www.ccsenet.org/ijef International Journal of Economics and Finance Vol. 3, No. 5; October 2011 www.ccsenet.org/ijef International Journal of Economics and Finance Vol. 3, No. 5; October 2011 170 ISSN 1916-971X E-ISSN 1916-9728 Published by Canadian Center of Science and Education 170 The Dynamic Effect of Unemployment Rate on Per Capita Real GDP in Iran Ali A. Naji Meidani Faculty of Economic and Administrative Sciences, Ferdowsi University of Mashhad PO box 91779- 48951, Park Square, Ferdowsi University of Mashhad, Iran E-mail: naji@um.ac.ir Maryam Zabihi (Corresponding author) Faculty of Economic and Administrative Sciences, Ferdowsi University of Mashhad PO box 91779- 48951, Park Square, Ferdowsi University of Mashhad, Iran E-mail: m.zabihi20@gmail.com Received: February 25, 2011 Accepted: April 21, 2011 doi:10.5539/ijef.v3n5p170 Abstract Unemployment is an important issue in developing economies. High unemployment means that labor resources are not being used efficiently. In this research, the dynamic effects of unemployment rate on per capita real GDP in Iran are investigated during the period 1971 to 2006 using an Auto-Regressive Distributed Lag (ARDL). Also in this model, the physical capital, the consumer price index and the ratio of government expenditure to GDP as control variables have been considered. The findings show that the unemployment rate has a significant and negative effect on per capita real GDP in long-run and short-run. The value of error correction coefficient is equal to -0.48 implying that around 95% of the per capita real GDP adjustment occurs after two years. Keywords: Unemployment rate, Per capita real GDP, Auto-Regressive Distributed Lag (ARDL), Error correction mechanism 1. Introduction Unemployment is an important issue in developing economies. High unemployment means that labor resources are not being used efficiently. Hence, full employment should be a major macroeconomic goal of any government because it maximizes output. The bivariate system of output and unemployment rate is one of the most commonly studied in the VAR tradition to analyze the propagation and the persistence of shocks in the real economy and the transmission mechanism between product and labor market. The Islamic Republic of Iran is the second-largest country in the Middle-east. With GDP per head standing at USD 3610 in 2007, the country is classified by the World Bank as a lower-middle-income country. Iran’s economy has experienced robust growth, with real GDP averaging 5.6% over the past five years. Strong performance was primarily bolstered by high oil prices and the fiscal stimulants. These factors will continue to support Iran’s economy in our forecast period. On the demand side, private consumption and investment will largely support the growth. However, private consumption will be hampered by skyrocketing inflation. Investment will remain strong, but is exposed to significant downside risks. The fear of military attack has eased after the release of the US intelligence report concluding that Iran eased developing nuclear weapons in 2003(Chen, 2008). Some observers contend that the unemployment rate is higher than figures reported by the Iranian government. The unemployment rate remains high, reaching an estimated 11.8% in 2008. At least one-fifth of Iranians lived below the poverty line in 2002. Iran has a young population and each year, about 750,000 Iranians enter the labor market for the first time, placing pressure on the government to generate new jobs. The emigration of young skilled and educated people continues to pose a problem for Iran. The IMF reported that Iran has the highest “brain drain” rate in the world (Shayerah, 2010) The purpose of this paper is to offer a thorough statistical investigation of the joint dynamics of output and unemployment rate.