Economists call unemployment a lagging indicator of the economy, as the economy usually improves before the unemployment rate starts to rise again. However, unemployment causes a sort of ripple effect across the economy. The two key problems resulting from unemployment, especially the unemployment of labor, are personal hardships and lost production. The owners of the unemployed resources suffer personal hardships due to the lack of income. The rest of society also suffers from unemployment due to the lack of available production.
Unemployment creates personal hardships for the owners of the unemployed resources. When resources do not produce goods, their owners do not earn income. The loss of income results in less consumption and a lower living standard. While this problem applies to any resource, it is most important for labor. The owners of capital, land, and entrepreneurship often earn income from more than one resource. Thus a loss of income from one resource is not a total loss of income. Many workers, however, often earn income only from labor.
The loss of income from labor might mean a total loss of income. Unemployment also causes total production in the economy to decline. If fewer resources are engaged in production, fewer goods and services are produced. As suggested by the circular flow model, the severity of the connection between lost production and unemployment is magnified by the multiplier effect. An initial decline in the income, consumption, and production associated with unemployment triggers further declines in income, consumption, and production. As such, members of society, who might escape the direct immediate personal hardships of unemployment, often succumb to the indirect, multiplicative problems of lost production.
Number-crunching economists have estimated that for each 1 percent rise in the unemployment rate, that gross domestic product declines by 3 percent. Lost production is especially troublesome because it is an opportunity that is lost forever. This lost production delays society’s efforts to increase living standards and address the problem of scarcity. That is, when an unemployed worker does NOT produce output today, that output can never be recouped. If a worker is unemployed on Monday, Monday’s production is lost forever.