What it is:
The unemployment rate measures the percentage of employable people in a country's workforce who are over the age of 16 and who have either lost their jobs or have unsuccessfully sought jobs in the last month and are still actively seeking work.
The formula for unemployment rate is:
Unemployment Rate = Number of Unemployed / Total Labor Force
How it works (Example):
In the U.S., the Bureau of Labor Statistics reports the unemployment rate in its Employment Situation report, which is released on the first Friday of each month at 8:30 AM EST. The report discloses the current unemployment rate, the change in the unemployment rate, and a variety of other labor statistics. The data in the report is generated by surveys taken from almost every major industry in over 250 metropolitan areas. The Bureau conducts two surveys: the household survey, which interviews 60,000 households, and the establishment survey, which reviews data from 160,000 businesses and agencies.
It is important to distinguish between the percentage of people who are unemployed and those who are simply not working. Some people may be in school full-time, working in the home, disabled, or retired. These people are not considered part of the labor force and are therefore not included in the unemployment rate. Only those people actively looking for a job or waiting to return to a job are considered unemployed.
Economists generally distinguish between three different types of unemployment. Frictional unemployment exists when a lack of information prevents workers and employers from becoming aware of each other. It is usually a side effect of the job-search process, and may increase when unemployment benefits are attractive. Structural unemployment occurs when changing markets or new technologies make the skills of certain workers obsolete. And finally, cyclical unemployment is a result of the cyclical nature of the economy and occurs whenever there is a general downturn in business activity.
Unemployed people typically fall into one of four classifications. Job losers are people who have been laid off or fired, either temporarily or permanently. On the other hand, job leavers are people who have voluntarily left their jobs, and the size of this group may actually reflect confidence in the state of the economy. New entrants are people seeking employment for the first time. And finally, re-entrants are people who left the labor force for a time and are now returning, such as parents who opted to raise families or those who left to pursue additional education.
Some level of unemployment will always be present in an economy as industries expand and contract, as technological advances occur, as new generations enter the labor force, and as workers voluntarily search for better opportunities. This is why most economists agree that there is a natural rate of unemployment in the economy (usually 4%-6%). This natural rate is most affected by the number of youthful workers in the labor force, as well as public policies that discourage employment or job creation, such as a high minimum wage, generous unemployment benefits, and few disincentives associated with laying off workers.
Why it Matters:
Employment is the primary source of personal income in the U.S. and has a major influence on consumer spending and overall economic growth. Thus, the unemployment rate, which is a lagging indicator, can provide considerable information about the state of the economy or the health of particular business sectors. For example, high unemployment generally indicates that an economy is underperforming or has a falling gross domestic product. Conversely, low or falling unemployment may reflect an expanding economy. At the same time, unemployment data can also point to changes in certain industries. For example, an increase in construction jobs might signal improving housing starts. For these reasons, the unemployment rate is one of the most widely followed economic indicators
While there is some controversy over the different methodologies used to measure unemployment, nearly all recognize its importance. Because unemployment statistics are so closely watched and heavily relied upon, differences between the expected unemployment rate and the reported rate may have a wide impact, not only in the securities markets, but also in the value of the U.S. dollar (which tends to rise in a strengthening labor market). Furthermore, unexpectedly low unemployment may motivate the Federal Reserve to increase interest rates in order to curb a possibly overheating economy, and vice-versa. This will also influence stock and bond prices.
To learn more about unemployment numbers, check out these featured articles:
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Why Structural Unemployment is Here to Stay -- learn how shortcomings in the education system lead to persistantly high unemployment.
The Economics of Unemployment -- The weekly unemployment reports can be misleading; we break down the numbers so you can have a clear understanding of how they're calculated.