Natural Rate of Unemployment

This represents the rate of unemployment to which the economy naturally gravitates in the long run.  The natural rate of unemployment is determined by looking at the rate people are finding jobs, compared with the rate of job separation (i.e. People quitting). In any given period, people are either employed or unemployed. As a result, the sum of structural and frictional unemployment is referred to as the natural rate of unemployment also called "full employment" unemployment rate. This is the average level of unemployment that is expected to prevail in an economy and in the absence of cyclical unemployment.

Labor Force = Employed + Unemployed

If we assume a fixed labor force and unemployment rate (fixed at the natural rate), the number of people losing jobs must be equal to the number of people finding jobs. However, this model is too simple so we must consider the job separation rate and the job finding rate to get a more accurate figure.

Where,

E = Employed

U = Unemployed

F = Job Finding Rate (This represents the fraction of unemployed people who are able to find a job each month)

S = Job Separation Rate (This represents the fraction of employed workers who lose their job each month)

 Job Separation Rate:  F * U = S * E

This equation demonstrates that the unemployment rate (U/L) is positively related to the job separation rate and negatively related to the job finding rate. Therefore, a higher (S) will lead to a higher unemployment rate while a larger (F) yields a lower natural rate of unemployment. In conclusion, to reduce the natural rate of unemployment, (S) must be reduced, or (F) must be increased.

 Okun's Law

Okun's law simply states that a 1% change in the rate of unemployment will be associated with a 2% change in output
 

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