Question

In April 2019, the U.S. unemployment rate fell to 3.6 percent, its lowest level in almost 50 years. In Texas, the unemployment rate was 3.4 percent in June 2019, its lowest level since individual state data began being kept in 1976. Unemployment rates this low are often viewed as being very good for the economy, so explain how low unemployment rates benefit the economy in terms of the following:

• productivity and GDP growth
• wages and wage growth
• consumer confidence
• labor supply & demand
• entitlement spending (make sure you understand the term “entitlement spending”)

Unemployment rates this low can also be viewed as being detrimental to the economy, so explain how low unemployment rates may also damage the economy in terms of the following:

• productivity and GDP growth
• employee loyalty
• potential inflation
• labor supply & demand

Answer 1

Productivity and GDP growth: productivity is output per unit of labour. Ceteris paribus, increase in labour (factor input) will lead to increase in output or GDP. Productivity doesn't directly depend on employment level so generally, lower unemployment boosts economic activities and promote GDP growth. Low unemployment increases income and discretionary expenditure which increases consumption. Consumption is a major component of GDP so rise in consumption leads to higher GDP.
Wages and wage growth: Generally, during low unemployment, demand for labour by employers exceeds supply of labour which leads to increase in wages to attract and retain the workers. However, it may not be always true. In USA for instance, unemployment rate was at multi year low (before COVID19, but wage growth was bearly keeping up with inflation. There are various reasons for that e.g. low wage bias in certain sectors, hedge against downturn etc.
consumer confidence: consumer confidence increases when economy is doing well and viceversa. Lower unemployment means higher overall income in the economy whhich boosts consumer confidence. For instance, consumer unemployment rate in USA was around 3.5% in January 2020 which is lowest in last 50 years, consequently, consumer confidence shot up to 99.8%.
labor supply & demand: In times of low unemployment, most of the labour force is already employed. An increase in labour demand at htis point will exceeds its supply and will make labour more expensive.
entitlement spending: It means entitlement of an eligible individual for certain benefits upon satisfaction of specified conditions. For example social security, unemployment benefits etc. During low level of unemployment, less people will qualify for unemployment benefits which will reduce federal spending on these programs which in turn will reduce government debt and improve fiscal health of the government.

Low unemployment is however not always beneficial for the economy. Consider the following situations:
productivity and GDP growth: sometimes, fall in unemployment may cause disguised employment. It is a situation when more workers are employed than required which leads to fall in productivity and may also cause decrease in overall output.
employee loyalty: During the time of low unemployment, frictional unemployment is often low i.e. people do not have to search for jobs very hard. In this situation, employee loyalty falls since people can easily find other bjob if the employer does not exceed worker's demand or expectations.
potential inflation: Low unemployment may lead to higher wage growth rate because employers will be ready to pay higher wages to attract labour. it may lead to rise in wage inflation which in turn cause general increase in price level in the economy.
labor supply & demand: As most of the labour force is already employed during low unemployment, labour supply is limited. At this povint, if employers increase their demand for labour, they will have to increase wages.