Unit 1 The supply side of the macroeconomy: Unemployment and real wages

1.3 Measuring the macroeconomy: Output, employment, unemployment, and inactivity

To understand how the whole economy works, we focus on aggregate measures, such as total employment (the total number of people employed), unemployment rate, and aggregate output. (The term ‘aggregate’ just means total.) In some cases, measurement is straightforward: the number of people employed on any given day can simply be counted. In other cases—for example, measuring total output—the adding up requires summing different things: a particular make and model of a car summed with a tin of tomatoes, a gym membership, and so on.

Once you start thinking about it, measuring the total output of the economy is a complicated task. We postpone explaining how that is done until Unit 3. For now, we assume that the national statistical agency has solved the problem of how to create a measure of the economy’s total output.

Aggregate output is one important indicator of the performance of the macroeconomy; another is the state of the labour market. Whether or not someone has a job (or has a family member who is working), makes a huge difference in their life. What kind of job it is, how much they earn, and how many hours they work are also very important. Searching for one’s first job, losing a job, starting a new job, retiring … these are all important life events. Here, we take a step back from these experiences and consider the numbers—statistics on employment, unemployment, and labour force participation. At the aggregate level, these numbers tell us a lot about the health of an economy. But when you consider the numbers, don’t forget all the experiences that lie behind them.

Another way to categorize the working age population is by considering those who are in employment or education and those who are not. The NEET category (not in employment, education, or training) is the working-age population minus the employed minus those who are studying or receiving training.

population of working age
A statistical convention, which in many countries is all people aged between 15 and 64 years.
labour force
The number of people in the population of working age who are, or wish to be, in work outside the household. They are either employed (including self-employed) or unemployed.
economically inactive
People in the population of working age who are neither employed nor actively looking for paid work are classified as economically inactive. Those working in the home raising children, for example, are not considered as being in the labour force, so they are classified this way.

Figure 1.3 provides an overview of the labour market and shows how these components fit together. We begin on the left-hand side, with the population. The next box shows the population of working age, usually calculated as the total population, minus children and those over 64. It is divided into two parts: the labour force and those out of the labour force (known as economically inactive). People out of the labour force are not employed or actively seeking work: for example, those who are unable to work due to sickness or disability, students who are not working, or parents who stay at home to raise children. Only members of the labour force can be considered as employed or unemployed.

The flowchart shows an overview of the aggregate labour market and how its components fit together. The population of an economy can be divided into population of working age, and the population not of working age (such as the young and the elderly). The population of working age can be further categorised into those who are in the labour force and those who are out of the labour force (i.e., are inactive). Those active in the labour force are categorised into the employed and unemployed. The flowchart summarises that the employed and unemployed make up the labour force. Adding those who are out of the labour force (inactive) produces the population of working age.
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https://www.core-econ.org/macroeconomics/01-supply-side-macroeconomy-03-output-employment-inactivity.html#figure-1-3

Figure 1.3 The aggregate labour market.

Labour market statistics

There are a number of statistics that are useful for evaluating labour market performance in a country and for comparing labour markets between countries. The statistics depend on the relative sizes of the boxes shown in Figure 1.3.

Participation rate

participation rate
The ratio of the number of people in the labour force to the population of working age. See also: labour force population of working age.
unemployment rate
The unemployment rate is the fraction of the total labour force that is seeking work, but is not currently employed. See also: labour force employment rate.
unemployed, unemployment
An unemployed person is someone who is able and willing to work, but is not currently employed.

The first is the participation rate, which shows the proportion of the working-age population that is in the labour force. It is calculated as follows:

\[\begin{align*} \text{participation rate} &= \frac{\text{labour force}}{\text{population of working age}} \\ \\ &= \frac{\text{employed + unemployed}}{\text{population of working age}} \end{align*}\]

Unemployment rate

The unemployment rate shows the proportion of the labour force that is unemployed. It is calculated as follows:

\[\begin{align*} \text{unemployment rate} = \frac{\text{unemployed}}{\text{labour force}} \end{align*}\]

According to the standardized definition of the International Labour Organization (ILO), the unemployed are the people who:

  • were without work during a reference period (usually four weeks); in other words, they were not in paid employment or self-employment
  • were available for work
  • were seeking work; in other words, they had taken specific steps in that period to seek paid employment or self-employment.

Employment rate

employment rate
The employment rate is the fraction of the population of working age that is employed. See also: population of working age, unemployment rate.

Lastly, we come to the employment rate, which shows the proportion of the population of working age that are in paid work or self-employed. It is calculated as follows:

\[\begin{align*} \text{employment rate} = \frac{\text{employed}}{\text{population of working age}} \end{align*}\]

It is important to note that the denominator (the statistic on the bottom of the fraction) is different for the unemployment and the employment rate. Hence, two countries with the same unemployment rate can differ in their employment rates if one has a high participation rate and the other has a low one. Particularly in cases where a country has low unemployment rates but also low participation rates, the employment rate can be very helpful for evaluating its performance by showing the proportion of working-age people who are working.

The figure shows two line charts comparing the UK and US’s macroeconomic performances. The first line chart shows the UK and US’s employment and participation rates. The horizontal axis shows the year, ranging from 2000-2024. The vertical axis of the first line chart shows working age population in percent, ranging from 0% to 70%. The UK and US’s employment rates remain relatively constant from 2003 to 2006, with the US’s employment rate at a higher level than that of the UK’s. During the global financial crisis, both the US and the UK’s employment rates fall, although the former falls by a larger amount, converging around 2011. From 2012 to 2019, employment rates in both countries increase, the UK’s increasing at a faster pace and overtaking the US, and they both experience a decline in 2020 during COVID-19, with the US experiencing a more significant decline in employment rate. The UK’s participation rate increases at a slow, steady rate for most of this period. The US’s participation rate starts at a higher level than the UK’s in 2000 but begins a slow and steady decline in 2007 following the global financial crisis, falling below that of the UK’s in 2012. Both countries see a decline in 2020. The second line chart shows the US and the UK’s unemployment rate. The horizontal axis shows the year, ranging from 2000-2024. The vertical axis of the second line chart shows the unemployment rate in percent, ranging from 0% to 20%. The UK’s unemployment rate increases in 2007 following the global financial crisis and continues increasing until 2012. It steadily declines until 2020, where it increases slightly. The US’s unemployment rate increases at a faster rate 2007 during the global financial crisis but converges with the UK from 2012 to 2020. During COVID-19, the US’s unemployment rate sees a much larger spike than the UK’s, decreasing from 2021 onwards.
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https://www.core-econ.org/macroeconomics/01-supply-side-macroeconomy-03-output-employment-inactivity.html#figure-1-4

Figure 1.4 Macroeconomic performance in the UK and US: employment, unemployment, and participation.

Labour market statistics for the UK and US (2000–2023). International Labour Organization. 2023. ILOSTAT Database.

The term ‘shock’ is used in macroeconomics to refer to unanticipated events both in the world and in macroeconomic models. Shocks can be positive or negative. Discovery and implementation of a new technology that enhances productivity or reduces greenhouse gas emissions per unit of output is a positive shock. A rise in the price of raw materials essential to production such as to the price of oil or gas is a negative shock to countries that import them.

Figure 1.4 shows that large macroeconomic shocks common to two economies produce different outcomes. Both the UK and the US experienced the global financial crisis in 2007–2009 and the COVID-19 pandemic in 2020–2021. The bottom panel shows that the unemployment rate went up in both countries in both crises by very different amounts. Both employment and unemployment are more responsive to these shocks in the US than in the UK.

Taking a longer-term view, the US began the period with a substantially larger proportion of working-age people in jobs than was the case in the UK. And although the unemployment rate in the US returned to its pre-financial crisis level by 2015, the employment rate has never regained its pre-crisis level. This is reflected in the long-run decline in the participation rate in the labour market in the US. A substantially lower share of the US population of working age are actively engaged in the labour market than was the case before the financial crisis.

The dramatic difference between the effect of the COVID-19 shock on UK and US unemployment is due to the policies adopted. In the UK, as in much of Europe, people were able to keep their jobs during the pandemic even if they did not do any work. Whole sectors of the economy, such as hospitality and entertainment, were closed in both countries, but in the UK these workers kept their jobs and were paid 80% of their wage by the government; in the US, the workers were laid off and the government paid them more generous unemployment benefits than would have occurred outside the pandemic.

Question 1.1 Choose the correct answer(s)

Read the following statements and choose the correct option(s).

  • Participation rate = employed/labour force.
  • Unemployment rate = unemployed/population of working age.
  • Employment rate = employed/population of working age.
  • Employment rate + unemployment rate = 1.
  • Participation rate = labour force/population of working age.
  • Unemployment rate = unemployed/labour force.
  • This is how the employment rate is calculated.
  • Unemployment rate = unemployed/labour force, while employment rate = employed/population of working age. They do not add up to 1 because the denominator is different.

Comparing labour markets

The chart in Figure 1.5 provides a picture of the labour markets in four countries—Australia, Germany, Norway, and Spain—between 2000 and 2019, and shows how the labour market statistics relate to each other.

It also shows that the structure of the labour market differs widely among different countries. The Norwegian labour market functioned better than the Spanish labour market over that period—Norway had a much higher employment rate and a much lower unemployment rate. Norway also had a higher participation rate, which is a reflection of the higher proportion of women in the labour force.

This bar chart shows labour market statistics for Australia, Norway, Germany, and Spain. The horizontal axis shows the employment rate as a percent of the workforce, participation rate as a percent of the workforce, and the unemployment rate as a percent of the labour force. The vertical axis displays the labour market statistic in percent as an average of the years 2000-2019, ranging from 0%-80%. Norway has the highest employment rate, participation rate, and the lowest unemployment rate of the four countries, while Spain has the lowest employment and participation rates and the highest unemployment rate. Australia and Germany fall in the middle, with Australia having higher employment and participation rates and a lower unemployment rate.
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https://www.core-econ.org/macroeconomics/01-supply-side-macroeconomy-03-output-employment-inactivity.html#figure-1-5

Figure 1.5 Labour market statistics for Australia, Germany, Norway, and Spain (averages over 2000–2019).

International Labour Organization. 2023. ILOSTAT Database.

Norway and Spain are illustrations of two common cases. Norway is a low-unemployment, high-employment economy. (Other Scandinavian countries—Sweden, Denmark, and Finland—are similar; and in the figure, Australia is the country most similar to Norway.) Spain is a high-unemployment, low-employment economy. (Other southern European economies—Portugal, Italy, and Greece—are other examples.) Other combinations are possible, however: Germany’s participation rate is low like Spain’s, but its unemployment and employment rate performance are much better.

Exercise 1.1 Employment, unemployment, and participation

  1. Visit the ILO’s website and use the ILOSTAT Database to calculate the average employment, unemployment, and participation rates over the period 2000–2019, for two economies of your choice.
  2. Create appropriate chart(s) to display these statistics for the US, UK, and your chosen countries. Using your chart(s), describe the similarities and differences in these statistics between your chosen countries, the US, UK, and those in Figure 1.5.
  3. Suggest possible reasons for the differences in unemployment rates in these countries. (After studying this unit, use the model of the labour market to expand on your answer to this question.)