According to neoclassical economics, the wage rate is determined by a process of labour-market clearing (in which workers and employers compete with each other, ensuring that labour supply equals labour demand). Why, then, do we almost always observe unemployment? Neoclassical theorists argue that observed unemployment reflects frictional, structural, or disguised effects that are consistent with labour market clearing. In other words, this “natural” level of unemployment is, in fact, full employment. It is fruitless, in this view, to try to reduce unemployment below this natural level: misguided attempts to do so only create inflation. Unions, minimum wages, and other “market-inhibiting” measures will tend to increase the natural rate of unemployment.
Definition