Download Disequilibrium unemployment

Disequilibrium unemployment
Recap: Equilibrium unemployment: We are already aware that equilibrium
unemployment is the unemployment which exists when the _________________ for
labour is equal to the ___________________ of labour and vacancies match the
number of unemployed. Whilst there may be unemployment equilibrium at the current
wage rate, people may still be unemployed. This is because they are unaware of the
vacancies, unsuitable for the vacancies or unwilling to take up the vacancies.
Disequilibrium unemployment
This occurs when there is disequilibrium in the labour market, specifically when
aggregate supply exceeds aggregate demand at the current wage rate. This is shown in
the figure below. At the wage rate W1 there is disequilibrium unemployment of xy. If
the wage rate were to fall to the equilibrium wage rate We, then disequilibrium
unemployment would disappear- but for some reason the wage rate W1 is unable to
fall….…..
Average real
wage rate $
ASL
There is disequilibrium unemployment of y-x
at the given wage rate W1. This wage rate is
above the market clearing wage rate of We.
W1
We
ADL
x
y
Number of workers
Causes of disequilibrium unemployment
There are a number of reasons why the real wage rate may be higher than market clearing
(equilibrium) wage rate:
1. Real wage rate unemployment
One possible reason is that the wage rate has been driven up above the equilibrium
wage rate either by trade union power or a government-set minimum wage rate. It is
argued that unions, by threatening to disrupt production, can force firms to pay higher
wages than would be required in a free labour market. Classical economists believed
that the severe unemployment of the great depression in the 1920s and 30s was
caused by labour unions driving real wages above the market clearing rate. (therefore
real-wage rate unemployment is often called classical unemployment). The diagram
below shows disequilibrium unemployment within a specific industry (for example,
ship building). The ship building labour market was intially in eqilibrium at wage
rate We. Trade union pressure forces the wage rate above We to W1 causing
disequilibrium unemployment of y-x within this industry.
Average real
wage rate $
ASL
There is disequilibrium unemployment of y-x
at the given wage rate W1. This wage rate is
above the market clearing wage rate of We.
W1
We
ADL
x
y
Number of workers
2. Demand Deficient (cyclical) unemployment
The most significant cause of disequilibrium unemployment is a fall in aggregate
demand for all goods and services and hence for labour (as labour is a derived
demand [where demand for one good or service occurs as a result of demand for
another]). This theory was first put forward by John Maynard Keynes in the 1930s
and contributed to the differences in opinion between classical and Keynesian theory.
A fall in the demand for all goods and services (i.e. a fall in aggregate demand) will
cause a fall in the demand for labour (usually the most expensive factor of
production). This is shown on the diagram below. AD1 shifts inwards to AD2.
Keynesians argue that labour markets do not work smoothly and will resist pay cuts.
Therefore the wage rate stays at the previous equilibrium level W1. Wages may
eventually fall but this is argued to be a slow process and so the labour market does
not clear resulting in demand deficient unemployment of ‘Q1-Q2’.
Wages are ‘sticky downwards’- they are not very flexible downwards as the existing
labour supply resists wage cuts. Such is the nature of labour that wages rise easily
but resist falling as workers are not passive commodities.
This is the type of unemployment that arises with a recessionary gap. Cyclical
unemployment extends across the whole economy, and across all industries. The term
‘cyclical’ refers to fluctuating economic growth that has been exhibited globally over the
last century. Fluctuating economic growth over time is known as the business cycle. Use
an AD/AS diagram to illustrate a recessionary gap below:
Price level (GDP
Price Deflator)
Output (RGDP)