Full Employment
What is Full Employment?
Full employment is the level of employment where there is no cyclical unemployment.
Full employment occurs when the economy is operating at its potential output, and there is no cyclical unemployment. However, full employment does not mean that everyone has a job, as there will still be some frictional and structural unemployment. Policymakers often aim to achieve full employment while keeping inflation under control.
Full Employment: a worked example
An economy has a labor force of 40 million. Of the unemployed, 1.6 million are between jobs or newly entering the market, 0.8 million lack the skills employers now demand, and 1.2 million lost jobs because output is below potential. Total unemployment is 1.6 plus 0.8 plus 1.2, or 3.6 million, so the actual unemployment rate is 3.6 divided by 40, times 100, which is 9 percent. The natural rate counts only frictional and structural unemployment: 1.6 plus 0.8 equals 2.4 million, and 2.4 divided by 40, times 100, is 6 percent. Full employment for this economy therefore means a 6 percent unemployment rate, not zero. The 3 percentage point gap between 9 percent and 6 percent is pure cyclical unemployment, and closing it with expansionary policy would return the economy to potential output.
The mistake students make with full employment
Folding cyclical unemployment into the natural rate turns a two step calculation into a wrong answer. Given a labor force of 20 million with 0.5 million between jobs, 0.3 million lacking the skills employers want, and 0.9 million laid off because output sits below potential, students add all three and call 8.5 percent the natural rate. Only frictional and structural unemployment belong in it, so the natural rate is 0.8 million divided by 20 million, or 4 percent, while 8.5 percent is the actual rate. The 4.5 point gap between them is the cyclical unemployment that full employment eliminates.
Full Employment questions
Does full employment mean everyone has a job?
Full employment does not mean everyone has a job. The term describes an economy with zero cyclical unemployment, producing at potential output, while frictional unemployment from normal job switching and structural unemployment from skill or location mismatches continue. Those two categories add up to the natural rate of unemployment, which is positive. An economy with a 5 percent natural rate is at full employment when measured unemployment is 5 percent.
What happens if unemployment falls below the natural rate?
Falling below the natural rate puts the economy above potential output in an inflationary gap. Firms compete for a shrinking pool of available workers, bidding nominal wages up faster than productivity grows. Rising wage costs then shift short-run aggregate supply left, raising the price level and pulling real output back toward potential. The self-correction ends with the economy at full employment again but at a permanently higher price level.
How is full employment shown on an AD-AS graph?
Full employment appears as the point where the aggregate demand curve, the short-run aggregate supply curve, and the long-run aggregate supply curve all cross. Long-run aggregate supply is vertical at potential output, so an equilibrium sitting on that vertical line means zero cyclical unemployment. An equilibrium to the left of LRAS shows a recessionary gap with positive cyclical unemployment, and an equilibrium to the right shows an inflationary gap with unemployment below the natural rate.
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