This topic is examined on Paper 2 (Macroeconomics and the Global Economy). You already know what unemployment is and the types of it. Now we ask: why does a government want unemployment to be low? The answer is that unemployment has costs for the economy, for the government and for people.
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Unlock This CourseWhen people who want to work cannot find jobs, the economy produces fewer goods and services than it could. This is a fall in output. Think back to the production possibility curve: an economy with unemployed workers is producing at a point inside the curve, below its maximum productive potential.
Labour is a scarce resource, and scarce resources are meant to be used well. An unemployed worker is a resource that is not being used at all. The skills and effort that could have made something useful are lost for that period. The longer a person is out of work, the more their skills may fade, which makes it harder for them to find work later.
Key terms:
More people out of work means government pays more in benefits but collects less tax
Losing a job means losing wages. Even with benefits, an unemployed household usually has much less to spend. It may struggle to afford food, heating and housing. The longer the unemployment lasts, the greater the risk of falling into poverty.
The government pays benefits to many more people when unemployment rises. Benefits do not directly produce goods or services, and the money has to come from somewhere, such as taxes or borrowing. It leaves less to spend on schools, hospitals and roads.
Workers who lose their jobs pay less income tax. They also spend less, so the government collects less in taxes on spending, such as VAT. Firms that sell less make smaller profits, so they pay less tax too.
Rising unemployment makes government spending go up and tax revenue go down at the same time. This widens the gap between what the government spends and what it collects.
In Country Pellan, 400,000 people lose their jobs. Before, each paid £4,000 a year in income tax. Now each receives £7,000 a year in benefits and pays no income tax.
Step 1: lost tax = 400,000 × £4,000 = £1,600 million.
Step 2: extra benefits = 400,000 × £7,000 = £2,800 million.
Step 3: total cost to the government = 1,600 + 2,800 = £4,400 million a year, or £4.4 billion.
Unemployment also changes how people and firms feel about the future.
This can become a downward spiral: unemployment lowers spending, lower spending lowers sales, and lower sales lead to more job losses. This is why high unemployment is often linked to a downturn or recession.
Long-term unemployment can hurt whole communities, not just the people out of work
Unemployment is not only about money. It affects communities too.
Some of these points depend on the situation. Not every unemployed person turns to crime, so use words like "may" and "can" in an exam answer.
| Area affected | Effect of rising unemployment |
|---|---|
| Output | Falls, economy below its potential |
| Scarce resources | Labour is wasted and skills can fade |
| Poverty | Incomes fall, risk of poverty rises |
| Government spending | More spent on benefits |
| Tax revenue | Falls, as less is earned and spent |
| Consumer confidence | Falls, so people spend less |
| Business confidence | Falls, so less investment and hiring |
| Society | More stress, health and social problems |
Benefits are government spending, not tax revenue. Do not forget to explain the chain. Writing "unemployment is bad" earns nothing, but "unemployed workers earn less, so they pay less income tax" does.
Country Rovan has seen a rise in unemployment after several factories closed.
| Year | Unemployment rate (%) |
|---|---|
| 2023 | 5 |
| 2024 | 7 |
| 2025 | 10 |
(a) Calculate the rise in the unemployment rate from 2023 to 2025. [1 mark]
(b) Identify one effect of rising unemployment on government spending. [1 mark]
(c) Explain how rising unemployment may reduce the tax revenue of the government. [3 marks]
(d) Analyse how rising unemployment may reduce business confidence. [4 marks]
(a) 10 − 5 = 5 percentage points (1).
(b) The government must spend more on benefits (1).
(c) People who lose their jobs no longer earn wages, so they pay less income tax (1). They also have less to spend, so the government collects less tax on spending, such as VAT (1). Firms selling less make lower profits and pay less tax too (1).
(d) Rising unemployment means fewer people have wages to spend (1), so consumers buy less and demand for firms' products falls (1). Firms expect weaker sales in future (1), so they are less likely to invest in new equipment or take on more workers, and their confidence falls (1).
For "analyse" questions, build a chain of linked steps: each sentence should lead to the next with a word like "so" or "which means".