Causes and effects of unemployment

Causes

• Frictional: people between jobs, searching for the right one; often short term. Made worse by poor information about vacancies.
• Seasonal: demand for labour varies with the season (tourism, agriculture, construction).
• Structural: long-term decline of an industry leaves workers whose skills or location do not match vacancies (occupational and geographical immobility).
• Demand deficiency (cyclical): AD falls in a downturn, so firms need fewer workers.
• Real wage inflexibility (classical): real wages are held above the market-clearing level, for example by a minimum wage or union bargaining, so labour supplied exceeds labour demanded.

Real wage unemployment in words

In a labour market diagram (real wage on the vertical axis, quantity of labour on the horizontal), if the real wage is fixed above the equilibrium where labour demand and supply cross, more people want to work than firms want to hire. The horizontal gap between labour supply and labour demand at that wage is the unemployment.

Effects

• Workers and consumers: lost income, lower living standards, loss of skills, stress and poorer health; lower consumer spending.
• Firms: lower demand for products, though easier recruitment and less wage pressure.
• Public finances: less income tax and VAT, more spent on benefits, so the budget deficit widens.
• Resource use: labour is idle, so the economy operates inside its production possibility frontier; output is lost permanently.
• Society: links with crime, family breakdown, regional inequality; long-term unemployment can become hysteresis, as skills decay and people become harder to employ.

Worked example

A coal-mining region loses its mines. Explain which type of unemployment results and why it may last.

1. The industry declines permanently, so this is structural unemployment.
2. Miners' skills do not match new jobs (occupational immobility) and new jobs may be in other regions (geographical immobility).
3. Retraining and moving take time and money, so unemployment can last years.

Answer: Structural unemployment, persistent because of occupational and geographical immobility.

Check yourself

1. A worker loses a job in shipbuilding when the industry closes and lacks the skills for local vacancies. This is
   • frictional unemployment
   • seasonal unemployment
   • real wage unemployment
   • structural unemployment
   Show answer

   structural unemployment. A permanent decline in an industry plus a skills mismatch is structural.

2. A software developer resigns and spends three weeks choosing between job offers. This is
   • structural unemployment
   • frictional unemployment
   • demand-deficient unemployment
   • seasonal unemployment
   Show answer

   frictional unemployment. Short-term search between jobs is frictional.

3. During a recession, AD falls and firms lay off workers in many industries. This is
   • frictional unemployment
   • seasonal unemployment
   • structural unemployment
   • demand-deficient unemployment
   Show answer

   demand-deficient unemployment. Low AD reduces the derived demand for labour.

4. A national minimum wage is set well above the market-clearing wage. Which type of unemployment may result?
   • Real wage inflexibility
   • Seasonal
   • Frictional
   • Demand deficiency
   Show answer

   Real wage inflexibility. Labour supply exceeds labour demand at a wage held above equilibrium.

5. On a production possibility diagram, high unemployment is shown by
   • a point on the frontier
   • an outward shift of the frontier
   • a point inside the frontier
   • a point outside the frontier
   Show answer

   a point inside the frontier. Idle resources mean output is below potential.

6. At the minimum wage, 520,000 people want to work but firms want to hire 470,000. How many are unemployed because of real wage inflexibility?
   Show answer

   50000 people. Labour supply - labour demand = 520,000 - 470,000 = 50,000.

7. Explain one effect of rising unemployment on government finances.
   Show answer

   Tax revenue falls because fewer people earn income and spend, while spending on unemployment benefits rises, so the budget deficit widens.. A two-way squeeze: less tax in, more benefits out, so the deficit grows.

8. Why can long-term unemployment be especially costly?
   • It always causes inflation
   • It raises the economy's potential output
   • It increases tax revenue
   • Skills decay and people become harder to employ even when demand recovers
   Show answer

   Skills decay and people become harder to employ even when demand recovers. This is hysteresis: past unemployment raises future unemployment.

Practise with instant feedback Print this lesson

Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification, Issue 2 (June 2018)

Last updated 8 November 2026. Spotted a mistake? Tell us.