Unemployment as Excess Supply
This definition reflects the idea that unemployment is an excess supply of labor. This is illustrated by Figure four.
Figure 4 -- Unemployment as Excess Supply
Figure 4 shows the supply and demand for labor in one particular industry. When there is a high level of unemployment in the economy, most industries would have excess supplies as shown here. This is the excess supply interpretation of unemployment.
Recall that the demand for labor is the marginal productivity of labor in money terms. In the case shown here, the wage, w, is above equilibrium, so the quantity of labor supplied is greater than the quantity demanded. Thus L2 minus L1 potential workers are seeking work at wage w but are unable to find jobs. According to the definition just given, they are unemployed.
As we have already said, though, many things about unemployment are controversial. There are at least two points of controversy in this excess supply interpretation of unemployment.
- Many "conservative" economists just do not accept the idea that unemployment, as we usually think of it, is an excess supply of labor. We will explore their alternative interpretation in a later chapter.
- Many "liberal" economists would say that the supply-and-demand interpretation points in the wrong direction. Looking at the diagram, we would say that wages are "too high" and that the solution of the problem is to decrease wages. But that reflects the "ceteris paribus" assumption, that wages fall while the supply and demand curves remain unchanged. Remember, the diagram reflects just one of many labor markets for different industries in society with excess supplies of labor. A cut in wages in other industries could reduce the demand for the output of the industry in the diagram, and thus reduce its demand for labor. Thus, we can't assume that the fall in wages in the economy as a whole could take place under ceteris paribus conditions, and we need to find another way to think about unemployment.
- Marxists have yet a different view of unemployment. However, we will not be discussing the Marxist view in this chapter.
Economists' "reasonable dialog" about unemployment has been going on for about 60 years now, but a number of things are still unsettled. All the same, the excess supply interpretation is the key to understanding the definition of unemployment.
But how is unemployment measured, in practice?
Measuring Unemployment