Underemployment equilibrium

In Keynesian economics, underemployment equilibrium refers to a situation with a persistent shortfall relative to full employment and potential output so that unemployment is higher than at the NAIRU or the "natural" rate of unemployment.

The concept of underemployment equilibrium originates from analyzing underemployment in the context of General Equilibrium Theory, a branch of microeconomics. It describes a steady economic state when consumptions and production outputs are both suboptimal – many economic agents in the economy are producing less than what they could produce in some other equilibrium states.[1] Economic theory dictates that underemployment equilibrium possesses certain stability features under standard assumptions[2] – the “invisible hand” (market force) can not, by itself, alter the equilibrium outcome to a more socially desirable equilibrium.[3] Exogenous forces such as fiscal policy have to be implemented in order to drive the economy to a better state.

In an economy E=((u^h,e^h )_h,(Y^f,(θ^fh )_h )_f): every economic agent h has a utility function u^h and an initial endowment of wealth e^h; every firm f has a production function Y^f; every agent’s share of firm f is (θ^fh )_h. An underemployment equilibrium, given a price vector p, is defined as the consumption-production vector (x^*,y^* ) such that[4]

Given a well-defined economy [2][4], there could be many stable equilibrium states – some are more desirable than others from a social welfare point of view. Many factors contribute to the existence of undesirable equilibriums, among which two are crucial for underemployment equilibrium: oversupply and insufficient demand. When the labor force are overeducated for the skill level of available employment opportunities in the economy, an underemployment equilibrium will occur. Insufficient demand addresses the same issue at the macro level. When there are many fewer job opportunities than unemployed individuals, the unemployment rate is high. Moreover, well-qualified workers will face a tougher job market and thus have to settle for jobs originally meant for less skilled individuals. “Oversupply” here refers to an excess in both labor quantity and quality.

Overqualification is the most common form of underemployment equilibrium and is a direct result of oversupply. It defines the situation when individuals work in professions which require less education, skill, experience or ability than they possess. In economic terms, these agents are producing less than their socially optimal output. Collectively, when a lot of individuals produce below their full potential, the economy is in a sub-optimal underemployment equilibrium. [5]

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