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The Unemployment Problem And Okun Law Economics Essay

Thomas Carlyle, Chartism (1923)

2.0 Unemployment definition:

According to Sloman (1991) unemployment can be expressed either as a number or as a percentage yet a question remain important who should be included in the statistic? Should it be everyone without a job? The answer is clearly not since we would not include children and pensioners and we will probably exclude people who are not looking for a job such as parents choosing to stay at home and look after children. However the most usual definition that economist uses to define number of unemployed are those of working age who is without work, but who are available for work at current wage rates. Sloman (1991) Nevertheless a dilemma remain important for distinguishing between people who genuinely want to work but cannot find jobs and those who choose to abstain from paid work. In the UK the number of people claiming unemployment benefit is counted and argued below.

2.1 Measurement of unemployment:

According to “Graham Dawson”, the purpose of measuring unemployment is to realise how many people satisfy the two essential conditions of being without a job and being interested in finding work. In the UK the official unemployment figures are produced by counting the number of people claiming unemployment benefit (or income support after twelve months of continuous unemployment) on the assumption that these are also the people who are out of work and really seeking a job. However the claimant count can misrepresent the reality of the level of unemployment. Those reality can be describe as people who are claiming unemployment benefits may have no intention to find a job or may even be working in the black economy, in which case the official figures overstate the ‘true’ unemployment level. On the other hand, some people who are desperately seeking work may not be eligible to receive unemployment benefits, in which case the official figures understate the ‘true’ unemployment level. The aim of measuring unemployment is to understand the number of people that satisfy the two important conditions. Furthermore different type of unemployment can affect the rate of unemployment within the economy and are argued below;

2.2 Type of unemployment

2.2.1 Frictional Unemployment:

Frictional unemployment can be express as a short period of time where a person goes out of job and seek for a new employment. The period spends between the loss and the finding of a new job is called frictional unemployment. In developed economy there is less probability of frictional unemployment due to a strong economy and large offers of job. This can be arguably criticised with the actual economic downturn that developed country are facing.

2.2.2 Structural Unemployment:

This type of unemployment takes place when there is a disparity of skilled labour in the market. Several reason of the structural unemployment is geographical immobility, occupational immobility, which can be defined as difficulties encounter to learn a new skill and technological change, in other word the development of an organisation in new technologies and techniques which lead to a reduction of labour. Pillai (2008)

2.2.3 Classical Unemployment:

Classical unemployment can also be defined as the real wage unemployment or disequilibrium unemployment. Pillai (2008) this phenomenon appears when public organisation such as (trade unions and labour organization) put in the table the probability to increase wages. This situation leads to a direct fall in the demand for labour. Pillai (2008) this type of unemployment could be classified as The TYPE OF UNEMPLOYMENT that is affecting The United Kingdom today.

2.2.4 Seasonal Unemployment:

This type of unemployment can be defined as a natural effect of decreasing offer of job by organisation due to seasonal issues. The industries that remain fragile depending the season are the tourism and hospitality industries, catering and agricultural industries. Pillai (2008)

Moving on, the following paragraphs describes the endogenous variables that are in direct relation to unemployment. The Gross domestic product and inflation are scrutinised below and juxtaposed to theories developed by economists for the past decade.


GDP, or Gross Domestic Product, is probably the most significant of the entire economical statistics, since it helps to measure the well being of a country. GDP represent the total quantity of goods and services produced in a country and enclose all segments of the economy: agriculture, manufacturing, energy, construction, the service sector and government.

According to peter Kennedy (2000) GDP can be measured in three approaches which produce the same number. The output approaches, which look at the value of the goods and services produced. The expenditure approaches which is composed of several components, for instance the overall amount of goods and services acquired by households, from overseas, by the government and by business in terms of investment and can be simplified as follow,

GDP (Y) = Consumption (C) + Investment (I) + Government spending (G) + Net Export (X-M)

Kennedy (2000)

Okun’s law

Okun’s law expresses the direct relationship between unemployment and the Gross domestic product (GDP) of a country. This theory is named after Arthur Okun (1928-1980), American economist who states that for every one percent increase in unemployment rate, GDP is directly decreasing (from two to four percent from its potential). In 1962, Arthur Okun was the first economist who discovered the probable relationship between these two variables. This observable fact can also be identified as “natural unemployment” referring to the fact that there is no perfect market economy and that unemployment would always be at a certain level, because of uncontrolled changes in employment and economic destitution. Hill (2003) According to Abel & Bernanke 2005, Okun law can be represented as follow

, where:

is the possible output or Gross domestic product at full employment

Y is real output

is the natural rate of unemployment

u is the tangible unemployment rate

c is the factor that express the modification in unemployment to changes in output


Inflation can be described as a direct increase on price of goods and services over a period of time or simply an increase in cost of living. In addition, when this phenomenon occurs it directly affect the value of money (falls). This phenomenon has been associated to The Philips curve which is defined below.

Philips curve

New Zealand born economist A.W Philips first put this theory forward in 1958, which was to provoke an enormous amount of subsequent research and criticism, was the result of empirical investigation of the relationship between the rate of change of money wages and the level of unemployment. His affirmation of trade off between inflation and unemployment was based on past research done from (1861-1957) for UK. The time data used shown and confirmed his idea of trade off between the two variables. In addition it has been discover that any attempt by the government to reduce unemployment will increase the inflation rate and vice &versa. Graph 1, shows the trade between inflation and unemployment. It can be stated clearly the assumption taken by Philips was right; (referring to Figure 1) the decrease of unemployment rate from 6percent to 4percent has driven the inflation rate up from 1 to 3 percent upward. This assumption of simple choice for policy makers remain difficult due to the fact that this theory suggested that inflation and unemployment cannot be lowered collectively and that the government has to accept by reducing one the raise of the other.

Figure 1

However, this negative phenomenon expressed by William Philips have been criticised by economists particularly during the 70’s where the assumption declared by Philips appeared to be incorrect in certain countries. For instance it has been noticed by economists that unemployment and inflation level could hit a high level at the same time. This observable fact has been called stagflation and has been developed and explained in different theories such as the (Rational expectation and NAIRU (Non accelerating inflation rate of unemployment)) which has been later called the Natural rate of Unemployment. According to Graham Dawson (1992) Friedman used the last concept cited to support all his arguments that in the long run the Philips curve is vertical, so there is no trade off between inflation and unemployment. In economy the theory that represent the trade off between inflation and unemployment can be defined economically by U* which state NAIRU and U which is the actual unemployment rate. The following statements are the representation observed by economists, which represent the properties of the NAIRU assumption. It has been stated that when;

U < U* during few years, an expectation of rise in inflation is observed and tends to accelerate

U > U* during few years, is the inverse effect, the probability that inflation falls is observed, and the inflation rate tend to slow (there is disinflation)

And if U = U*, the inflation rate have a propensity to remain identical, unless an exogenous shock affect one of those two variables.

According to Edmund Phelps whom developed the Philips curve theory and won by his long research The Nobel Prize in Economics in 2006; No trade between inflation and Unemployment in the Long Run is stated. In the following figure, the long-run Philips curve has been represented by the vertical red line. The natural rate of unemployment stipulates that when the rate of unemployment is defined by this line, inflation will be stable. Nevertheless, in the short run policymakers will encounter a trade off between unemployment and inflation which is defined on the graph by “Initial short run Philips curve”. However during this time unemployment rate can temporarily be reduced, moving as described in the diagram from point A to B trough expansionary policy. It has been argued that by exploiting this short run trade off will increase inflation expectation, and automatically a right shift of the short run to the new short run Philips curve will be stated (point B to point C). Due to this outward movement to reduce unemployment,

Empirical research

Employment, Unemployment, labour force and unoccupied vacancies are called stock variables according to the Economist due to the fact that they give indication and are measured at a certain time. Changes in the labour force are due to flow variables such as natural population growth, new entrants and retirements from the labour force. The Economist (2008)

However unemployment, as one of the various macro economy variables can be classified as major elements that can affect the whole economy. The focus of this research it’s to focus on two others important macro fundamentals that might also be in relation to unemployment and be significant to it s rate.

The following statement describes and juxtaposes the two exogenous variables that are related to unemployment. Past research from economists the by economists includes two exogenous factors that will be critically scrutinised using past studies derived from academic journals and books.

How useful is Okun law?

This study has been completed by Edward S. Knotek, II in 2007. Mr Knotek American Economist who works at the Federal Reserve Bank of Kansas City. To complete this research, associates economists participated to its realisation.

This study has been carried out to find out the usefulness of the Okun Law. The abstract summarised adequately the article and gives a clear vision of where the study is going. In addition the introduction was set to encompass a clear impact on the reader and explain clearly the different aspect of Okun’s law and its approach. For instance, the author argued that Okun’s law is a statistical relationship rather than a structural feature of the economy, in other word the author argued that the Okun’s law express the relationship between GDP and Unemployment rather than being a simple theory with no use of data and statistical tools. Knotek (2007) Additionally, It can be stated from the introduction that relevant literatures have been used by the author. For example regression model and real time data undertaken have proved to be extremely important and accurate for the study. Thus, terms have been defined in some cases only; it could be difficult for a novice with no background in economics to understand some of the terms used by the author. Existing studies have not been used by the author himself, however historical data have been chosen for their degree of significance and level of relationship. The data gathered such as analysis techniques and tools used by the authors pinpoint the importance and requirement for any research and researchers on the Okun law principles. However the authors argued that using a long time series for instance 1950 to 2007, history could hide alteration in relationship. All the data chosen in this research have been specially chosen by the author as past important events where unemployment and GDP trend has been volatile, moreover an end note has been created on this research to explain the data and the type of statistical tools used on the paper. The study has been successful in demonstrating the ability to move beyond description and critically analyse data. In fact each chapter has its own heading and findings have been clearly developed for the readers. On overall the paper add constructive theory to the one already in use Okun’s law and the difference version in page (75) has been explain clearly related to the theory origin. Moreover statistical test completed have been developed and rather than being confirmatory proved to be descriptive. For example, different charts have been produced by the author to show the correlation between variables and the changes occurred in the past. One of the facts that brought my interest to this particular study is that it clearly state and prove that Okun’ s law has proven to be accurate and that all the techniques used to find out the relation of variables are the one that has been used in my research.

The Robustness of Okun’s Law

This research has been conducted in spring 2000, by Jim Lee from the Corpus Christi University in Texas. The study has been carried out to evaluate the robustness of the Okun relationship based on post-war data for 16 OECD countries (journal of Macroeconomics, spring 2000, Vol.22, No 2, pp. 331). In addition it explores the structural changes on output and unemployment dynamic. In particular, it explores how changes in economic policies affect output and employment and proposes ways of assessing the implications of these changes for policy makers. By being critical on an academic research paper and also scrutinizing step by step will give a good idea on how an article may be conducted and how it might be improve according to guide (attachment 2).

The abstract according to the article has been well and clearly structured for the reader; the study has been summarized in three paragraphs which for the initial give explanation of the Okun’s law and it s direct relationship with high unemployment and low output growth after the oil shocks in the 1970. The second paragraph enhances the importance and robustness of Okun law in the labour market and finally the last paragraph explain the finding of the study. Accordingly the introduction follows the abstract flawlessly and set the context on steps, it report the previous point sited in the abstract but with a deeper explanation of the terms and expressions used and finally explain efficiently, how the paper will be structured. However After the introduction, relevant literature have been implicated in the study and can be clearly defined has being derived from books, article, official databases and among the other all these literature have been used to define appropriately information’s, and expression utilized in the study the following references have been used in the paper definition OECD database (, Unemployment rates, GDP, CPI and oil prices data derived from the Bureau of Labour Statistic.

Accordingly most of the terms used in this article refer to economical idiom and are totally understandable by students, or people interested on the relationship between post war, economic policy, GDP and employment. Moreover econometric and complex expressions are well developed and explain in the appendices if misunderstanding occurs. Consequently All studies are well discussed in the paper, if number or percentage occur table are immediately created and a full analyses discussed under the table in top of those information’s if formulas have been used an explanation of it will be discussed in the appendices.

The study has been conducted to have at the end a complete understanding of the subject, each part of the study has been well conducted not just by being explained but by being critically and descriptively developed for instance unemployment and GDP relationship has been explained facts such as output growth has been carried out table have been constructed and opinion has been given by the author. It is difficult to judge a report, conducted by professional for my point of view as a student the report has been conducted in the right way according to what it is explained by books and teacher at University the paper follow the rules and no gaps or oversights are element of the study. In addition the study has a 91 pages length, with different types of data that have been taken from, books, journals, and official websites, which gave sufficient information’s to scrutinize the subject adequately, it can be concluded that the sample has enough quality information to write a valid conclusion. The research have been clearly described by the authors, the research methods outlined the fundamental of a research methods which are, outline the design and present a timeline, describe participant selection and recruitment, explain the procedures for assignment to condition and methods for experimental control, describe the independent variable, the intervention, present the dependent variables or measures, discuss data collection and management procedures, provide the data analysis strategy, including a power analysis if appropriate, and address attrition and missing data. Smolkowski (2007) however different types of data have been used the research mostly comprise of the use of secondary data which were derived from journals, books, articles and economical databases. The secondary data in this research include both quantitative and qualitative data. The quantitative data that were used are the GDP figures, unemployment rate, Interest rates, and inflation rate. The qualitative data were made available from survey. Moreover the study shows weaknesses in term of how the research has been conducted, the authors did not introduce any paragraphs or long sentences in concern to how the study was conducted, which might help students or future writer to find interesting point in that. In the study the writing style is clear and well developed there is at some point evidence of vagueness and repetition, yet the study design follow the protocol in respect to references. The article was very successful in terms of its analysis as it was not just giving descriptions of data and theories but was relating those to the actual happenings and critically analysed them. The structure of the article argument was very comprehensive as the terms and debate used were accessible to everyone; moreover these were well structured as they respected the steps to a clear understanding. Additionally all arguments were backed up by supported findings which were referenced by academicals works. The data used in the article were a mixture of previous and actual statistics at the time of the issue of the article (2000) which help to have a future perspective of what will happen in the employment sector. The paper was highly supported by empirical research on the effects or depend variables affecting the employment issue. This provided a more in depth overview of economic fundamentals such as GDP and inflation on employment. The methods and the data adopted were supported by the literature review and past research conducted. However the article was very clear and concise about the objectives which were the effect of output on the unemployment. Moreover the paper was highly critical on economic policies providing new theories and innovative insight. The study is highly important for policy makers and in this way provides effective policies to be implemented in order to reduce unemployment and increase output growth. The analysis were conducted on the measurement of GDP per capita, income level, standard of living, and inflation rate in order to statistically identify the significant dependent variable which is highly dependent o the level of structural changes. Those statistics clearly point out the importance of economic policies and their fluctuations. The claims provided by the study were supported by facts from different developed and developing economy supporting the importance of incremental economic policies implementation. Additionally, it provided a more critical view point on how this gap between economic policies and unemployment can be reduced. However the policies and findings provided were more of a general prospective which must be customised for individual countries. Representing a limitation for this paper, the findings were highly relevant to the interpretation of the paper. Moreover the interpretation were also based on economic theoretical background such as macroeconomic policies and theories related to unemployment issues.

As a result, this study clearly pin point the important changes occurred on the labour market and industrial structures in developed countries. Moreover it also re-examine the relationship between unemployment and output known as Okun’s law and revaluate this law supported by data (post-war) from 16 OECD countries . Consequently the author stated that data have validated the law. However, the author stipulates that the findings are not as strong as those stated at first by Okun (1970). Finally the author pinpoint that the OECD data revealed a real evidence of structural changes in the Okun relationship.

Inflation and unemployment

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