The new classical perspective

In the new classical model, full employment describes a situation where actual output is equal to potential output and unemployment is equal to the natural rate of unemployment. The natural rate of unemployment consists of structural, seasonal and frictional unemployment and is the level of unemployment that is consistent with the long-run, equilibrium level of output in the economy.

New classical economists believe that the market is inherently self-adjusting and that it will reach its equilibrium state if it is allowed to operate freely without interference. However, they argue that labour market rigidities, such as minimum wage laws, unemployment benefits, and unionization can prevent the market from reaching its natural equilibrium state.

By reducing labour market rigidities, new classical economists argue that the market will be able to reach its natural level of employment and wages, resulting in full employment. This will also lead to increased economic efficiency and productivity, as workers will be able to find jobs that best match their skills and abilities.

The Keynesian perspective

In contrast, the Keynesian model sees full employment as a goal that can be achieved through government intervention. In this view, the economy is not always naturally self-correcting, and there can be times when the aggregate demand for goods and services is too low to fully employ all workers. In these situations, the government can use fiscal and monetary policy to stimulate aggregate demand and create jobs. This can be done through measures such as tax cuts, increased government spending, or lowering interest rates to encourage borrowing and investment.

Confusion surrounding terminology

There is confusion around the use of the term “full employment” as the meaning of the term differs across various economic models. In the new classical model, full employment describes a situation where unemployment is at the natural rate, which still includes some structural, frictional, and seasonal unemployment. There is no cyclical unemployment.

According to Keynes, full employment is achieved when the level of aggregate demand is sufficient to keep the unemployment rate at or near 0%. In this situation, any unemployment is likely to be frictional and workers who are willing and able to work are able to find employment. Thus, there is no excess capacity in the labour market. However, most textbooks use the new classical definition of full employment, even when referring to the Keynesian model.

It is also important to note that full employment in the production possibility frontier (PPF) model refers to the full utilization of all economic resources, including labour, land, capital, and enterprise, rather than just labour resources as it does in the new classical and Keynesian models. Thus, full employment is sometimes referred to as maximum employment in the PPF model.

Author Profile

Luke Watson

Luke Watson has a BSc (Hons) in international business and economics. He is currently working as an IBDP economics teacher at Shanghai United International School in China.