Explain how unemployment changes over the business cycle. Why do these changes occur?
What will be an ideal response?
Unemployment will fall during an expansion and rise during a recession. When the economy begins slowing down during a recession, firms cut back on production and workers get laid off. But it doesn't stop there. The unemployment rate typically rises even after the end of the recession. This happens for a couple of different reasons. First, it reflects the behavior of discouraged workers. When the economy goes into recession, the number of discouraged workers rises. When a discouraged worker drops out of the labor force, this actually lowers the unemployment rate. During the recession, the unemployment rate does not rise as much as it would if we counted discouraged workers as unemployed. When the recovery begins, these former discouraged workers enter back into the labor force and start searching for work again. This influx of people without jobs into the labor force raises the unemployment rate.
Second, firms are reluctant to start adding back workers when the recovery begins to take hold. They are cautious and want to be sure that the recession is over. They work their workers overtime rather than add new workers. Both these effects, discouraged workers re-entering the labor market and firm's reluctance to hire in the early part of a recovery, contribute to keeping the unemployment rate high.
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