Unemployment

Question 1

Phillips Curve

Answer 1

This is used to show an inverse relationship between inflation and unemployment.
• Keynesians argue that if there is spare capacity, an increase in AD causes Real GDP to rise therefore unemployment falls, but there is a trade off of higher inflation.
• Keynesians argue that the evidence of the 1950s and 1960s suggest that there was a trade off between unemployment and inflation.

Question 2

Monetarist View of the Phillip Curve

Answer 2

• Monetarists argue that the Long Run AS curve is inelastic, and therefore any increase in AD will only lead to inflation in the long run.
• If there is an increase in AD firms will increase wages to encourage more workers to supply their labour. Workers believe they have higher real wages and so are willing to supply more labour.
• This increase in the supply of labour leads to an increase in output and therefore there will be a temporary fall in unemployment. Therefore, there will be a movement along the SR Phillips curve.
• However workers later realise inflation has increased, therefore they re-adjust their expectations of inflation, and realise the increase in wages is only a nominal increase. Therefore, workers don’t supply more labour and output returns to the Long run equilibrium of Yf.

Question 3

Monetarist View of an increase in AD

Answer 3

• Despite an increase in AD in the long run Real output has stayed the same Yf.
• But inflation has increased

Question 4

Keynesian v Monetarist who is correct?

Answer 4

• Monetarists point to the 1970s where there appeared to be a breakdown in the Phillips curve. The UK experienced stagflation, which is a period of rising unemployment and inflation.
• Keynesians would respond to this by arguing that the Phillips curve had merely shifted to the right because of a rise in structural unemployment and structural inflation. For example, in the 1970s, there was an increase in cost-push inflation due to rising oil prices and powerful trades unions.
• Between 1992 and 2007, there was a fall in both inflation and unemployment. But, at times 2008-2010, we had rising unemployment and rising cost-push inflation.

Question 5

The Natural Rate of Unemployment 1

Answer 5

• The Natural Rate of Unemployment is the rate of unemployment when the labour market is in equilibrium.
• This is the difference between those who would like a job at the current wage rate and those who are willing and able to take a job.
• The Natural Rate of unemployment includes frictional and structural unemployment. The natural rate of unemployment is unemployment caused by supply side factors rather than demand side factors.

Question 6

The Natural Rate of Unemployment 2

Answer 6

• Monetarists argue that the Natural Rate of Unemployment occurs when the Long Run Phillips Curve crosses the x axis
• The Natural Rate of Unemployment is sometimes known as the Non-accelerating inflation rate of Unemployment NAIRU
• Sometimes the natural rate is known as the full employment level of unemployment. This is because even if the economy is operating at full capacity and there is no demand deficient unemployment then there will still be some unemployment caused by supply side factors.

Question 7

What Determines the Natural Rate of Unemployment?

Answer 7

i) Availability of job information
ii) Quality of Education and retraining schemes
iii) Degree of labour mobility
iv) Flexibility of the labour market, e.g. powerful trades unions may be able to restrict the supply of labour to certain labour markets.
v) Hysteresis. A rise in unemployment caused by a recession may cause the natural rate of unemployment to increase. This is because when workers are unemployed for a time period they become deskilled and demotivated.

Question 8

Explaining Changing Natural Rates of Unemployment (fall in the uk)

Answer 8

• It has been argued that the UK has seen a fall in the natural rate of unemployment since the 1980s. This has been explained by:

1. Increased labour market flexibilities, e.g. unions less powerful.
2. Privatisation has helped increased the competitiveness of industry leading to more flexible labour markets.
3. Better education and training.
4. Recent changes to benefits have made it more difficult to remain on JSA.

Question 9

Explaining Changing Natural Rates of Unemployment (rise in rest of EU)

Answer 9

The rest of the EU has seen a rise in the natural rate of unemployment in the 1990s this could have been caused by:
1. Rigidity in EU labour markets e.g. min wages, max working week discourage firms employing workers.
2. Restrictions on closing factories and mandatory severance pay for workers made unemployed; this makes firms more reluctant to set up in these countries.
3. High degrees of unionisation resulting in wage rigidity.
4. Generous benefits which lessen the pain of unemployment, but reduce the incentive to take a job.
5. Hysteresis effects. Long periods of unemployment, especially amongst the youth have had long lasting effects in discouraging people applying for jobs.
6. Growing competition from Asian countries
However the rising unemployment may not just be due to the Natural rate increasing, but also due to below trend economic growth. Therefore, part of the unemployment could be cyclical.

Question 10

Consequences of Unemployment 1

Answer 10

Loss of income - Unemployment normally results in a loss of income for the unemployed leading to a decline in spending power, debt problems and worse living standards.
Negative multiplier effects - One person’s spending is another’s income so to lose well-paid jobs can lead to a drop in demand.
Fiscal costs - The government loses out because of a fall in tax revenues and higher spending on welfare payments for families with people out of work leading to a budget deficit which then increases the risk of high tax and low spending in the future.

Question 11

Consequences of Unemployment 2

Answer 11

Loss of national output - If some people choose to leave the labour market permanently because they have lost the motivation to search for work, this can have a negative effect on long run aggregate supply and thereby damage the economy’s growth potential. Some economists call this the “hysteresis effect”.
Social costs - Regions that suffer from persistently high long-term unemployment see falling real incomes and a widening of inequality of income and wealth leading to higher crime and social dislocation including increased divorce rates, worsening health and lower life expectancy.