Involuntary unemployment occurs when a person is willing to work at the prevailing wage yet is unemployed. It is a situation where workers are willing to work at the market wage or just below but are prevented by factors beyond their control. Involuntary unemployment is distinguished from voluntary unemployment, where workers choose not to work because their reservation wage is higher than the prevailing wage. These factors could include deficiency of aggregate demand, labor market inflexibilities, implicit wage bargaining, and efficiency wage theory.
In an economy with involuntary unemployment, there is a surplus of labor at the current real wage. This type of unemployment is due to a deficiency of aggregate demand sufficient to ensure full employment. This occurs when there is some force that prevents the real wage rate from decreasing to the real wage rate that would equilibrate supply and demand (such as a minimum wage above the market-clearing wage). Structural unemployment is also involuntary. It indicates an excess supply of labor that the rigid wage-rate has failed to eliminate.
In Keynesian theory, involuntary unemployment is associated with insufficient aggregate demand and so is closely related to demand deficient unemployment. Economists have several theories explaining the possibility of involuntary unemployment including implicit contract theory, disequilibrium theory, staggered wage setting, and efficiency wages. The officially measured unemployment rate is the ratio of involuntary unemployment to the sum of involuntary unemployment and employment (the denominator of this ratio being the total labor force). Other economists such as Stiglitz and Shapiro point to efficiency wage theories causing wages to rise above market equilibrium. So, it is unemployment that results from workers being unable to find paid jobs even though they are prepared to work at current wage rates because there are insufficient jobs available due to recession or because they do not have the necessary skills to perform available work.
Reasons for involuntary unemployment
- Implicit contract theory. Theoretically, unemployed workers may be willing to accept a job for a lower wage rate than the market wage. However, in practice, there are difficulties in actually offering a lower wage.
- Trade unions. If trade unions successfully bargain for wages above the equilibrium, then those ‘ outsides’ the trade union are prevented from accepting a job at a lower wage rate.
- Efficiency wage theory. This theory states that firms pay workers above the market-clearing wage rate because it improves the productivity of workers. By paying a higher wage, workers are more attached to their job and work harder to avoid losing it.