How unemployment affects an economy?

The driver of economy is consumption, which can be internal or external. Unemployment have a negative effect on both internal and external consumption. Not only does it choke demand but hampers supply as well. Not to mention, it changes psychology of the individuals and the nation to doom and gloom.

After every economic expansion the subsequent contraction is almost inevitable. What goes up comes down. This theory fits perfectly into the boom and bust cycles of the economies. Even thought in the long run economies do go significantly high in their expansionary efforts but some checks and balances in the form of economic contraction are a fact. Below inforgraphic explains the relationship

between a boom and bust cycle in the economy. It explains after every downturn a expansion is always seen. Where does this put us in the scenario of unemployment and how can we interrelate the boom and bust cycle with unemployment expansion and contraction? Let's try to understand in detail.

The expansionary cycle in any economy leads to an increase in consumption as we have already discussed. The reason being the increase in disposable income which is a by product of high levels of employment, thus we call it a cycle. When this economic expansion takes place, there is a significant influx of employment opportunity in the economic system. This employment is a direct result of the greater degree of psychological impact entrepreneurs and business owners have when the market is filled with demand, the demand leads to a realization in the part of a business owner that he/she can fulfill the demand and make a profit out of it. But to supply this demand the business owner would need people or as we call it manpower. Which leads to employment.

Further, this employment puts income into the hands of the people, since they work for the business owner, they receive wages. This also leads to increase in wages in due time. As more and more business owner try to fulfill the demand in the market and the growing employment keeps increase the subsequent demand in the market, the supply of manpower gets strained and the forces of economics come into play. Anything which has a limited supply and high demand, the price of that commodity goes up. Labor or manpower here is a commodity which sees a wage increase on the backdrop of excess demand and limited supply. Which in turn leaves a higher amount of disposable income in the hands of the common people who in turn spend it on discretionary products and services, leading to a further economic expansion and subsequent higher levels of employment.

It is all well and good while we talk about economic expansion but forget not, we also have to discuss about economic contraction. Since we already discussed every economic expansion leads to a contraction simultaneously. Almost all contractions are caused due to either contraction in demand or a constraint in supply. Supply side constraints are really minuscule as these days it is simply not possible to have a supply choke while we live in a highly globalized automated world where we can produce or buy the stuff we need and consume it. Almost, all economic contractions are caused by demand contraction. This can be due to many reasons but the most common being the depletion of income and loss of confidence to get that income back. 

We are officially talking about unemployment. Unemployment leads to a loss in income and a loss of consumer confidence. Which is directly responsible for a slump in demand in the economy. When the demand contracts the existing inventory in the system stops moving and gets stuck, which is later liquidated through discounting and gifts etc. This leads to negative sentiment in the minds of the business owners and entrepreneurs. They are not sure of the demand returning back to normal and when. This leads to him/her cutting back on goods and services he/she produces and delivers. Which in turn leads to cutting back on employment, since less people are needed to produce less units etc. This increase in unemployment further leads to cut back on consumption by more number of people, causing significant demand deterioration. As cutting cost on a unit level is fine but cut back on a massive level by lots of people leads to a recessionary gap.

We have ample evidence to suggest, if we continue to provide UBI (universal basic income) to people irrespective of their employment status, we are to see a stable demand in the economy irrespective of loss in employment. This leads to the economy reviving faster and not going into a viscous cycle of unemployment leading to cut back in consumption and the cycle continuing. We can see in the developed economies like USA and Europe, governments are proving unemployment benefits to their citizen, this is not only leading to a safety net but also keeping the demand in the market which will contribute a lot when the economy opens up and people get back to work, the economy will be faster to spring back into motion and expansionary cycle will start faster.

Conclusion:

We can conclude that unemployment has a direct impact on the economy and it leads to an economic contraction cycle. We can avoid such economic contractions by introducing the concept of UBI(universal basic income). By keeping the demand intact, we can make sure that we avoid the recessionary gap and never get caught into the viscous cycle of economic contraction. At a macro level this will lead to a more healthy, innovative and psychologically stable society, which will lead to significant expansion of the economy, while arresting the contraction at bare minimum levels.