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Lesson M03.L02: Types of Unemployment: Frictional, Structural, Cyclical

Module: Unemployment and the Labour Market; Introduction to Short-Term Fluctuations Level: intro Duration: 30 minutes Learning Objective: Classify unemployment into frictional, structural, and cyclical types; define the natural rate of unemployment; relate it to Australian data. Data as of: 2024 Provenance: OpenStax Macro 3e | RBA Education

Explanation

Not all unemployment has the same cause. Economists classify it into three main types:

Frictional unemployment arises from the normal time it takes workers to find new jobs that match their skills and preferences. A recent university graduate searching for their first role, or a Sydneysider who quit a job to move to Melbourne and is now job-hunting, is frictionally unemployed. It is short-term and largely unavoidable in a dynamic economy.

Structural unemployment occurs when the skills workers have no longer match the skills employers need, or when jobs move geographically. Automation replacing manufacturing roles in regional Victoria, or the decline of coal mining in the Hunter Valley, can create structural unemployment. Retraining takes time, so this type tends to be longer-lasting.

Cyclical unemployment (also called demand-deficient unemployment) arises when the economy contracts and total demand for goods and services falls. During the 1991 recession, unemployment in Australia rose from around 6% to over 10% — that surge above the baseline was largely cyclical.

The natural rate of unemployment (NAIRU) is the unemployment rate when the economy is at full output — it equals frictional plus structural unemployment. In Australia the RBA has historically estimated NAIRU at around 4–5%. When actual unemployment exceeds NAIRU, cyclical unemployment is positive and the economy is underperforming. In 2024, with unemployment at around 4.1%, Australia was close to its estimated NAIRU.

Worked Example

Suppose the Australian labour force is 14.8 million and the unemployment rate is 6.5%, giving 962,000 unemployed workers. Economists estimate that:

  • Frictional unemployed: 300,000 (workers between jobs, recent graduates, short-term searchers)
  • Structural unemployed: 250,000 (workers in declining industries, skill mismatches)
  • Cyclical unemployed: Remainder

Step 1 — Total unemployed: 14,800,000 × 0.065 = 962,000

Step 2 — Cyclical unemployment: Cyclical = Total − Frictional − Structural = 962,000 − 300,000 − 250,000 = 412,000

Step 3 — Natural rate of unemployment: Natural unemployed = Frictional + Structural = 300,000 + 250,000 = 550,000 NAIRU = (550,000 ÷ 14,800,000) × 100 = 3.7%

Step 4 — Cyclical unemployment rate: = (412,000 ÷ 14,800,000) × 100 = 2.8 percentage points above NAIRU

This tells policymakers there is significant spare capacity — the economy is operating below potential.

Common Misconception

Misconception: Zero unemployment is both achievable and desirable as a policy goal.

Correction: Even in a healthy, fully employed economy, frictional unemployment will always exist because workers take time to find suitable jobs, and structural unemployment exists as industries evolve. Trying to push unemployment below the natural rate (NAIRU) typically generates inflation rather than real gains in employment — a lesson reinforced by Australia's experience in the late 1980s. The realistic goal for policy is to eliminate cyclical unemployment, not all unemployment.

Practice Prompts

  1. A car factory in Adelaide closes due to foreign competition, and 500 workers with specialised assembly skills struggle to find new employment. What type of unemployment is this? → Answer: Structural unemployment. The workers' skills no longer match available jobs; retraining or relocation is needed. This is not cyclical (it isn't caused by a general downturn) and not frictional (it won't resolve quickly through normal job search).

  2. Australia's labour force is 14.5 million. Frictional unemployment is 350,000 and structural unemployment is 200,000. What is the NAIRU? → Answer: Natural unemployed = 350,000 + 200,000 = 550,000. NAIRU = (550,000 ÷ 14,500,000) × 100 = 3.79% (≈ 3.8%).

  3. During the COVID-19 pandemic in 2020, many businesses shut down and demand collapsed. Unemployment rose sharply. What type of unemployment dominated this increase? → Answer: Cyclical unemployment. The surge was caused by a collapse in aggregate demand — businesses had fewer customers and cut staff. This is demand-deficient by definition. (Note: the Australian JobKeeper program suppressed the measured unemployment rate during this period.)

Further Resources