Thursday, August 27, 2009

Theoretical Reasons of Unemployment

Practically we see that unemployment has assumed the form of a big issue in the economy. Accordingly we see why unemployment is rising in the free market economies or why forces of demand and supply fail to bring full employment. The economists present following reasons in this regard.


The economy which is under going changes may suffer from some frictional unemployment. For example if in an economy the demand for Personal Computers increases, the demand for type writers may go down. The labour that will get unemployed from type writer producing firms may be given the name of frictional unemployed, as they will have to remain unemployed for some time before they get new job. Again the localities while oil is extracted here the demand for labour may go up when the demand for oil increases. Again the demand for labour producing cosmetics may go down in localities where they are produced if the demand for cosmetics decreases. Such all is given the name of sectoral shift. Therefore when such like changes occur the frictional unemployment may rise.

2. Real Wage Rigidity:

As we know that if real wages are made inflexible in classical model i.e. they are not allowed to fall, then economics may suffer from unemployment. The same has been made a basis by Keynesian that in real life wages are rigid down ward. As a result the demand for and supply of labour are not equalized and economy faces unemployment. The unemployment rises due to rigid wages and rationing of employment is given the name of ‘wait employment’. Here the labour are not unemployed because they are in search of job which suits them rather they are unemployed because supply of labour is more than demand for labour. Therefore they are waiting for availability of jobs.

Now question arises why wage rigidity and unemployment rise. This is due to reason though there is excess supply of labour in the economy, yet the firms do not decrease the wages. Now the question rises why firms do not decrease the wags. Three reasons are advanced in this regard: (1) The minimum wage laws (2) The monopolistic powers of trade unions and (3) The efficiency wages.

(i) Minimum Wages Laws: The government so often in order to protect the minimum life standard of labourers set the minimum wage levels i.e. it is stipulated that no firm will give wages lower than certain minimum level. Hence it is being observed that the wages for semi-skilled and inexperienced labourers are determined more than the equilibrium wages. But such situation leads to reduce the demand for labour which results in unemployment.

(ii) Trade Unions and Collective Bargaining: The labourers who are the members of the unions their wages are set as a result of contracts between the union leaders and management of the firms in addition to demand and supply. It has been observed that the wages determined through collective bargaining are higher than equilibrium wages. This gives the firm power to employ the labour as much they like. Accordingly the firms normally reduce the demand for labour. This increases the quantity of labour that is prey to wait unemployment. Moreover unions also influence the wages of those firms which lack unions. As the firms do not like that the labourers could establish unions. Therefore the wages remain above the equilibrium wages. The unions not only pressurize for higher wages but they also stress upon reducing working hours and improvement of working conditions. Again so many firms will like to please employ workers by giving them higher wages so that they could not engage in union formation.

In this connection the experts also consider the insider and outsider model. According to them the workers who are employed in the firms are given the name of Insiders, while who are unemployed and are out of the firms are outsiders. The outsiders desire that the firms should decrease wages so that more job opportunities could be created. But Insiders are desirous to keep the wages higher. Moreover it has been observed that the firms negotiate with those workers who are employed not with those who are unemployed. It is because of the reasons that it is not possible for the firms to displace those workers who they have trained or educated. In this way insiders are superior to outsiders. The insiders may threat the employers that they may reduce their interest for work. In this way when their productivity suffers, the total output of the firm may decrease. Accordingly the firms are bound to make agreement with insiders, to pay them higher wages despite the economy is having unemployment and they are prepared to work even on lower wages.

Thus according to insider-outsider model, the wages will not decrease despite unemployment. As a result the economy will not attain full employment rapidly once it experiences depression.


According to efficiency wage theories that firm works more efficiently this pays more wages to its workers. In other words “Sometimes it is in the interest of firms that they should pay higher wages to workers, than equilibrium competitive wages though it may lead to increase the wait unemployment.


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