Revision: Consequences of Unemployment

Geoff Riley

1st January 2011

Persistently high unemployment create huge costs for individuals and for the economy as a whole. Some of these costs are difficult to value and measure, especially the longer-term social costs.

1.Loss of income: Unemployment normally results in a loss of income. The majority of the unemployed experience a decline in their living standards and are worse off out of work. This leads to a decline in spending power and the rise of falling into debt problems. The unemployed for example may find it difficult to keep up with their mortgage repayments.

2.Negative multiplier effects: The closure of a local factory with the loss of hundreds of jobs can have a large negative multiplier effect on both the local and regional economy. One person’s spending is another’s income so to lose well-paid jobs can lead to a drop in demand for local services, downward pressure on house prices and ‘second-round employment effects’ for businesses supplying the factor or plant that closed down.

3.Loss of national output: Unemployment involves a loss of potential national output (i.e. GDP operating well below potential) and is a waste of scarce resources. If some people choose to leave the labour market permanently because they have lost the motivation to search for work, this can have a negative effect on long run aggregate supply and thereby damage the economy’s growth potential. Some economists call this the “hysteresis effect”. When unemployment is high there will be an increase in spare capacity - in other words the output gap will become negative and this can have deflationary forces on prices, profits and output.

4.Fiscal costs: The government loses out because of a fall in tax revenues and higher spending on welfare payments for families with people out of work. The result can be an increase in the budget deficit which then increases the risk that the government will have to raise taxation or scale back plans for public spending on public and merit goods. The problems facing the UK government at the moment are closely linked to the surge in unemployment.

5.Social costs: Rising unemployment is linked to social deprivation. For example, there is a relationship with crime and social dislocation including increased divorce rates, worsening health and lower life expectancy. Regions that suffer from persistently high long-term unemployment see falling real incomes and a widening of inequality of income and wealth. The recent figures on poverty in the UK are testimony to the social damage that high unemployment can have.

Evaluation points:

Exam questions quite often ask students to discuss some of the effects of a sustained rise in unemployment. Good answers will include AD-AS analysis on the economic impact and also make a distinction between economic and social consequences. Evaluation might also include the following:

*The impact of high unemployment on human capital / labour productivity
*Structural problems caused by occupational and geographical immobility of labour
*Effects on wage inflation e.g. the possibility of wage freezes or wage cuts
*The effects of people leaving the labour market because they have given up the search for work - this is known as a hysteresis effect
*Mention of some positive effects - e.g. it increases the pool of available labour for businesses wanting to expand and take on more workers
*Experience of unemployment might prompt some people to become self employed and start their own businesses.

A selection of other revision blogs and revision presentations on this topic can be found by selecting from the choices below

Geoff Riley

Geoff Riley FRSA has been teaching Economics for over thirty years. He has over twenty years experience as Head of Economics at leading schools. He writes extensively and is a contributor and presenter on CPD conferences in the UK and overseas.

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