natural rate of unemployment is the rate of unemployment where the labour
market is in a position of equilibrium. This means that the labour supply =
labour demand at a given real wage rate. All those people willing and able to
take paid employment at the going wage rate do so.
diagram below shows the labour supply (those willing and able to take work at
a going wage rate) and the labour force - the number of active participants
in the labour market. The labour force expands as the real wage rises because
there is a greater incentive to search for paid work and sacrifice leisure.
on the x-axis measures the total labour hours supplied by workers in the
economy in a given time period. As the real wage increases, the total number
of hours supplied by the labour force will expand.
natural rate of unemployment is not zero - at the equilibrium wage W1
in the diagram above, there is unemployment measured by AB. This is made up
of frictional plus structural unemployment.
a wage rate W2 (above the equilibrium "market-clearing
wage") employment contracts along the labour demand curve and total
unemployment rises (see the diagram below)
unemployment rises to the level shown by the distance CD. This is because
labour demand has fallen and the labour force has expanded. There is an excess
supply of labour - some people who are willing and able to find employment
cannot get paid work.
in the UK economy has fallen someway below the average for the leading 23
nations that comprise the Organisation of Economic Cooperation and
Development (OECD). This is shown in the chart above. Some economists claim
this is evidence that the natural rate of unemployment has fallen, allowing
the economy to operate at a higher level of economic activity without
experiencing an acceleration in inflation.