The 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.

The 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.

Employment 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.

The 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.

At 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)

Dis-equilibrium 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.

Unemployment 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.