP:

 can be hard as potential GDP isn’t fixed
 it changes over time as technology & other factors change
3.2 MEASURING UNEMPLOYMENT PART 1:
 It’s very important to understand the situation of our labour market & where its heading as unemployment has
many impacts for the economy, society & personal lives of those employed

for policymakers: the labour market condition is often a key factor in the deliberation of policies

 the unemployment rate can also provide insights into how the economy is performing more generally, making
it an important factor in thinking about monetary policy

UNEMPLOYMENT IN AUS: 2005-2017

Unemployment: people who want to work but do not currently
have a job

Underemployment: people who work part-time, but would like

to work more hours

Unemployment & underemployment rates differ b/w states

ABS SURVEY:
 every month the ABS conduct a survey to collect data on those aged 15 & above regarding their participation
in the labour market

working age population: population aged 15 & above

DRAWBACK OF THIS DEFINITION: incudes retirees, or people simply too old to work
ALTERNATIVE DEFINITION: aged 15 to 64

when we site any stat, we

need to be sure how those
stats are defined before
trying to make inferences

ABS CATEGORIES:
In the labour force: includes people who
are willing to work, regardless of whether
or not they have a job
Not in the labour force: includes people who are NOT in a job & not looking for work

 includes fulltime students, stay-home parents or caretakers, retirees & people who are permanently unable to
work for health reasons

2 SUB-CATEGORIES FOR THE LABOUR FORCE:

1. Employed: includes people who are in a job for one hr or more in a week & people who are underemployed

2. Unemployed: includes people who are not in a job but are actively looking to work & available to work

Once the number of people in each of these categories has been estimated we can construct some indicators to
monitor the labour market development

LABOUR FORCE: sum of employed & unemployed people

 People in the army or prison are NOT considered to be part of the (civilian) labour force
UNEMPLOYMENT RATE: % of people in the labour that are unemployed 
PARTICIPATION RATE: % of people in the working age population that are in the labour force

IMPORTANT FORMULAS:

3.3 MEASURING
UNEMPLOYMENT PART 2:
RBA EXAMPLE:
  the unemployment rate is also affected by changes in the size of the labour force (the denominator).

Among those employed: 1.1 M  underemployed (use

to calculate underemployment rate & underemployment
ratio)

 Underemployment rate and unemployment rate measured against labour force NOT working age population

CASE STUDY: 0.2M PAUL

 Suppose Paul has been unemployed ever since the only car manufacturing factory in town closed down 2
years age
 After failing to get another job for 2 yrs he gave up & stopped applying for jobs  people like Paul are called
discouraged workers
DISCOURAGED WORKERS:
 person of legal employment age who is not actively seeking employment or who has not found employment
after long-term unemployment, but who would prefer to be working  because they have given up

if hypothetically, 0.2 million workers faced the same situation & took the same decision as Paul  it would affect the
labour market indicators

when these 0.2M people

stopped looking for jobs, labour force: ↓from 13.3M to 13.1M
they would be considered as
dropping out of the labour labour force ↓
force ×100
working age popualtion
labour force participation rate: decline from 65.6% to 64.5%

UNEMPLOYMENT RATE:
once someone leaves labour
force they’re no longer
counted as unemployed ∴ # of unemployed people will ↓ by 0.2M
unemployed ↓
×100
labour force ↓
unemployment rate: ↓ from 5.3% 3.8%

when people give up hope in

finding a job 
unemployment rate ↓  depending on the cause of the change, a lower unemployment rate isn’t
necessarily a good sign & higher unemployment rate isn’t necessarily as
bad sign either

 if someone says unemployment rate is getting better, check other indicators such as labour force participation
rate & underemployment rate to get a full picture

questions:
if more women decide to enter the labour market, the immediate effect will be….

 An increase in the labour force participation rate

 The unemployment rate will decrease in some unemployed persons are forced into early retirement. The
labour force participation rate will increase if some full-time students drop out of school to find jobs

3.4 TYPES OF UNEMPLOYMENT PART 1:

 Unemployment can rise naturally w/in an economy

CYCLICAL UNEMPLOYMENT:
 caused by business cycle fluctuations  when GDP moves above or
below its potential

DURATION:
 often described as being medium-term in nature (one to 12 months)
UNEMPLOYMENT AT DIFFERENT STAGES OF THE BUSINESS
CYCLE:
ECONOMIC DOWNTURN: where GDP is below its potential lvl. & demand for GAS is weaker than
usual

 as a result, businesses might lay off existing workers or hire fewer new workers
 this makes it harder for people looking for a job to get a job

 so cyclical unemployment goes up

ECONOMIC EXPANSION: demand is strong & more jobs are created

 as a result, cyclical unemployment ↓

when GDP = potential lvl. by

definition, there’s NO cyclical
unemployment
cyclical unemployment is
inversely related to the
output gap

CYCLICAL UNEMPLOYMENT & OUTPUT

GAP:
 depending on whether the output gap is +ve, zero or -ve  cyclical unemployment can be less than, = to or
greater than zero

LESS THAN ZERO:

 DOES NOT mean that unemployment is -ve

 the cyclical unemployment component is -ve

 there are 2 other components of unemployment & they are always +ve

 when we combine all 3 components of unemployment, the sum is always +ve

 although cyclical unemployment is driven by business cycles, it tends to lag behind changes in the business
cycle by months or even more

INCREASE IN CYCLICAL UNEMPLOYMENT:

 might suggest the economy is operating below its potential.
 with more people competing for jobs, businesses might offer lower wage increases, which would contribute to
lower inflation.
 Policies that stimulate aggregate demand, such as expansionary monetary policy, can help reduce this type of
unemployment (because businesses experiencing stronger demand are likely to employ more people).

FRICTIONAL UNEMPLOYMENT:
 arises from the natural rhythm of the labour market
  it’s natural for some people to move b/w jobs as well as moving in & out of the labour force
 but it can take time for workers to find the right job & for firms to find the right employees
 may not influence wages or inflation

DURATION:
 generally shorter term (less than 1 month)
 likely to occur at all points of the business cycle

EXAMPLES:
1. Michelle dislikes a 9:00 -5:00 office job so she quits & goes to search for a more creative job

During this time, she is considered frictionally unemployed

2. when you graduate & start to look for a job, you become part of the labour force so you become frictionally
unemployed until u get a job

DURATION OF SEARCHING PROCESS:

the longer the searching
process, the longer the
duration of a job seeker is
unemployed  employment agents (both online & offline) are supposed to reduce costs &

time of matching the right person w/ the right job ∴ help lower frictional
unemployment

 however, even w/ good matching technology, it still takes time for a job seeker to write resume, submit
application, interviews, checks etc

∴ for an economy there’s

always frictional
unemployment
STRUCTURAL UNEMPLOYMENT:
 Arises if there’s a mismatch b/w the jobs that are available & people who are looking for jobs
 this mismatch b/w the supply of job seekers & demand for workers can be caused by many factors
 never = 0
 exits even when economic conditions are good

DURATION:
 Tends to be longer lasting than other types of unemployment  it can take a number of yrs to develop new
skills or move to a different region to find a job that matched their skills

 people who are unemployed due to structural factors are more likely to face long-term unemployment

POLICIES:
  in theory, this type of unemployment shouldn’t directly influence wages or inflation & is best addressed
through policies that focus on skills & supply of labour

FACTORS CAUSING STRUCTURAL UNEMPLOYMENT:

1. TECHNOLOGICAL CHANGE:
For example:
 when car manufacturers brough machines & robots into their production line, many workers w/ skills in car
manufacturing lost their jobs & couldn’t find work in other industries that require car manufacturing skills

 as a result, many car technicians became structurally unemployed

2. GEOGRAPHICAL DISTANCE B/W JOBS & SEEKERS:

 People who are looking for work are far away from the jobs

For example:
 jobs in urban areas will not help reduce unemployment in rural areas if people are reluctant to move
 Workers can become unemployed if they work in industries that are declining in size

TECHNOLOGICAL PROGRESS:
Automation contributes to
structural unemployment
 While technological improvement often creates structural unemployment, it
also created new job opportunities

Example, although car manufacturers laid off manufacturing workers, there was more demand for software engineers
to program the robots to build cars

3.5 TYPES OF
UNEMPLOYMENT PART 2:
COMBINING THE 3 TYPES OF
UNEMPLOYMENT:
 unemployment = cyclical + frictional + structural

 GDP = potential GDP  cyclical unemployment = 0  economy attains “full employment” & its natural rate of
unemployment

 natural rate of unemployment consists of frictional & structural unemployment

since frictional & structural unemployment is always +ve  the natural rate of unemployment is always +ve

when an economy is at full employment it

doesn’t mean that unemployment = 0

unemployment rate = natural rate

NON-ACCELERATING INFLATION RATE OF UNEMPLOYMENT
(NAIRU):
 when GDP = potential GDP  there will be no
pressure for inflation to change

 ∴ natural rate of unemployment is called the Non-

Accelerating Inflation Rate of Unemployment 
NAIRU

 NAIRU is NOT fixed

 It changes as the structure & characteristics of our

economy changes

For example:

 The RBA estimated that AUS’s NAIRU has declined

from just over 7% in 1995 to about 5.5% in 2017

LONG-TERM UNEMPLOYMENT:
 the duration an individual experiences unemployment may be long or short

Long-term unemployed: when unemployed continuously for 12 months or more

Structural unemployment is a key driver for long-term unemployment

LONG-TERM UNEMPLOYMENT TO TOTAL UNEMPLOYMENT

RATIO (%):
 peaked soon after economic downturn in
early 1990’s

 since then, it has gradually declined but

picked up again after the 2008 GFC

REASONS WHY LONG-

TERM UNEMPLOYMENT
IS A BIGGER CONCERN THAN SHORT TERM
UNEMPLOYMENT:
 People who are unemployed for long periods of time may experience economic hardship & poverty more than
those unemployed for shorter periods
 are likely to miss out on the networks & social interactions that employment can offer
 Loss of financial resources & social connection ccan also affect mental & physical health
 long -term U often affects whole family rather than individual  therefore there’s a concern that long-term U
may contribute to intergenerational disadvantage
 Poses a challenge to gov. budget die to cost of U benefits & cost of dealing w/ related health problems or
other problems
ADDRESSING LONG-TERM UNEMPLOYMENT:
 It’s difficult as the longer the people are unemployed, the harder it becomes for them to get a job

WHY CAN IT BE HARDER TO GET A JOB:

Can be due to loss of…
 Workplace networks
 Relevant skills
 Confidence
 Motivation
 Employees -ve perceptions of their employability

THESE THREE TYPES OF UNEMPLOYMENT ARE NOT

NECESSARILY INDEPENDENT OF EACH OTHER…
 Imagine you are unemployed after your company has closed down during a recession (cyclical
unemployment).

 In normal economic times you would have been able to find another jobs within months (had this been the
case, you would have been frictionally unemployed).
 However, because of the poor economic environment, companies are not hiring and you remain unemployed
for two years.
 Unfortunately, your skills become outdated and you have lost most your industry connections over this period
of time.  you have gradually changed from cyclically unemployed to structurally unemployed!

QUESTIONS:
Consider the causes of these three types of unemployment. Can you tell which kind of unemployment is not
only necessary but could also be good for the economy?

Frictional unemployment will never be fully eliminated - people will always be leaving old jobs and starting new ones.
Job changing could potentially improve job-skill matching and thus productivity. As such, frictional unemployment is
arguably necessary and desirable.

3.6 LABOUR SUPPLY & DEMAND

ANOTHER FACTOR THAT CAN CAUSE STRUCTURAL
UNEMPLOYMENT:
 Labour market rigidity
  full employment at equilibrium
 if labour demand > labour supply  NO unemployment

3.7 THE FUTURE OF EMPLOYMENT

 During the 1st industrial revolution in the early 19th century, textile machines were first developed in England
 Some textile workers feared losing their jobs & protested against the use of machines
 The legend is that a worker called Ned Ludd smashed 2 machines

LUDDITE:
 people who are opposed to technological changes for job security concerns are known as the Luddite

LUDDITE FALLACY:
 the concern of the luddite turns out to be a fallacy

 textile machines didn’t cause widespread unemployment for the economy  although textile machines initially
reduced # of workers in textile factories, it led to lower output prices & thus higher demand textile products,
creating new jobs at the same time

 w/ cheaper textile products, consumers were left w/ more money to spend on existing or new products 
increasing other new employment opportunities

ANOTHER EXAMPLE:
 in 1900, 41% percent of the US workforce was in agriculture.
 by 2000, the share had fallen to 2% due to better labour-saving technology.
 but it did not result in massive unemployment, because people moved from agriculture to other new
industries, such as entertainment, finance, and manufacturing.

MODERN DAY CONCERNS:

 today, people are once again concerned with the future of employment due to rise of artificial intelligence and
robots.

Will this be a modern version of luddite fallacy?  technology will make some old jobs obsolete by create new jobs at
the same time
Even if new jobs are created as a result of new technology, can we learn fast enough to benefit from it?
What if new technology emerges faster than we can adapt?