Cyclical Unemployment

Cyclical unemployment is one of the types of unemployment, which usually happens during the contraction phase of the business cycle where the unemployment rate starts rising as businesses start laying off their employees during the recession period & unemployment rate decreases during the expansionary phase of the business cycle.

Thus, it occurs during negative economic growth periods for at least two consecutive quarters. Business wants to compensate for the loss due to an extra supply of goods and services and a fall in demand. There are many ways and tools to recover from the same and reduce the negative effect as far as possible.

1. Cyclical unemployment occurs during the contraction phase of the business cycle. It causes the unemployment rate to increase as businesses begin to lay off people during the recessionary period and fall during the expansionary phase of the business cycle.
2. There are four phases to how cyclical unemployment works. The Expansion, Peak, Contraction, and Trough phases.
3. It is calculated by first adding the structural unemployment rate with the frictional unemployment rate, then subtracting the sum from the country's current unemployment rate.

Cyclical unemployment is caused due to changes in the business cycle, where the demand changes, and to adjust the supply, entities lay off employees, causing unemployment. It rises during the recession, and as the business picks up again, they take time to hire permanent human resources, resulting in no immediate change. Gradually level of unemployment goes down as the economy recovers.

The increase and decrease in the cyclical unemployment rate are temporary. During the contraction period, overall consumer demand decreases, which leads to a rise 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, which leads to cyclical unemployment solutions.

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.

Cyclical unemployment rate 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 rate 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. Thus, this is an example of  policies to reduce cyclical unemployment.

We can calculate the cyclical unemployment in economics by subtracting the frictional unemployment 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.

Some industries are highly sensitive to the business cycle concerning the unemployment rate, such as the automobile industry, construction industry, or other consumer durable manufacturing industries, etc.

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

When an economy is struggling with a recession period, consumer spending goes down, which is directly related to overall demand in an economy. One example is the automobile industry. During the contraction period in the business cycle, when consumer demand goes down for automobile 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 margin, increasing the cyclical unemployment rate. Once the expansion period starts, an economy gets cyclical unemployment solutions, where 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 in economics.

Some effects of this type of unemployment is as follows:

• If it continues for long term, there may be unemployment due to outdated skills or time gap.
• It will lead to the control of society being shifted to the hand of a few individuals and concentration of wealth.
• Higher education may become useless if the economy is unable to create job opportunities.
• It may have a compounding effect is continued for a long time, leading to forceful government intervention.

Thus, the economy needs to devise policies to reduce cyclical unemployment.

Cyclical unemployment is caused due to economic changes, whereas frictional unemployment is caused due to time gap in changing jobs and structural unemployment is due to shift in economy. However, let us look at their differences.

This has been a guide to what is Cyclical Unemployment. We explain it with examples, causes, how to calculate, and differences with frictional unemployment. You can learn more about accounting from the following articles –

• Unemployment Compensation
• Political Risk
• Underemployment
• Formula of Unemployment Rate