Underemployment Equilibrium: What it is, How it Works

What Is Underemployment Equilibrium?

Underemployment equilibrium, also known as below full employment equilibrium, is a condition where employment in an economy persists below full employment. The economy reaches an equilibrium state that sustains a rate of unemployment above what is considered desirable. In this state, the unemployment rate remains consistently above the natural rate of unemployment or non-accelerating inflation rate of unemployment (NAIRU) because aggregate supply and demand are in balance at a point below full potential output. An economy that settles into an underemployment equilibrium is explained by Keynesian theory as a persistent depression.

"Underemployment" refers to total employment being below the level of full employment. It refers to workers who are employed but working fewer hours or in jobs that require lower skills and often come with lower pay compared to their education level and experience. Underemployment may be included in the general unemployment rate but is otherwise unrelated to the concept of underemployment equilibrium.

Key Takeaways

• Underemployment equilibrium describes a state in an economy where unemployment is persistently higher than usual.
• In this state, the economy has reached a point of macroeconomic equilibrium below full potential output, resulting in sustained unemployment.
• Underemployment equilibrium is a classic part of Keynesian theory in explaining how recession can lead to persistent depression in an economy.
• Underemployment, by itself, refers to one possible component of unemployment but is unrelated to the idea of underemployment equilibrium.

Understanding Underemployment Equilibrium

An economy in long-run equilibrium is said to be experiencing full employment. When an economy is below full employment, it is not producing what it would in full employment. This state of underemployment means there is a gap between actual and potential output in the economy.

In Keynesian macroeconomic theory, when an economy falls into a recession, it can become stuck in a situation where it finds a new balance between aggregate supply and demand with a lower total volume of output. Uncertainty and fear can induce businesses and investors to reduce investment, leading to a reduction in aggregate demand and supply, resulting in elevated unemployment. The economy settles into a new equilibrium at a lower level of output and employment.

This theory contrasts with Walrasian general equilibrium, which suggests that the economy will adjust toward equilibrium at full employment once the recession and its associated shocks have passed. Keynesian economics advocates for deficit spending and monetary policy to stimulate the economy as a solution to underemployment equilibrium.

Underemployment vs Underemployment Equilibrium

"Underemployment" refers to a type of labor under-utilization where a worker is employed but not working at their full potential or as much as they would like. Underemployed workers may work part-time when they want full-time employment or work in low-skilled, low-productivity jobs despite having more advanced skills.

Broad measures of unemployment reported by government statistical agencies may account for underemployment as well. Underemployment may result from an oversupply of higher education relative to job opportunities or a mismatch of skills and education to available jobs. However, underemployment is not related to the concept of underemployment equilibrium, and the two terms should not be confused with each other.