What is Cyclical Unemployment? Examples and Formula
According to Keynes, cyclical unemployment is caused by too little aggregate demand. It arises when there is a decrease in the demand for goods and services in an economy. If this type of unemployment is eliminated in the economy, then we consider the economy to be at full employment. In other words, the absence of cyclical unemployment is evidence that the economy is fully employed.
What is cyclical unemployment?
Therefore, cyclical unemployment is unemployment that occurs because the economy is contracting. Hence, full employment is the level of employment reached when there is no cyclical unemployment. With this, if cyclical unemployment is eliminated in the economy, then the economy is at full employment.
Most of the unemployment during the great depression was cyclical unemployment. This means cyclical unemployment results from cycles of economic upturn and downturn. It is certain that business production, as well as economic growth, take place in cycles.
An increase in cyclical unemployment will result in the slowing down of the economy which is not good. By implication, a lack of demand implies insufficient consumption. However, when cyclical unemployment increases and other things remain the same, the natural unemployment rate remains unchanged. Therefore, cyclical unemployment tends to increase when the economy is in a recession.
Cyclical unemployment definition/meaning
We can define cyclical unemployment as a type of unemployment that results from a contraction in economic growth. That is, cyclical unemployment occurs when the economy declines. Cyclical unemployment is the result of economic recession.
In essence, cyclical unemployment arises when economic growth is declining. Remember that if cyclical unemployment is zero, the economy is fully employed. Cyclical unemployment includes people who become unemployed from economic contractions. This will call for the need for government interventions such as fiscal and monetary policies.
A decrease in cyclical unemployment will result from an increase in aggregate demand which can be facilitated through expansionary fiscal and monetary policies. As output (GDP) is increasing, the amount of cyclical unemployment would decrease. The growth of an economy is measured by its GDP. This implies that cyclical unemployment happens when the economy’s GDP decreases as well as aggregate demand. These are indicators that the economy is recessing.
Cyclical unemployment and recession often arise from the macroeconomic situations in the economy. This is as well trying to say that cyclical unemployment is primarily caused by economic contractions/recessions. It has been observed that cyclical unemployment occurs from a decrease in aggregate demand. Cyclical unemployment is closely associated with upward and downward trends in the economy’s business cycle. In other words, it describes the job loss that is related to a downturn in the economy.
Furthermore, cyclical unemployment happens because of a decrease in aggregate demand which is a result of an economic downturn. This is because the need for employees drops as the demand for goods and services decreases. Certainly, firms will lay off some workers because they will have to reduce their production when demand decreases. This in turn is the major cause of high unemployment rates. As more people are unemployed, demand further decreases because of the decrease in purchasing power.
Although cyclical unemployment is temporary, it is dependent upon the length of economic contractions that results from recession. Ideally, a recession lasts for eighteen months and then the business cycle re-enters its expansion phase. In this phase, firms begin to re-employ the unemployed.
Therefore, during healthy economic periods, cyclical unemployment is at its minimum. Cyclical unemployment and recession often arise from an aggregate demand decline. In other words, when aggregate demand declines, cyclical unemployment and recession will arise. In the latter part of this article, we will explain how to calculate the cyclical unemployment rate.
Causes of cyclical unemployment
- Decline in demand
- Negative multiplier effects
- Market crash
Cyclical unemployment is caused by the above-mentioned. They are explained below:
Decline in demand
A decline in demand in an economy is the major cause of cyclical unemployment. It is on a macro basis that this takes place as the demand in various households declines all the time. Now, looking at a nationwide decline in demand, it is a factor that contributes to a decline in business investment of businesses.
In turn, companies will require fewer employees than usual. There will be times when a need will arise for households to reduce their consumption to save for other things. When many households end up doing this at the same time, cyclical unemployment will arise.
As demand begins to fall, there will be no need for businesses to produce as many products and services as they use to. They begin to reduce the number of workers they have in this case. This may take the form of redundancies or simply letting the employees leave without making any replacements.
This is trying to explain that when there is a fall in the demand for goods and services, it amounts to a decrease in production which in turn lowers the need for employees thereby causing layoffs. Consumers will then have less to spend which will further cause a loss of revenue. With this, businesses lay off more firms in order for them to be able to maintain their profit margins. Generally, economies are already in a recession as of the time cyclical unemployment starts.
Negative multiplier effects
The multiplier effect is the chain reaction that a decrease in demand has. An instance is a case whereby a fall in the demand for a particular product, say beef, may not only have an effect on the local supermarket. It will also have an effect on the farmer, the butcher, and the transporters of the goods. This implies that a decline in the demand for a product in one sector will end up having effects on multiple areas. So, taking this into a wider scale, it is often seen that unemployment is multiplying across the industries that are interconnected.
Market crash
Market crash contributes to cyclical unemployment, for example, the 2007/2008 crash and the dot-com crash in 2001/2002 contributed to causing cyclical unemployment. Technology firms spent too much and too quickly, trying to reach the top which was the driving force of the dot-com crash.
Technology firms incurred high levels of debt which were only sustainable if they achieved high growth. The increase in interest rates in 2000 helped push many firms over the edge into bankruptcy. As a result, millions of employed workers in such firms lost their jobs.
When market crashes are in place, they do not only affect certain industries, they also affect market confidence in general. With this, there is often a decline in employers that look forward to hiring and expanding because a level of uncertainty has been created.
Cyclical unemployment examples
- The 1929 stock market crash
- The 2008 recession
- COVID-19 pandemic
Cyclical unemployment is more predominant in certain industries than in others. An example of cyclical unemployment with regard to this is house builders, they tend to suffer this as a result of a decline in demand as well as the inability to afford new homes. Let us look at other examples of cyclical unemployment.
The 1929 stock market crash
An example of cyclical unemployment is a market crash that took place in 1929. After a great rise in the economy throughout the 1920s, unstable financial trends that resulted mostly from excessive purchases of stocks brought about a decline in the prices of stocks as people were in a rush to sell and make their money back.
Businesses that had successful public stocks were suddenly worth close to half of their previous wealth. With this, the financial structure of the stock market in the United States collapsed in October 1929.
Although the market started to grow slowly in the next decade, the nation’s workforce was crippled by unprecedented unemployment for many years. This caused many firms to cut their labor force, which is laying off workers and caused millions to go without jobs. This high period of cyclical unemployment is referred to as The Great Depression.
The 2008 recession
In the Great Recession of 2008, cyclical unemployment reached another high level which was caused by the housing market this time around. After the soaring housing prices when loans were easily accessible, many people were unable to pay their debts which led to another financial crisis. Loans that were once easily accessible became increasingly difficult to access.
The building of new homes and remodeling practically stopped, thereby causing many construction workers to lose their jobs. Also, factories made use of computerized processes to complete production which caused many skilled workers to be laid off from work.
COVID-19 pandemic
In early 2020, the global economy came to a halt as a result of the COVID-19 pandemic. This is because businesses were forced to close down for a long period of time in order to stop the spread of the coronavirus. This reduced the revenue as well as buyer demand, thereby resulting in unemployment.
This crisis brought about a crisis for everyone in the workforce, especially women, lower wage earners, and the ones with less education. During this period, many firms had to lay off some of their workers due to the decrease in demand as well as the need to reduce production.
However, businesses like retailers and restaurants reopened as they were allowed to, so they re-employed employees to meet renewed demand. Also, in various ways, different governments across the world have attempted to stimulate the economy in different ways which include expansionary fiscal and monetary policies to stimulate the economy.
Cyclical unemployment effects
- Low production
- Declining demand
- Decreased spending
- Lower volume in the stock market
- Deflation
- Declining profits
- Falling house prices
- Hysteresis effects
Low production
When cyclical unemployment occurs, there is a decrease in consumer demand for goods which results in lower production of items across several industries. With this, firms will begin to lay off workers to avoid overproduction as well as maintain their profit margin. Therefore, there will be low production.
Declining demand
Cyclical unemployment results from a decline in economic growth and it has a close relationship with falling consumer demand. People lose their jobs as demand decreases because the need for workers reduces as emphasized. Furthermore, this affects their demand thereby affecting the jobs of more people. With this, the initial decline in demand can have greater effects beyond casual imaginations.
Large-scale job loss
The fact that consumer demand for goods and services decreases causes companies to have less need for workers thereby laying off workers across industries. So, there is a massive job loss.
Decreased spending
During cyclical unemployment, buyers usually reduce their purchases because consumer confidence is low especially when it comes to large purchases such as buying a home.
Lower volume in the stock market
One of the largest factors affecting cyclical unemployment is the stock exchange, which is buying and selling of stocks. This is because fewer stocks are traded for less value which has a negative effect on the economy. It is unfortunate that cyclical unemployment has become a self-fueling downward spiral.
The newly employed will have less disposable income thereby lowering demand and business revenue which in turn leads to more layoffs. When intervention does not take place, the spiral will continue until supply has dropped to meet the demand that has been lowered.
Deflation
As the economy declines, unemployment rises and then consumer demand decreases. In the short term, this has the potential of contributing to deflation. This is because as consumers demand less, businesses will begin to reduce prices in order to gain back customer attraction.
Declining profits
As firms are faced with declining demand, they are also faced with cost pressures. This may force them to reduce the number of workers they have which may involve paying redundancies as well as the inefficiency of keeping them on until they realize the fall in demand that has taken place. There will also be a need for them to reduce prices in order to attract customers. These factors have the potential of reducing their profits.
Falling house prices
During cyclical unemployment which results from economic recession, a trend for house prices to fall also exists. With people losing their jobs as well as a general fall in demand, there is an equal fall in the bargaining power of sellers. Those who can afford to buy have a greater advantage. Simultaneously, those that lost their jobs may be in desperate need to downsize so that they can protect their capital invested in their house.
Hysteresis effects
This is the idea that cyclical unemployment can bring about a further rise in the natural rate of unemployment. If young people remain unemployed for a long time during a recession, it will become very difficult for them to get back to the state of employment because they lack job experience as well as a decline in motivation.
Solutions to cyclical unemployment
- Expansionary fiscal policy
- Expansionary monetary policy
Cyclical unemployment is predominantly driven by the demand of consumers which accounts for most of the economic activities. Certainly, consumer demand is significant in contributing to the creation of such fluctuations. So, the above-mentioned are the tools that governments use in solving the problem of cyclical unemployment.
Expansionary fiscal policy
The expansionary fiscal policy takes the form of government spending and a decrease in taxation. In order to stimulate economic growth, governments can either increase government spending, decrease taxation, or both.
Government spending
With the increase in government spending, the government borrows money from tomorrow to use today. In the long run, this implies higher taxes. Economist John Maynard Keynes lauded its effectiveness when he stated that it is necessary for the government to step in to prevent cyclical unemployment and a decline in aggregate demand. The idea is that the government would spend money on infrastructure, employment programs, increased social welfare, etc. This money will, in turn, filter into the wider economy thereby preventing a dramatic decline in demand.
The major challenge with this is that it can starve the private sector funding. Increasing government spending must be facilitated by either public taxation or debt. However it goes, private individuals have less to spend how they see fit. The government here is deciding where the money will go to. It is a good thing during a recession but this does not provide a stimulating environment for growth. This makes private individuals find themselves dependent upon the government to drive growth because private entities are starved of capital.
Reduced taxation
By reducing taxation, the aim of the government is to put more money into the pockets of individuals. Here, the theory is that as consumers are taxed less, their disposable income increases. While some may choose to spend that extra income, others may save it instead. This has a stimulating effect on the wider economy. However, it is dependent upon the manner in which the average consumer reacts.
If everyone would spend all of the additional income received from tax cuts, the economy will experience a significant boost in consumer demand. This depending on the extent of tax cuts largely staves off cyclical unemployment.
Oftentimes, recessions come alongside a decline in consumer confidence. As consumers are losing their jobs, those who do not may become scared that they might lose their jobs. With this, the economy will experience a more cautious public. Also, the public may save the money they gain from lower taxes, however, this is equally unlikely as this happens oftentimes somewhere in between. It, therefore, does not have the positive effects most governments predict, however, it does not have any effect.
Expansionary monetary policy
Central banks employ expansionary monetary policies usually to control the rate of inflation as well as the rate of unemployment and economic growth.
Quantitative easing
Quantitative easing aims at increasing the supply of money, here, central banks create money and buy public debts from financial institutions. This helps in pumping money into the private market thereby increasing the availability of credit to both businesses and consumers. When central banks create capital, it goes into the wider economy. The act of buying government debt from financial institutions avails more money for them to lend out.
Quantitative easing helps in stabilizing the asset market. The demand for government debts helps to restrict the relative price movements of other assets which include stocks and bonds. With the creation of this stability, panic reduces, and business confidence with regard to investment increases. The aim of quantitative easing is to stimulate the economy by injecting cash into it. When there is more cash in the economy, people will have more which in turn will stimulate demand. When businesses see an increase in demand, they will pick up and begin to employ more workers.
Interest rates
Central banks can reduce interest rates and by doing so, those dependent on credit will benefit. This provides more access to loans for consumers and firms to meet the demand of consumers by expanding their production. In other words, there will be a level of income leading to greater consumption in the economy as well as improving employment.
When businesses end up spending less on interest, it implies that more funds are available for other investments or employment opportunities.
Cyclical unemployment rate
The cyclical unemployment rate is defined as the difference between the natural unemployment rate and the current rate. The natural unemployment rate is unemployment resulting from workers coming and going or in search of other jobs while the current rate has to do with the total amount of unemployed. If the cyclical unemployment rate is negative, then the natural unemployment rate is greater than the actual rate of unemployment within the economy.
How to calculate cyclical unemployment rate
We already know that the unemployment rate is calculated as;
Unemployment rate = number of unemployed workers/labor force x 100
The labor force includes both the number of employed workers and the number of unemployed workers. Now, the natural unemployment rate is obtained when we sum up the frictional and structural unemployment rates. This implies that the formula for the cyclical unemployment rate takes account of these two types of unemployment. Cyclical unemployment calculation is not a difficult task as it is the difference between the current unemployment rate and the natural unemployment rate.
Cyclical unemployment formula
The formula that guides how to find cyclical unemployment rate is;
Cyclical Unemployment Rate Formula = Current Unemployment Rate – (Frictional Unemployment Rate + Structural Unemployment Rate)
Note that one is considered unemployed only if he is not working but actively in search of a job. This implies that if you do not want to be a part of the labor force, you are voluntarily unemployed and will not be included in the unemployed rate calculation. When the rate of cyclical unemployment is zero, the economy is in its expansion phase.
Cyclical unemployment graph
We can describe cyclical unemployment as an event that begins with a recession. There is a decrease in demand during a recessionary phase of the business cycle because overall consumers are less likely to spend. At the same time, businesses are forced to lay off workers so that they can make up for losses in sales as well as reduce expenses. This continues until there is a decrease in supply to meet the new demand.
In the graph below, when the demand for labor decreases from D0 to D1, workers become excess, who are unable to find jobs at the same wage rate as before. The points AB signify the increase in unemployment while the new equilibrium is W1 and Q1. With this, unemployment is a direct result of economic contraction.
Structural vs cyclical unemployment
Structural unemployment is the type of unemployment that results from the mismatch between the skills of the unemployed and the jobs available by firms. On the other hand, cyclical unemployment is the unemployment that results from economic downturns. These are two types of unemployment that have an impact on the economy.
Structural vs frictional vs cyclical unemployment
Structural, frictional, and cyclical unemployment have an impact on the economy and are differentiated based on their causes. Structural unemployment is a job loss that results from the mismatch between the demand and supply of labor, whereas frictional unemployment results from workers transitioning from one job to another (short-term joblessness).
Cyclical unemployment, on the other hand, is unemployment that results due to economic downturns or a decrease in aggregate demand. Frictional, structural, and cyclical unemployment are the three major types of unemployment that exist in an economy.
