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Cyclical Unemployment

Cyclical Unemployment – Concept, Methods, Causes and Examples | Macroeconomics

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Cyclical Unemployment

Cyclical unemployment occurs when labor forces are reduced due to business cycles or fluctuations in the economy, such as recessions (periods of economic decline).

The rate of cyclical unemployment is low when the economy is at its peak or experiencing continuous growth. During this period, sales and income increase, so more people are needed to meet the demand.

The main reason for high unemployment rates is cyclical unemployment. This is caused by a downturn in the business cycle. It occurs as part of the natural rise and fall of economic growth over time.

Unemployment caused by cyclical economic contractions is temporary and determined by the length of the recession.

Recessions usually last around 18 months. The unemployed tend to be rehired when the business cycle enters an expansionary phase (rising toward the peak of the wave).

In contrast, during a recession, cyclical or involuntary unemployment increases due to a decline in demand for goods and services.

This means that production decreases, resulting in fewer workers needed, leading to layoffs. In the labor market, there are more unemployed workers than job openings.

Ways to determine the cyclical employment rate

The cyclical unemployment rate is calculated using the unemployment rate and the other two types of unemployment. The formula goes as follows:

  • Cyclical Unemployment Rate = Current Unemployment Rate – (Frictional Unemployment Rate + Structural Unemployment Rate)

An example of cyclical unemployment is when automobile workers are laid off during recessions to cut labor costs. During a downturn, fewer people buy vehicles, so manufacturers don’t need as many workers in order to keep up with demand.

During periods of economic recovery, when consumers start spending more money on vehicles, the unemployed worker can be rehired in order to meet demand.

In other words, the unemployment of a person is cyclical, depending on the economic cycle. Whether high or low, cyclical unemployment is only temporary.

The rate of unemployment changes continuously when the economy enters and exits business cycles. When the economy goes into a depression, a business cycle can last up to 10 years.

During a recession, a business cycle can last up to 18 months, and it can take up to 18 months to complete a business cycle.

Frictional Unemployment Rate

A frictional unemployment rate is the percentage of the total labor force that is voluntarily unemployed due to workers’ decisions to change careers.

The worker could be transitioning from one job to another or choosing to be temporarily unemployed while looking for a job that better matches his or her skills, income needs, location, or other factors.

To calculate the rate, divide the total number of frictional unemployed workers by the total labor force, then multiply by 100 to calculate the percentage.

The National Statistics Agency or the Bureau of Labor Statistics have the most up-to-date, accurate figures for frictionless unemployed workers and the total labor force.

Structural Unemployment Rate

The structural unemployment rate is the percentage of the labor force that is involuntarily unemployed because of mismatched skills, technological changes, business competition, or government policies.

It is possible to obtain statistics for the structurally unemployed workforce and the total labor force from the National Statistics Agency or the Bureau of Labor Statistics.

Causes of Cyclical Unemployment

The causes of cyclical unemployment are:

  • Decline in Demand
  • Negative Multiplier Effects
  • Market Crash
  • Decline in Demand

Generally, cyclical unemployment occurs when demand throughout the economy declines. In other words, as demand in individual households declines all the time, this occurs on a macro level.

Therefore, demand is falling across the country. The savings will at least contribute to businesses investing less and employing fewer people.

There may be times when individual households need to cut back on consumption to save for a new car or something else. Nevertheless, cyclical unemployment occurs when many households do this at the same time.

  • Negative Multiplier Effects

A reduction in demand leads to a chain reaction called a multiplier effect. The decline in demand for beef may not only affect the profits of the local supermarket or store, but also those of the farmer, butcher, and those involved in transporting the goods.

In other words, what appears to be a decline in demand in one sector ends up affecting multiple sectors.

We may often see unemployment multiplying across each of the connected industries when we take this into a broader perspective.

  • Market Crash

Market crashes such as the one in 2007/08 and the dotcom crash in 2001/02 contributed to cyclical unemployment.

The financial consequences were far-reaching. For example, the dotcom crash was caused by technology firms spending too much too quickly in order to reach the top.

Debt levels in technology firms were high and could only be sustained through high growth. The increase in interest rates in 2000 helped push many into bankruptcy.

Millions of people employed by such firms lost their jobs as a result. Crashes tend to affect not only certain industries, but also confidence in the market as a whole.

Effects of Cyclical Unemployment

The effects of cyclical unemployment are as follows:

  • Falling Demand
  • Deflation
  • Declining Profits
  • Decreasing Productivity
  • Falling House Prices

  • Falling Demand

As economic growth declines, business demand falls, leading to fewer workers being needed to meet consumer demand, resulting in cyclical unemployment.

Therefore, when consumer demand declines, people lose their jobs, affecting their demand, which then affects more jobs. So, the initial decline in demand can have a large impact.

  • Deflation

When the economy slows and unemployment rises, consumer demand falls. This may lead to a short-term drop in prices. As consumers demand less, businesses may lower their prices to attract customers.

  • Declining Profits

If businesses face declining demand, they may also face cost pressures. They may have to reduce the number of staff they have on hand.

This may involve redundancy payments and the inefficiency of keeping them on until they realize demand is declining.

It may also be necessary to lower prices to attract customers. Both of these actions have the potential to reduce profits.

  • Decreasing Productivity

The majority of cyclical unemployment is caused by an economic decline, which is also accompanied by declining consumer demand.

Consumers are demanding less, which means businesses are making less money. As a result, businesses are cutting costs rather than investing in more productive machinery and capital.

  • Falling House Prices

In times of economic recession and cyclical unemployment, it’s also common for house prices to fall, as people lose their jobs and general demand decreases.

Those who are able to purchase their own home have the upper hand. However, those who have lost their jobs may need to downsize urgently so that their capital investment in their house can be protected.

Example of Cyclical Employment

When the housing bubble burst during the financial crisis in 2008, the Great Recession began. A decline in demand for new construction occurred as more and more borrowers failed to meet their home loan obligations, and the qualification requirements for new loans became more stringent.

An overall increase in unemployment, coupled with more borrowers who could not make their mortgage payments, led to the foreclosure of more properties, further reducing demand for construction.

This led to the unemployment of approximately 1.5 million workers in the construction industry. This rise in unemployment was cyclical in nature.

References

Boyce, P. (2020, November 4). BoyceWire. Retrieved from BoyceWire: https://boycewire.com/cyclical-unemployment-definition/

Corporate Finance Institue. (n.d.). Retrieved from Corporate Finance Institue: https://corporatefinanceinstitute.com/resources/knowledge/economics/cyclical-unemployment/

Potters, C. (2021, January 24). Investopedia. Retrieved from Investopedia: https://www.investopedia.com/terms/c/cyclicalunemployment.asp#:~:text=Cyclical%20unemployment%20is%20the%20component,and%20declines%20during%20economic%20expansions.

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