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2.3 B Causes and Solutions for DisEquilibrium Unemployment B & D pages 208 – 211 Learning Objectives • Describe, using examples, the meaning of disequilibrium (cyclical) unemployment. • Explain, using a diagram, that disequilibrium unemployment is caused by a fall in aggregate demand. • Evaluate government policies to deal with the different types of unemployment. Wages and employment adjusts to balance the aggregate supply and aggregate demand for labour. (similar to the microeconomic that is specific to a type of job; what key word is different to this macro model?) Average Wage (labour price index) ASL Equilibrium wage, W ADL 0 Equilibrium employment Quantity of Labour The Aggregate Demand for Labour ADL Demand for Labour – slopes downwards from left to right as employers are able to afford to employ more labour at a lower wage rate. Increase in Demand for Labour may be due to: Increased GDP Capital more costly • Increased productivity (output per worker) ADL’ ADL The labour supply curve reflects how workers’ decisions about the labour-leisure tradeoff respond to changes in opportunity cost. Wage (price of labour) Increased supply of labour are due to… Work/leisure/education trade-offs Immigration Demographic changes –aging population Market wage Market wage Maximum participation ASL 0 Supply of workers Quantity of Labour 1. Disequilibrium u/e (also called Cyclical Unemployment) 1. Due to the downturn in the business cycle i.e. decreasing GDP (whatever causes that) 2. less production across all industries means less aggregate demand for labour 3. Wages do not fall easily – at least in the short run (in fact, typically u/e doesn’t begin until after about 3-6 months of falling output. Disequilibrium unemployment: also called “Cyclical”ASU/E Why? Average (real) wage rate L “involuntary” unemployment W1 W2 ADL 1 ADL 2 O Q2 Q1 No. of workers 1. Is it Demand-deficient u/e? Keynesians would say this is due to market behaviour of both workers (supply) and employers (demand) – For workers due to Sticky wages: workers are unwilling to accept lower wages. – for employers due to Efficiency wages: wages set by employers to attract – or keep – higher quality workers (due to cost of retraining as well). Demand Side Solutions - How they work • Fiscal policy: spending more (income or welfare benefits or special projects) – or taxing less! • Monetary policy: resulting in lower interest rates – thus increasing business investment Both are expansionary – thus leads to ↑ AD and ↑ ADL • Thu ADL returns to previous level and eliminates “Demand Deficient” u/e Evaluation of demand side policies Keynesian Theory focuses on demand side policies and dominated government policy from 1950 – 1980. Research the main weaknesses of using demand management to control the economy: trade-off problems; time lags and political changes; and classical economists' critique of demand management. 1. Why might there be conflicts between several of the macroeconomic goals? Explain one of these conflicts in terms of a "trade-off'. 2. How might fiscal policy actually serve to increase the amplitude of the business cycle? 3. Explain how classical/monetarist economists use "rational expectations" to criticise demand-side policies. 4. Why do you think Keynes referred to classical policies during recessions in terms of people in the economy having to "grin Spot where expansionary policy stopped working! 2. Or is it Real wage (classical) unemployment? Not reaching a new equilibrium because of … • • • Minimum-wage laws: wages regulated by government to bring about equity. Collective Bargaining (Union Power): wages contracted through unions on behalf of workers. Generous welfare (unemployment) benefits: more attractive benefits increases the opportunity cost of working for a living! Supply Side [Market Reform] Solutions How they work • Indirectly, lower union/minimum wages and Lower unemployment benefits will tend to reduce other wages – thus reducing the average wage – thus eliminating “real wage” u/e and increasing employment • With lower costs of labour, Aggregate Supply (ASAD model) should increase and thus return to Yfe.