What is unemployment?

It is the part of the labour force which is available for work at current wage rate but don’t have work. It can be expressed as a number or as a percentage of labour force.
Labour force: Part of the whole population which is willing and able to work.

How to calculate Unemployment rate?

Number of unemployed/Labour force X 100

Unemployment rate in different regions

Cost of Inflation 

Cost for people in work

1. Fall in income will result in a fall in the standard of living for the unemployed.
2. The longer the people are unemployed, the more dispirited they may become. It leads to stress and loss of self-esteem for the unemployed.

Cost for the economy

1. The opportunity cost of so many workers unemployed is the goods and services they could have produced. The total output of the economy will fall and people will have fewer goods and services.
2. Unemployment benefits have to be borne by the tax payers. Higher taxes have to be paid to cover the unemployment benefits.
3. The opportunity cost of using the public money for unemployment benefits. That money could have been used for something more productive.
4. Unemployment leads to fall in income which in turn results in a fall in aggregate demand in the economy.
5. Social cost of unemployment is a rise in crime and vandalism.

What is a Recession?

Recession is defined as a period of reduced economic activity, a business cycle contraction.

The U.S.-based National Bureau of Economic Research (NBER) defines economic recession as:

"a significant decline in [the] economic activity spread across the economy, lasting more than a few months, normally visible in real GDP growth, real personal income, employment (non-farm payrolls), industrial production, and wholesale-retail sales.”

In macroeconomics, a recession is a decline in a country's gross domestic product (GDP), or negative real economic growth, for two or more successive quarters of a year. A recession has many attributes that can occur simultaneously and can include declines in coincident measures of activity such as employment, investment, and corporate profits.

A severe or prolonged recession is referred to as an economic depression.

During a recession

• There will be reduced customer confidence and a reduce consumer spending.
• Businesses will reduce production levels as they find it difficult to sell their goods and services.
• In order to sustain growth, businesses will cut cost and will lay off employees.
• Economy will see an increased rate of retrenchment and more money is spent by the government on unemployment benefit.
• Government will get less revenue from income tax and VAT.
• Stock exchanges will see reduced activity.

How can government tackle the situation

In order to boost economic growth, governments may resort to several strategies. These strategies for moving an economy out of a recession vary depending on which economic school the policymakers follow.

Fiscal policy moves involve increase government spending to boost aggregate demand in the economy. Government may also reduce taxes. Tax cuts will promote business capital investment. Lower-bracket tax reductions are more effective and serve a double purpose including relieving the suffering caused by a recession.

Monetary policy involves increased money supply and reducing the price of money i.e. interest rates. Reduced interest rates will promote capital investment and spark economic growth.

Supply side policies involve giving subsidies and increasing the level of education of the work force.

Global recessions

According to International Monetary Fund (IMF) global recessions are periods when global growth is less than 3%. The IMF estimates that global recessions seem to occur over a cycle lasting between 8 and 10 years. During what the IMF terms the past three global recessions of the last three decades, global per capita output growth was zero or negative. By this measure, three periods since 1985 qualify: 1990-1993, 1998 and 2001-2002.

Types of unemployment

Cyclical or Demand Deficient unemployment

Cyclical unemployment exists when individuals lose their jobs as a result of a fall in aggregate demand (AD). The fall in AD, in the economy, results in the fall in real output and thus unemployment. It is called also known as demand deficientor Keynesian unemployment. 

Cyclical unemployment through a diagram

As we can see in the AD/AS diagram, the fall in AD to AD1 will result in a fall in the Real output (Y1).

This will force the firms to reduce their output and hence reduce their workforce from ADL to ADL1. However, due to ‘wage stickiness’ it is less likely that real wages will fall (as seen in the labour diagram). Therefore, the wages instead of coming down to W1 will remain at We. This will create a surplus situation where the aggregate demand for labour will be at ‘a’ and the aggregate supply of labour will be ‘b’.

Wage stickiness: The firms may not be able to reduce the wages may be as a result of the following reasons:

• They don’t want to create discontent among the workers by reducing their wages
• Trade unions may not allow the wages to go down.
• Labour contract may deter the firms to reduce the wages.

Structural unemployment

Structural unemployment occurs when certain industries decline because of long term changes in market conditions. These structural changes in the economy might lead to fall in demand for certain sectors of the economy. This is usually common in developing countries where primary sector generally reduces in size and secondary sector and tertiary sector might gain more importance. Change in technology is also one of the major reasons for structural unemployment, whereby certain kind of jobs become obsolete. Changes in consumer taste or preference may also be a cause of structural unemployment

Structural unemployment may worsen if there is 

• Occupational immobility occurs when there are barriers to the mobility of labour between different industries and occupations.
• Geographical immobility exists when there are barriers to people moving from one area to another to find work.

Frictional Unemployment

Frictional unemployment occurs when people leave their jobs and are unemployed while they are looking for a new job, or just having a break from working.

Seasonal Unemployment

Unemployment attributable to relatively regular and predictable declines in particular industries or occupations over the course of a year, often corresponding with the climatic seasons. 

Solutions to Unemployment problem 

Attempts to reduce the level of unemployment beyond the Natural rate of unemployment generally fail, resulting only in less output and more inflation. However the following ways may reduce unemployment.

Phillips Curve

It used to be largely believed that unemployment could be solved using the Phillips curve. This involves increasing inflation to reduce unemployment by fooling workers into accepting jobsat a lower rate than they would otherwise have done, due to the declining value of money. However, since the work of Milton Friedman, it is widely accepted that the Phillips curve is vertical in the long run: you cannot achieve a lowering of the unemployment rate in the long run, and attempts to do so will only cause inflation.

Demand side policies

Monetary policy and fiscal policy can both be used to increase short-term growth in the economy, increasing the demand for labour and decreasing unemployment. The demand for labour in an economy is derived from the demand for goods and services. As such, if the demand for goods and services in the economy increases, the demand for labour will increase, increasing employment and wages.

Supply side policies

Minimum wages and union activity keep wages from falling, which means too many people want to sell their labour at the going price but cannot. Supply-side policies can solve this by making the labour market more flexible. These include removing the minimum wage and reducing the power of unions, which act as a labour cartel.
Other supply side policies include education to make workers more attractive to employers. Cutting taxes onn businesses and reducing regulation, create jobs and reduce unemployment.

Shifting tax burden

This method will shift tax burden to capital intensive firms and away from labour intensive firms. In theory this will make firms shift operations to a more politically desired balance between labour intensive and capital intensive production. The excess tax revenue from the jobs levy would finance labour intensive public projects. However, by raising the value of labour artificially above capital, this would discourage capital investment, the source of economic growth. With less growth, long-run employment would fall.

IGCSE ECONOMICS NOTES-How a change in Interest rates affects economy?

How a change in Interest rates affects economy?

Controlling the interest rates affects the aggregate demand, inflation rate and the exchange rate.

Scenario one: Increasing the interest rates

An increase in the interest rates will reduce the demand for borrowing from customers and firms. If they borrow less money, they will have less money to spend and the aggregate demand will fall or rise more slowly. Moreover, individuals will be encouraged to save more due to high interest rates.

Higher interest rate will also raise the value of the country’s exchange rate as more international investors will be interested in investing their money in the country, to get better interest rates.

Scenario one: Reducing the interest rates

Reducing the interest rates will encourage people and firms to spend more money. As loans become cheaper, more people will be interested in taking loans and purchasing houses and cars. Even firms will be encouraged to expand as the cost of capital is cheap, they will find it easier to raise funds. This will fuel the aggregate demand in the economy.

How Government controls the money supply?

Money supply includes all the notes and coins in circulation with the public plus the money with banks. It also includes the deposits in banks and building societies. The later is more significant supply of money and is usually the target of Governments monetary policy. The ways through which Government controls the money supply are:

Open market operations

Government usually sells treasury bills and bonds to raise money. Private individuals invest in these bonds and bills in order to get a healthy rate of interest. This reduces the deposits with banks and the money supply.

Variation of legal reserve requirements

Usually, the commercial banks have to maintain a certain percentage of their assets as deposit with the Central Bank. When the Central Bank wants to reduce money supply it will increase the limit of the deposit kept by the banks. The commercial banks are left with less money to lend to their customers.

How the supply of money affects the economy?

If the Government reduces the supply of money, banks and money lenders will find they have less money to lend to people and firms. This shortage of the supply of money will lead them to charge higher interest rate. Moreover, in order to obtain more money they will increase the interest rates to attract savers to put money in deposit accounts. All these actions will lead to lowering the aggregate demand and the prices will come down.

On the other hand, if the Government increases the supply of money to banks, they will lower the interest rates in order to encourage people and firms to borrow more. More individuals and firms will borrow thus boosting the aggregate demand and the output of the economy. But if the increase in supply is not calculated properly it can result in inflation.

IGCSE NOTE Supply side Policies

Supply side Policies

Most supply side policies aim to enable the free market to work more efficiently and attempt to promote employment, low inflation and economic growth. The main idea behind Supply side policies is to reduce Government interference.

Supply side policies include

Privatisation

Privatisation is the selling of state owned businesses to private individuals and groups. This increases the efficiency of these organisations as they face more competition. Profit motive increases the incentive to utilise the resources in the best possible way.

Deregulation

Deregulation involves reducing barriers to entry in order to make the market more competitive. It does away with unnecessary rules and regulations on business which results in reduced cost, increased output and lower prices. Moreover, it increases the competition in the economy, leading to higher efficiency for businesses.

Increased education and training

Improving the level of education, training and skills of the workforce will raise the labour productivity and increase the aggregate supply. Governments usually give a lot of importance to education and encourage more and more people to attend universities and colleges and enhance the skills of the workforce.

Labour Markets reforms

By controlling the actions of the trade unions the Government can ensure that there is least disruption in the business activities.