Notable fluctuations in
unemployment over the business cycle can be observed during times of economic
recession and expansion. During such periods of growth and decline,
unemployment is seen to be either positive or negative depending on the state
of the economy. Unemployment is positive and above the natural unemployment
rate at a business cycle trough, and is negative and below the natural
unemployment rate at a business cycle peak; this is called cyclical unemployment.
As the unemployment rate fluctuates around the natural unemployment rate, real
GDP fluctuates around potential GDP.
When the economy is at full
employment, real GDP equals potential GDP resulting in the output gap being
zero (output gap equals real GDP minus potential GDP, expressed as a percentage
of potential GDP). When the unemployment rate is above the natural unemployment
rate, the output gap is negative (real GDP is below potential GDP), and vice
versa for when the unemployment rate is below the natural unemployment rate.
Hence, the relationship observed between unemployment and real GDP can be
explained in short: as the unemployment rate fluctuates around the natural
unemployment rate, real GDP fluctuates around potential GDP causing the output
gap to fluctuate between negative and positive values.
In the equation stated above
(in question b-ii), it can be noted that there are two variables that directly
affect the unemployment rate – the number of people unemployed, and the number
of people in the labour force. Since the multiple of 100 does not pragmatically
affect the unemployment rate, it can be excluded in this explanation. Assuming that
the number of people unemployed does not change, we can write this variable in
terms of being a constant (k).
Unemployment rate = k / Labour force
From this equation above, it can be perceived that there is
an inverse relationship between the unemployment rate and the labour force.
This means that if the labour force increases, the unemployment rate decreases
– and vice versa. Therefore, if the labour force decreases by 2,500 people, the
outcome will be an increase in the unemployment rate. This can be proven by
calculating the new unemployment rate:
New Unemployment rate =
(Number of people unemployed/ Labour force) x 100
New Unemployment rate = 5,500/
(50,555-2,500) x 100
New Unemployment rate =
This shows that a decrease in the labour force by
2,500 people results in a growth of the unemployment rate by 0.57%.
In this situation Ravi would be considered cyclically unemployed. Due
to a global economic recession, foreclosed properties would undoubtedly begin
to flood the market and cause downward pressure on prices that could
potentially make it harder for real estate agents to close deals. This, coupled with the
fact that sellers generally resist offers that reflect reduced market values,
could be a viable reason for why the business went under. Seeing as Ravi
lost his job in consequence of the global economic recession, his unemployment
would be considered cyclical. Ravi’s best option for employment would be to
either improve his business skills -in terms of negotiation, closing deals,
understanding the growing mix of alternative financing options, and/or addressing
the psychology of buyers and sellers- or to challenge the market by distinguishing
himself from other competitors through specialisation or by creating a niche market.