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Unemployment rate primer

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Not everyone who isn't working is considered unemployed. Learn how the official rate of unemployment is calculated in this video, and learn what it means to be officially unemployed. Created by Sal Khan.

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Video transcript

Voiceover: What I want to do in this video is think a little bit about how the unemployment rate is actually computed by the Bureau of Labor Statistics. So to figure that out let's just start off with the entire U.S. population. So let me draw a big circle here that represents the entire U.S. population. U.S. population and right now if my numbers are correct, the latest numbers are 304 million people. Now, not all of those 304 million people are capable of working, including my two and a half year old son or my newborn daughter so you have to think of, when you think about unemployment, you want to think about the percentage of these people that are actually old enough to work. That actually can be employed theoretically. So let's take a subset of that U.S. population and let's think about who's essentially an adult, who's working age. So this subset right over here is 16 years and older, so people who can legally work and the numbers I have here is that this is 100- sorry, this right here is 237 million people. 237 million people. Now we can't just say all of these people could possibly work because a lot of them are in college, some of them are in high school, some of them might not have the ability to work, some of them might be retired. So what we want to do is take a subset of this population, that is essentially part of the labor force in that they are working or they are actively looking for work. So let me draw that right over here. So this right over here is the labor force. Labor force, so these are not retirees or people who are in college. Those people would be sitting right over there assuming they're 16 years or older. The labor force, so this is working or- or I should say working and actively looking for work, and we'll think about what actively looking for work means in a little bit more depth in a few minutes. Actively looking for work. And that number if my numbers are correct is right around 154 million although the numbers here aren't so important, the more important thing is how the unemployment rate itself is calculated. And so then within the labor force you have a subset, so this is working and actively looking for work, so you have a subset of the labor force that is actively looking for work. So they don't have a job but they're actively looking. So this right here is unemployed and actively looking. Actively looking and this actively looking is probably more important than you might realize at first. And this number, let's just say for the sake of argument, this is sitting at around 15 million people. 15 million people. So if you have a job you're right over here, if you don't have a job but are actively looking you're going to be right over here. What we're going to see in a little bit is if you don't have a job but you are not actively looking but you could be working, you would actually be sitting out here. This is going to be interesting when we think about trends in the unemployment rate when it goes up or down. But just to see how the unemployment rate is calculated, let's just do it for this example. So the unemployment rate- unemployment rate is literally just the number of unemployed over the entire labor force. So in this situation it would be 15 million- so that's just the number of unemployed and actively looking over the entire labor force. Over 154 million and so if we get my handy TI-85 out, that gives us in this example right over here, an unemployment rate of 15 divided by 154 million. So it's about 9.7, if we write it as a decimal it's 0.097, if we write it as a percentage this would be 9.7 percent. This is approximately 9.7 percent. Now I told you that the details are going to be important and the reason why they are is because interesting things happen when people stop looking for work or when they start looking for work. So I said unemployed and actively looking puts you in this bucket over here. If you're unemployed, if you don't have a job, and you're not actively looking you're actually not in the labor force. And so you might be saying, "Sal, what does it mean "to be actively looking for work?" And this means that you've looked for a job or you are actively searching in the past, let me do this in a new color, in the past four weeks. Past four weeks. And you might say, "Sal, how do they know whether these 15 million people "have actively searched for jobs in the past four weeks?" And the answer is they do a survey. They're not going to survey every human being in the labor force or the U.S. population or all 15 million that are unemployed, that would be logistically impossible. What they do is they do a survey and right now they do about 60,000 people every month and they essentially ask them are you employed, are you unemployed, if you are unemployed have you looked for a job in the past four weeks? If you have looked for a job in the past four weeks as an unemployed person you get thrown into this bucket right here, you're actively looking. You're still part of the labor force. But if you've gotten so discouraged that you're no longer looking for work, maybe you've given up, then you get thrown out of the labor force. And that is what most people don't realize. If things get bad enough and people get really discouraged, you have people actually exiting the entire labor force. To see how that affects the numbers, imagine a situation. So this is the unemployment rate right now. There's 15 million people who are unemployed and actively looking for work. Let's say that this is just a horrible recession or depression and five million of these people get so discouraged they don't, in the last four weeks, they do not look for work anymore. So they maybe even stop altogether or they want to take a break. So what we're going to do is we're going to take five million people out of this bucket over here. So we're going to take five million people and move them out over here, outside of the labor force. If you did that, what happens? Well now the official unemployed number is now going to be 10 million, it's now going to be 10 million. And what's the labor force number? Remember they went completely out of this green circle over here. So they've also left the labor force. So the labor force number is now 149 million. So in this bad situation where people have left the labor force the unemployment rate would now be 10 million people unemployed and actively looking for work over a labor force of 149 million, the labor force has shrunk because they're so discouraged. So what do we get there as our unemployment rate? We have 10 divided by 149, it gives us 6.7 percent. So this is fascinating. If things get bad enough and people actually exit the labor force, then the unemployment rate could go down because the labor force is shrinking. The other thing could also happen, maybe things get really good, maybe things get really good and you have 10 million people who are sitting out here, they're either marginally attached workers which are people who are hoping to get a job but haven't looked for a job in the past four weeks, or they could be discouraged workers who have altogether, they wouldn't mind working, but they've given up altogether looking, but you can imagine it when the economy gets good, let's say we're starting from this baseline here, when the economy gets good and all of these people who are unemployed but not part of the labor force all of a sudden start looking for work. So then they'd be part of the official unemployed. So this 10 million would grow to 20 million, 20 million so now this number is 20 million and this green area would go up by 10 million. So now this would be 159 million. So in this situation, the official unemployed would be 20 million, and the entire labor force would be 159 million, and now you would get a situation- so you have 20 divided by 159 million, which is 12.6 percent. 12.6 percent, approximately 12.6 percent. So the whole point of this video, I'm not saying that the unemployment rate, the way it's calculated is wrong or that's it supposed to be misleading, I just want to give you a little bit of nuance that it doesn't always give the complete picture, in particular that one number, and there's other unemployment rates that give a little bit more nuance here, but this one headline unemployment rate that is typically given on the news doesn't capture the whole story. In particular it doesn't capture the people who might be exiting the labor force when things are bad, so in that situation the unemployment rate would probably be understating how bad things are, and it also doesn't capture the people who are entering the labor force, and that situation the unemployment rate would probably make things look worse than they are when things might actually be improving.