Effects of Unemployment

What is unemployment?

Unemployment in an economy occurs when there are people who are both willing and able to work but do not have a job.

For example, let’s say that a person in the United Kingdom loses their job in a manufacturing firm. If this person starts actively looking for another job, they are classed as unemployed.

What are its effects?

Unemployment in an economy has many impacts on the government, firms and, of course, the unemployed people themselves.

On the government:

  • Fewer tax revenues – Because fewer people are working, there will be fewer people earning enough income to pay tax. As a result, the government will receive less tax revenue and this will have a large impact on the government’s finances.
  • Lower economic growth (GDP) – As fewer people have jobs, firms won’t be able to produce as many goods and services. As a result, the output of goods and services in the economy, GDP, will be lower. This also has an impact on government taxation and spending and will negatively affect their finances.
  • Higher welfare costs – Unemployment in an economy means that fewer people will be working and more people will be claiming benefits. More people claiming benefits creates a drain on the government’s finances and means they have to spend more on benefit payments and less on other areas of the economy – so there is an opportunity cost.
  • Higher supply-side costs – With unemployment in an economy, more people won’t be working. These people need to be taught skills in order for them to be employable by firms. The government will have to spend more money on training the unemployed so that they have the right skills to be employed in a modern economy. This is also a drain on government finances and this money could also be spent elsewhere.

On firms:

  • Lower wage costs – Unemployment in an economy increases the supply of labour available for firms to employ. This creates a downward pressure on wages as labour is less scarce and more people are willing to get a job at a slightly lower wage. This will have a positive effect on firms as their variable costs will fall.
  • Larger pool of labour – Unemployment creates a large pool of labour which gives firms more choice of who to employ. This allows them to employ workers with higher skills and more experience.
  • Less demand for goods and services – Unemployment in an economy means that a lot more people will have less disposable income. Therefore spending on most goods and services will fall. As a result, firms will experience lower sales revenue and will likely see a fall in profits.
  • Increase in demand for inferior goods – There are some goods in an economy that people buy more off when their incomes are lower – these are known as inferior goods. When unemployment increases in an economy more people start buying inferior goods because they have lower incomes. As a result, sellers of inferior goods will see an increase in sales revenue and potentially an increase in profits.
  • Higher training costs – As we have seen, many firms will benefit from lower wage costs as a result of unemployment. However, many firms may also have to spend more resources on training new employees because they have been out of work for so long. Training new employees uses up a firm’s time and resources and as a result most firms will see an increase in employment costs.

On people:

  • Lower standard of living – The people who are unemployed will suffer a loss of income and will either have to survive on private savings or on benefits. As a result, they will be able to buy fewer goods and services and will see a fall in their standard of living.
  • Loss of skills – When someone becomes unemployed they will stop working and will start losing their skills and ability to work. The longer someone stays unemployed, the less employable they will be to firms because firms will need to spend money on retraining them.
  • Loss of confidence/depression – People who are unemployed will also suffer a loss of confidence in their ability. Many people who become unemployed will also suffer stress related illnesses and depression.

Key terms

  • Discouraged workers – These are people who are unemployed for so long that they eventually give up the search for a job and leave the labour market.
  • Gross domestic product (GDP) – This is the total value of all goods and services produced in an economy during a set period of time.
  • Inferior goods – These are goods that are of inferior quality to other products and have negative income elasticity.
  • Labour force – The labour force is the total amount of people who are willing and able to work. It is also referred to as the number of employed people plus the number of unemployed people.
  • Normal goods– These are goods that we buy more of as incomes rise and we consider them as luxury.
  • Supply side policies – This is when the government uses policies to increase the aggregate supply in the economy.
  • Taxation – This is the money collected by governments from people’s earnings, wealth or spending.
  • Unemployment rate – This measures the percentage of people in the labour force who are unemployed. If the labour force is 10 million and there are 1 million people who are unemployed, the unemployment rate is 10%.
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