We expect there to be some frictional unemployment, even in a well-functioning economy. We also know that there is cyclical employment associated with the ups and downs of the business cycle. When cyclical unemployment is zero, we say that the economy is operating at full employment. The natural rate of unemployment is defined as the amount of unemployment we expect in an economy that is operating at full employment—that is, it is the level of unemployment that we expect once we have removed cyclical considerations.
The natural rate of unemployment can seem like an odd concept because it says that it is normal to have unemployment even when the economy is booming. But it makes sense because all economies experience some frictional unemployment as a result of the ongoing process of matching workers with jobs. Government policies that affect the flows in and out of employment lead to changes in the natural rate of unemployment.
KEY TAKEAWAY
The static model of labor supply and labor demand fails to capture the dynamic nature of the labor market and does not account for job creation and destruction.
In the United States, labor markets are very fluid. Each month, a significant fraction of workers lose their jobs, and each month a significant fraction of unemployed workers find jobs.
Search theory provides a framework for understanding the matching of workers and jobs and wage determination through a bargaining process.
The economy is operating efficiently when workers are assigned to jobs based on comparative advantage. Inflexible labor markets lead to inefficient allocations of workers to jobs.
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Checking Your Understanding
Is it best to assign workers to jobs based on absolute advantage or comparative advantage?
Why is frictional unemployment not always zero?
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