Cyclical Unemployment Definition Example Phases How To Calculate

Cyclical Unemployment Definition

Cyclical Unemployment Phases

Cyclical unemployment is directly related to macro-economic factors in an economy as the unemployment rate moves along with the business cycle phases. Usually, the business cycle has four phases, i.e., trough, expansion, peak, and contraction, which define the fluctuation in demand or production activity in an economy measured by a growth rate of real gross domestic product (GDP).

Let’s get into each business cycle phase to understand its impact on cyclical unemployment.

#1 – Expansion Phase

In this business cycle phase, overall economic activity increases, representing the spike in the overall demand, and the consumer starts buying more items. To meet this increase in demand, businesses react by increasing their production capacity by investing in equipment. In addition, businesses require more people, which forces them to hire more employees to fulfill the economy’s ongoing demand. Hence, this results in an overall drop in the unemployment rate in an economy, and the overall GDP growth rate increases.

#2 – Peak Phase

As the name suggests, the business cycle reaches its peak and the maximum level of economic output. Both consumer spending and business investments increase but at slower rates. The product price increases due to an increase in the inflation rate. At this point, the economy is at its full potential employment, which means the unemployment rate is nearly zero. The economic growth stabilizes for some time but soon starts to decline. The unemployment rate decreases, but new recruitments slow down.

#3 – Contraction Phase

The inflation rateInflation RateThe rise in prices of goods and services is referred to as inflation. One of the measures of inflation is the consumer price index (CPI). Rate of inflation = (CPIx+1–CPIx )/CPIx. Where CPIx is the consumer price index of the initial year, CPIx+1 is the consumer price index of the following year.read more rises after the peak, forcing product prices to rise, but consumer income becomes stable. Thus, consumers start reducing their expenses which affects the overall economic demand, and it starts declining. Businesses also cut their production capacity and produce fewer products to react to this consumer demand. Now, as demand & production both decrease, employers initially decrease the employees working hours and then start laying them off to manage their cost of production. This cyclical increase in unemployment creates a loop where recently unemployed people cannot afford their basic needs, decreasing consumer demand in an economy. Hence, more people lose their jobs because of declining consumer spending and inflation. As a result, the unemployment rate starts increasing. As a result, the GDP growth rate becomes negative.

#4- Trough Phase

The trough is a phase in the business cycle where the contraction period ends & the GDP growth rate changes from negative to positive. Once again, overall consumer demand starts increasing in an economy, leading to the expansion period in an economy. The unemployment rate stops increasing & begins to fall as economic demands pick up.

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How to Calculate Cyclical Unemployment Rate?

We can calculate the cyclical unemployment rate by subtracting the frictional unemploymentFrictional UnemploymentFrictional unemployment occurs when unemployed individuals look for jobs as a part of life transitions or after quitting previous employment to find a better one. Short-lived frictional unemployment, in a way, reflects that the economy has enough jobs for workers to have the courage to quit and find a replacement. read more and structural unemployment rates from the current unemployment rate.

where,

unemployment rate formula = number of unemployed workers/labor force.

labor force = number of employed persons + number of unemployed workers.

Frictional Unemployment

It is temporary unemployment that occurs because of time lag, i.e. when a person searches for a job or is in the process of moving from one job to another. It can be calculated by dividing the labor force’s total number of actively looking for jobs.

Structural Unemployment

This is usually caused due to technological advancements in an economy where workers lack the skills to fulfill the technological tasks, making it difficult to find a job. It can be calculated by taking the total number of structurally unemployed workers and dividing it by the labor force.

Example of Cyclical Unemployment

Some industries are highly sensitive to the business cycleBusiness CycleThe business cycle refers to the alternating phases of economic growth and decline.read more concerning the unemployment rate, such as the automobile industry, construction industry, or other consumer durable manufacturing industries, etc.

Note

A person is considered unemployed only if they are not working but actively searching for work.
A person who doesn’t want to be part of the labor force is voluntarily unemployed, and such people are not included in the unemployment rate calculation.

Let’s look into one of these industries and find out how it relates.

When an economy is struggling with the recession period, consumer spending goes down, directly related to overall demand in an economy. One of the examples is the automobile industry. During the contraction period in the business cycle, when consumer demand goes down for automobiles products, automobile manufacturers deal with it by decreasing the supply. Thus, fewer workers are needed. The manufacturers cut the workers ‘ strength to the main cost of production and profit marginProfit MarginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. read more, increasing the cyclical unemployment rate. Once the expansion period starts, consumer spending increases, and the overall demand in an economy increases. To meet this increase in demand, automobile manufacturers need to produce more products. Thus, they need more workers, so they start hiring again, decreasing the cyclical unemployment rate.

Conclusion

The increase and decrease in the cyclical unemployment rate are temporary. During the contraction period, overall consumer demand decreases, which leads to an increase in the unemployment rate. However, as the contraction period ends, the economy enters into the expansion period of the cycle where consumer demand starts increasing, and the unemployment rate starts decreasing.

As the economy moves with the business cycle phase, its unemployment also keeps changing. Remember that it is usually considered a recession period when two consecutive quarters of negative economic growth. Whereas, when there are two consecutive quarters of positive economic growth, it is regarded as an expansionary period in an economy.