Classical Unemployment Explained

Quick Definition: Classical unemployment is a type of unemployment caused by real wages being too high in the economy. Too high real wages mean firms cannot afford to employ all available workers so some are left unemployed

Real-wage unemployment

What is classical unemployment?

Unemployment occurs when there are people who are willing and able to work but don’t have a job.

Classical unemployment is one of the main types of unemployment. It occurs when the real wages for workers in an economy are too high, meaning that firms are unwilling to employ every person looking for a job.

When real wages are too high, it means that the cost of employing an extra worker (the real wage) is higher than the benefit from employing an extra worker (the value of output the worker produces).

So when real wages are too high in an economy, firms cannot profitably employ all the labour on offer. As a result, some of the economy’s pool of labour is not used. This is known as classical unemployment.

Another way of explaining classical unemployment is by looking at a supply and demand diagram.

In an economy labour is supplied by people and labour is demanded by firms. In the diagram above, the supply curve shows the relationship between the quantity of labour supplied and the price of labour (the real wage rate). The demand curve shows the relationship between the quantity of labour demanded and the price of labour.

Where the two curves intersect it means the market is in equilibrium. In equilibrium, all the labourers in the economy are being employed. In the diagram above, the wage rate that achieves market equilibrium is labelled W1.

As discussed, when real wages for workers in the economy are too high it means firms are unwilling to employ all available labour. In the diagram above W2 is an example when the real wage rate is too high.

At this wage rate Q1 shows the amount of labour demanded and Q3 shows the quantity of labour supplied. As you can see the supply for labour outstrips the demand for it. As a result, there is a quantity of labourers that won’t be employed by firms. This is called classical unemployment.

Key terms

• Unemployment – This is a situation in an economy where there are people who are willing and able to work but do not have a job.
• Unemployment rate – This measures the percentage of people in the labour force (those who are able to work) who do not have jobs.
• Real wages – These are the wages taken home by workers after the impact of inflation has been accounted for. Real wages represent the actual amount of purchasing power a worker earns.
• Supply – The amount of a good or service offered for sale.
• Demand – The quantity of a good that people are willing to buy at a given price.