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Employment and Unemployment » Consequences of Unemployment

What you'll learn this session

Study time: 30 minutes

Cambridge spec: 4.6.4

How unemployment hurts the individual: income, skills and health
How it affects firms and the government
Why it wastes output and widens inequality in the economy
How to write a clear chain of reasoning in the exam

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Unemployment hurts more than one group

When someone loses their job, the effects do not stop with them. Their family, local shops, the firms that would have hired them and the government all feel it. Cambridge asks you to look at four groups: the individual, producers (firms), the government and the economy.

Remember from the last lesson that unemployment can be frictional, structural, cyclical or seasonal. The consequences below apply to all of them, but they are worse the longer the unemployment lasts.

Key terms:

Unemployment benefits: payments from the government to people without a job who are looking for work.
Lost output: the goods and services that unemployed workers could have produced but did not.
Skills loss: workers' skills becoming rusty or out of date because they are not being used.

Consequences for the individual

💵 Income

Wages stop. Benefits are usually lower than a wage, so the person and their family can afford fewer things and may fall into debt.

🔧 Skills

Skills that are not used fade, and new methods are missed. The longer the gap, the harder it is to get a job again.

❤️ Health

Money worries and a loss of routine and purpose can cause stress, anxiety and low confidence. Poorer diets and heating can harm physical health too.

These effects feed each other. Less income causes stress, stress makes job hunting harder, and a longer search means more skills loss.

Consequences for firms

Firms are affected in two main ways.

Sales: unemployed people have less to spend, so firms that sell to them, such as shops and cafes, sell less. Lower sales mean lower revenue and profit, and some firms may cut output or close.
Recruitment: there are more people looking for work, so firms find it easier to recruit and may be able to pay lower wages. But the unemployed may have lost skills, or have skills that do not match the vacancies, so firms may have to spend on training.

Notice that the second point has both a good and a bad side. Exam answers are stronger when they show this.

Consequences for the government

📉 Lower tax revenue

Unemployed people pay little or no income tax. They also spend less, so the government collects less indirect tax. Firms with falling sales and profits pay less tax too.

🏦 Higher benefit spending

The government pays more unemployment benefits to the people who have lost their jobs.

Together these push the government budget towards a deficit, which can force it to cut spending elsewhere or to borrow more.

Consequences for the economy

Lost output: unemployed workers are a wasted factor of production. The economy produces less than it could. If you drew a production possibility curve, the economy would be at a point inside the curve rather than on it, as in the lesson on Production Possibility Curves.
Inequality: unemployed households have much lower incomes than households where people are working, so the gap between rich and poor can widen. Unemployment tends to be higher in some regions and among some groups, such as young people or those with few qualifications.
Lower demand: unemployed people spend less, which can reduce firms' sales and cause more job losses. This is a downward spiral.

Worked example

Counting the cost for the government

In the made-up country of Dovmark, 100,000 more people become unemployed. Each used to pay $4,000 a year in income tax and now claims $3,000 a year in benefits. The government loses 100,000 x $4,000 = $400 million in tax revenue and spends an extra 100,000 x $3,000 = $300 million on benefits. The budget is $700 million worse off, before counting the lower sales tax from reduced spending.

Another worked example

A factory closes in Marvella

A shoe factory in the made-up town of Marvella closes and 500 workers lose their jobs. Individuals: they lose wages and rely on lower benefits. Firms: local shops sell less because spending falls. Government: it collects less income tax and pays more benefits. Economy: 500 workers produce nothing, so output is lost and the town's inequality with nearby areas grows.

Common mistakes

Writing only "people have no money" with no chain of reasoning. Saying the government "loses money" without saying that tax revenue falls and benefit spending rises. Forgetting that firms can gain from a bigger pool of workers.

Exam-style question

In the country of Garnova, a fall in demand for its main export has caused many factory workers to lose their jobs. Unemployment has risen from 5% to 11%.

(a) Identify two consequences of unemployment for an individual. [2 marks]

(b) Explain two ways in which the rise in unemployment may affect the government. [4 marks]

Model answer

(a) Loss of income (1). Loss of skills or poorer health (1).
(b) Tax revenue falls because fewer people are earning and spending (1), so the government has less to spend on public services (1). Benefit spending rises as more people claim unemployment benefits (1), which may push the budget into deficit (1).
(c) Firms may sell less because unemployed people have less income to spend (1), so revenue and profit fall (1). Firms could also find recruiting easier because more workers are available (1), but some workers may have lost skills, so training costs may rise (1).

Exam tip

In "Explain" and "Analyse" questions, link each point with "so" or "which means" to show the chain from unemployment to its effect, as in (b).

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