Question

Suppose an economy has 10,000 people who are not working but looking and available for work and 90,000 people who are working. What is its unemployment rate? Now suppose 4,000 of the people looking for work get discouraged and give up their searches. What happens to the unemployment rate? Would you interpret this as good news for the economy or bad news? Explain.

Answer 1

The unemployment rate is measured by dividing the economically active unemployed population seeking employment divided by the total economically active population.

In this case 10,000 / (90,000 + 10,000) = 10%

If of these 4,000 unemployed people did not want to work, they would cease to be part of the economically active population, this decreases the number of the rate since the formula will be 6,000 (unemployed looking for employment) / (90,000 + 6,000) (it is the total of economically active population)

= 6.25%

This is bad for the economy because the unemployment rate underestimates the true level of unemployment in force and, therefore, gives a wrong picture of reality, as it shows that the situation is not as bad as it really is. Since these people could belong to the economically active population, but they are out of it because they have not found work and decided to cancel their search.