AS Macro Revision: Cyclical unemployment

This is a revision blog on cyclical unemployment. Cyclical unemployment is involuntary unemployment due to a lack of aggregate demand for goods and services. This is also known as Keynesian unemployment. When there is a recession or a slowdown in growth, we see a rising unemployment because of plant closures, business failures and an increase in worker lay-offs and redundancies. This is due to a fall in demand leading to a contraction in output across many industries.

An important evaluation point to note is that the economy does not have to go into recession for cyclical unemployment to start rising. Many jobs can be lost even in a mild slowdown phase and one reason for this is because of rising productivity. Say for example that a country’s real GDP is expanding at 1 per cent a year but output per worker is growing by 3 per cent. This means that the same national output can be produced using fewer workers.

That said the recession makes the problem of cyclical unemployment much worse and we have certainly seen that happening in the UK and many other economies during recent years. Since the peak of the trade cycle in the summer of 2008, real national output has declined by 6 per cent whilst employment has contracted by nearly 3% and the rate of unemployment has also grown.

Labour as a derived demand

The relationship between national output and demand for labour – when there is an economic recession or slowdown in growth, the demand for labour may fall as businesses look to cut back on employment in order to control costs. The result is a fall in employment and a rise in cyclical unemployment. This will affect some industries more than others depending on how severe the recessionary effects are in a particular sector of the economy

The multiplier effect can amplify the impact of a fall in spending on the number of jobs available. For example, when a steel plant makes hundreds of workers redundant due to a cyclical fall in demand for and profits from making steel, there are sizeable second round effects on businesses supplying the steel maker and reductions in real incomes, spending power and profits for local and regional industries.

Unemployment in the UK has risen sharply in the last two years but not quite as much as many economists feared or expected. There are several reasons for this

1/ The impact of economic stimulus policies designed to boost demand and production
2/ Many workers have accepted pay cut or pay freezes
3/ Some employers have opted to cut average working hours instead of making more workers redundant
4/ The lower value of sterling has helped to stabilise sales and production in many export businesses