Question

Explain the difference between cyclical, frictional, and structural unemployment and how they relate to the natural rate of unemployment.

Answer 1

Cyclical unemployment arises solely out of a business cycle recession phase when aggregate demand is lower, so producers reduce their output and demand less labor, causing job loss and unemployment.

Frictional unemployment is a permanent component of unemployment, which arises when people remain jobless in-between two jobs held or are in transition between two jobs. Working-age people who are just out of college and awaiting a job belong to this category.

Structural unemployment arises mostly due to skill mismatch between skills required by employers and skills possessed by workers, which results from industrial reorganization and technological improvement. This too is a permanent component of unemployment.

Natural rate of unemployment is sum of frictional unemployment and structural unemployment. When economy produces at its natural rate of output, cyclical unemployment is zero.