Unemployment IBDP Economics Chet Khatu What is

Unemployment IBDP Economics Chet Khatu

What is unemployment? ØThe labour force is essentially the economically active population ØLegal ages to start work and to retire vary with countries ØThose not part of the work force Ø children Ø Students Ø Stay at home parents Ø Retired people Ø Those who choose not to work Ø Those who cannot work (e. g. disabled) ØIt is surprisingly difficult to measure the size of the labour force and the unemployed ØEvery country has its own system ØInformation is gathered from national censuses and surveys as well as unemployment insurance records and social security information Unemployment – people of working age who are without work, available for work and actively seeking employment Unemployment rate – number of people unemployed expressed as a percentage of the total labour force

Hidden unemployment ØOne reason for the difficulty in measurement is hidden unemployment ØExamples Ø People who have been unemployed for a long time and given up! Ø People who have part time work but would like to be working full time Ø People who are working in jobs for which they are greatly over qualified ØIf the unemployment rate is low it would appear that this economy is doing well but there could still be room for improvement

Measuring unemployment Ø There are two main ways in which we measure unemployment Ø Claimant Count – counts those that claim the Jobseeker’s Allowance Ø Excludes people that don’t meet the eligibility criteria Ø Labour Force Survey Ø Includes those who have looked for work in the past month Ø Tends to exceed the claimant count by about 500, 000 Ø Used for international comparison

Distribution of unemployment ØThe national unemployment rate is only the average for the whole country ØIt does not show inequalities among different groups within an economy ØGeographical – UK higher in the north ØAge disparities – youth very high in Europe ØEthnic disparities due to lack of opportunities or prejudice ØGender disparities – unemployment among women tends to be higher in many industrialised countries

Cost of unemployment ØThe reason that unemployment is such an important macro objective is that it poses a great cost (mainly with long term unemployment) ØCosts to the people themselves Ø low income (benefits) means a lower standard of living for them and their families Ø High levels of stress, anxiety and depression Ø High levels of divorce and suicide ØCosts to society Ø High levels of unemployment in particular areas can be seen in the forms of poverty, homelessness, high rates of crime and increased gang activities ØCosts to the economy as a whole Ø Operating at a point within the production possibility curve Ø Opportunity cost of government benefits Ø Less income tax, less consumption, less indirect tax Ø More government spending on fixing social problems

Movements in and out of the pool of unemployment affect the supply of labour in an economy at any time. This, and the demand for labour will determine the level of employment and unemployment in an economy

The labour market Remember that demand for labour in an economy is dependent on demand for goods and services (aggregate demand) ASL - The aggregate supply for labour – the total number of an economy’s workers that are willing and able to work in the economy at every given average wage rate Slopes upwards because as wages increase workers will be willing to work ADL - The aggregate demand for labour – the total demand for labour (by all firms in the economy) at every given average wage rate Slopes downwards because as wages decrease firms will be demand more labour

Causes of unemployment – Disequilibrium unemployment This happens when there any conditions that prevent the labour market from clearing (reaching equilibrium Real Wage Unemployment – trade unions negotiate or government implements minimum wage - this pushes up wage rates and interfering with the labour market Unemployment is Q 2 -Q 1 or a-b At the higher wage more people are willing and able to supply themselves to the labour market but less firms are willing and able to demand – there is surplus of labour (unemployment)

Solutions to real wage unemployment ØBy making changes to legislation government could reduce the power of trade unions ØIf the minimum wage is preventing the market from clearing then it should be reduced ØEvaluation Ø It is difficult to reduce union power Ø This may harm the poorest workers Ø High income workers don’t receive the minimum wage Ø Reducing the living standards of low income workers – inequitable (unfair)

Causes of unemployment – Demand deficient or cyclical unemployment (also called Keynesian unemployment) ØAs the economy moves into a period of slower or negative growth AD falls (AD 1 shifts to AD 2) ØLess goods and services are demanded (Y 1 to Y 2) ØLabour is a derived demand ØLess labour is required to make the goods and services (ADL to ADL 1 ) ØWages should reduce to W 1 but wages are ‘sticky downwards’ ØThe aggregate supply of labour at We is higher than aggregate demand leading to unemployment of a-b (or Qe-Q 1) unemployment

Solutions to demand deficient unemployment ØThis is caused by low AD ØNeed to increase AD ØAny policy that increases AD should solve the problem (Keynesian demand management policies) Ø Monetary policy – reduce interest rates or increase money supply Ø Fiscal policy – Government spends more or reduces income tax or indirect taxation ØEvaluation Ø All of these things take time Ø Unemployment is a lagging indicator

Causes of unemployment – Equilibrium unemployment (natural unemployment) ØTheoretically the labour market may be in equilibrium with no demand deficient or real wage unemployment but there is still unemployment ØThis is voluntary unemployment ØThere may be jobs available but people are not willing to take them ØThey may not have the skills ØThey may not want to accept the wage ØThey may not be aware of the jobs ØThey are either unable or unwilling to take the available jobs ØAt higher wages the gap becomes smaller (more people are willing to take the jobs) unemployment

Types of natural employment – Frictional unemployment ØThis is when people are between jobs or they have left education and are waiting for their first job ØIt is not normally seen as a serious problem ØSolutions Ø Unemployment benefits should not be at a level that removes the incentive to work ØIf unemployment benefits were reduced unemployed workers might become more willing to work (shift the aggregate supply of labour to the right) Ø Improve awareness of available jobs

Types of natural employment – Seasonal unemployment ØDemand for certain workers falls at certain times of the year ØExamples Ø Tourism industry Ø Farming ØSolutions? Ø Encourage people to take different jobs in their off season Ø Reduce unemployment benefits political effect is apa? Ø Greater flow of information

Types of natural employment – Structural unemployment ØThis is the worst type of equilibrium unemployment ØIt happens due to the changing structure of an economy ØOne reason why it is so harmful is that it tends to result in long term unemployment Ø People who lose their jobs in one area lack the necessary skills to take on the newly created jobs – occupational immobility Ø If there are other jobs in other parts of the country but people are not willing or able to move this is geographical immobility ØDifferent causes Ø New technologies replace humans Ø Demand for a particular type of labour - lower cost labour in other countries Ø Changes in consumer tastes – e. g. environmentally friendly types of energy or eco friendly products Structural unemployment occurs when there is a permanent fall in demand for a particular type of labour e. g. coal mining in the UK

Solutions – Structural unemployment – Supplyside policies (interventionist) ØThe key is to increase occupational mobility (allow workers to move from job to job) Ø An education system that trains people to be more occupationally flexible Ø Adult retraining programmes Ø Government gives subsidies to firms that provide training for workers Ø Enhance geographic mobility by building affordable housing or give subsidies/tax breaks Ø Set up apprenticeship programmes to allow people to gain skills ØDisadvantages Ø Involve a high opportunity cost Ø These policies are only effective in the long run

Solutions – Structural unemployment – market based/free market supply side policies ØReduce unemployment benefits to give unemployed people to take available jobs ØReduce labour market regulations which increase labour market flexibility Ø E. g. regulations about hiring and firing – if it is difficult for a firm to get rid of labourers that do not work well they will not take on people ØEvaluation Ø People that lose benefits will have lower living standards (increasing inequity) Ø Labour market regulations are in place to protect workers from unfair treatment and guarantee working conditions Ø Unemployment might fall but there may be a high cost to the workers themselves.

Are demand-side policies or supply side policies more effective in reducing unemployment? ØThe answer is …it depends on what type of unemployment ØIf it is demand deficient then demand side policies will be required ØCreate demand firms will demand more labour ØEvaluation - There are concerns with using these policies Ø Expansionary fiscal policy - means spending more or taxing less Ø Either may mean running a budget deficit (spending more than taking in from revenues) Ø This may not be a problem in the short run but could be in the longer run Ø When lowering tax there is no guarantee that people will spend their additional disposable income if confidence is low

Are demand-side policies or supply side policies more effective in reducing unemployment? ØMore evaluation ØEven if the reduction in taxes worked there would be a lag before it came into effect ØBy the time it worked the economy could have recovered and the extra AD would be inflationary ØWith structural unemployment supply side policies may be better such as making sure labour is suitably skilled and flexible ØIn practice it is difficult to distinguish between different types of unemployment ØThe economy will likely be suffering from different types at the same time ØGovernments are likely to need a combination of both

Crowding out Ø To spend government wants to stimulate the economy and reduce unemployment it may have to borrow Ø Some economists say that there is a problem with government running budget deficits called ‘crowding out’ Ø Government sells bonds to financial institutions who then sell them on to people who want to save their money Ø By borrowing they push up the interest rates Ø When interest rates increase investment (I) falls Ø There is plenty of argument for and against Ø Keynesians say that it will not occur if the economy is producing at less than full employment Ø New classical economists (who are against demand management policies) say it is a significant problem. What is a bond? http: //www. youtube. com/watch? v=sv. Os Kn. Wl. W-g

Is there a trade off between inflation and unemployment? ØMore evaluation ØOne of the main areas of evaluation when we are discussing solving unemployment is the Phillips curve ØProfessor Phillips noticed that there was an inverse relationship between wage inflation and unemployment ØWe can substitute wages with inflation because wages are the main cost for a business Øif wages go up then firms will put their prices up which leads to inflation ØTherefore if we look at this diagram we might say that if government wants to reduce unemployment by pushing up AD it will have to put up with more inflation ØIt will need to make a trade off between inflation and unemployment

With an increase in output from Y 1 to Y 2 there must be an increase in the amount of labour used (less unemployment)

Is there a trade off between inflation and unemployment? ØMonetarist view ØMonetarists have a different point of view and argue that any manipulation of AD will only cause inflation with no change in unemployment ØWatch this video Øhttp: //www. youtube. com/watch? v=Fk_2 i. Rf. C 18 The main point to be taken from this is It is better to use supply side policies than AD policies to fix unemployment because this will be non inflationary

Equilibrium is at A and inflation is at P 1 There is an increase in AD and firms increase wages to encourage more workers to supply their labour Workers have money illusion (think they have higher real wages) and supply more labour Firms can supply more There is a temporary movement along the SRAS curve to Z Workers realise that inflation has increased and adjust their expectations (the increase was only nominal) Workers supply less labour Output returns to Yf at point B There is no trade off between unemployment and inflation in the long run – the long run AS curve is inelastic and therefore any increase in AD will only lead to inflation Monetarist (Classical) View of the Phillips Curve

Phillip’s Curve for dummies!

Can you believe how expensive things are these days? I know, my food bill is getting bigger each week!

The company I work for is doing really well. I think I am going to ask for a pay rise One of my friends who does economics tells me that AD has increased

What is AD? Um. Not sure, but it means more people are buying stuff and that’s why we are working overtime and they’ve taken new people on

If business is that good we should definitely ask for a pay rise! Yes, but my friend says that we need to think about our real wages

Real wages? ! Wtf. What, as opposed to imaginary wages? Your mate is a d*ck. Apparently there are nominal wages or real wages and if we don’t think about inflation we could be no better off!

. . . Eh? Well if we ask for a rise of 2% and inflation has risen 2% our nominal wages will have stayed the same

So we might feel better because we got our pay rise but actually we are no better off. Exactly…. we would be suffering from Money Illusion!!

Oh ok! So really we need to ask for a rise that is at least the same rate of inflation plus a bit more! Exactly…. so if the inflation rate is 2% then let’s ask for a 3% rise!

Asking for that pay rise may not have been such a good idea! Yeah I know, everyone had the same idea and now we are at risk of losing our jobs. Um. Sorry. I guess. Three Months Later

How does your friend explain this one!? Well apparently AS has dropped! Please don’t ask…I have no idea! Three Months Later

It’s ok…My neighbour, this bald dude called Chet, he explained…The AS curve has shifted to the left because costs (due to the increase in wages) have increased. Because labour is a derived demand there is less demand for us! And all because we didn’t want to get that stupid money illusion! Three Months Later

Back in Time…. 50 Years ago! Change in wages Professor Phillips you seem very excited! I finally finished my research on the relationship between wages and unemployment

Back in Time…. 50 Years ago! Change in wages So what does the diagram mean? I plotted the speed of wage inflation and size of unemployment from 1861 and 1957 and then drew the line of best fit

Back in Time…. 50 Years ago! Change in wages I see that there is an inverse relationship! Well done Charlie…you are right…why do you think it bows in the middle?

Back in Time…. 50 Years ago! Change in wages Is it something to do with the amount of available labour? It is…when there is surplus of labour firms don’t have to offer higher wages to get more labour but they do when there is very little labour available. That’s why the curve is so steep as unemployment gets closer to zero

Important! ‘Why is the Phillips Curve shaped like it is? It is…when there is surplus of labour firms don’t have to offer higher wages to get more labour but they do when there is very little labour available. That’s why the curve is so steep as unemployment gets closer to zero

Over at the Keynesian School of Economics a few years later What do you mean? I think we might be able to do something with that Phillips curve

Over at the Keynesian School of Economics a few years later You can’t do that! I think we should substitute wages for inflation

Over at the Keynesian School of Economics a few years later Wow! That means we can use it to show the trade off between unemployment and inflation Yes we can. Think about it…an increase in wages means an increase in labour costs which means an increase in total costs which means prices have to go up…inflation!!!

Over at the Keynesian School of Economics a few years later They will have to choose between one or the other I know, won’t governments just hate that…they will not be able to do both things

Over at the Keynesian School of Economics a few years later No! I love that curve…why? ! The only problem is that we will need to change our LRAS curve!

Over at the Keynesian School of Economics a few years later We should make it a bit curvy so it is not so easy for econ students to draw We will need to do something with the bit between a and b that shows the trade off

Over at the Keynesian School of Economics a few years later I am loving it already! Not just that…it shows how, as AD moves towards the full employment, Price Levels change (inflation)

Over at the Monetarist School of Economics a bit later I think those Keynesians need their butts kicked!! I know! School boy error…they completely ignored the long run!

Over at the Monetarist School of Economics a bit later They should know that in the long run there is no trade off How could they not know about the natural rate of unemployment or the NAIRU?

Over at the Monetarist School of Economics a bit later They even changed their curve!! In the long run it doesn’t matter how much inflation there is …unemployment will be the same

The Monetarists create Phillips for Dummies Lets make a guide for them! Yeah! Let’s call it Phillips Curve for Dummies!

The Monetarists create Phillips for Dummies First explain what happens when AD increases OK. . So, as AD increases and firms are paying more overtime and employing more people unemployment drops as inflation rises from point A to Z – there is a trade off in short run

The Monetarists create Phillips for Dummies This is the bit where the outcome depends on whether workers suffer from money illusion or not Yes, if workers don’t realise there is inflation (suffering from money illusion) they will bid up their wages and labour will be less attractive and unemployment will increase back to A

The Monetarists create Phillips for Dummies So now we need to explain what happens if they realise there is inflation Yes, This is when they ask for more and again labour will be less attractive but this time the inflation rate of 5% will be embedded into the economy and we will move onto the new curve PC 2

The Monetarists create Phillips for Dummies So prices continue to rise at 5% but the unemployment is back to the natural rate or NAIRU That’s it and this can happen again and again to C and to D

The Monetarists create Phillips for Dummies We should explain what the NAIRU is Oh yes, let’s say that we are at point C where there is 10% inflation. Inflation is not rising; it is staying at 10%. Anything on this line is the Non Accelerating Inflation Rate of Unemployment – the rate of inflation at which the economy is in equilibrium.

The Monetarists create Phillips for Dummies We need to remind them that although inflation is not changing that prices are still rising (they are going up by 10%) And we also need to mention how we can get that rate of inflation down. If government wants to reduce the rate it can reduce AD in the short run and in the long run workers will lower their wage expectations so that more are employed and we once again come back to the natural rate

The Monetarists create Phillips for Dummies Plus they could use supply side policies to shift the Long run phillips curve inwards Perfect! That should show them!

Back at the Keynesian School of Economics Natural rate of unemployment! I don’t think that actually exists Can you believe those monetarists or classicists or neo-classicists or whatever you call them these days!!!?

Back at the Keynesian School of Economics And a government that creates unemployment of CB may find the economy gets stuck at that 3 m level It takes ages for labour markets to clear especially when there is mass unemployment

Back at the Keynesian School of Economics Exactly! Unless it waits a decade or more it can only reduce unemployment by expanding demand again and accepting higher inflation

And so the argument goes on ……. http: //www. youtube. com/user/pa jholden? blend=1&ob=5#p/searc h/0/-Fk_2 i. Rf. C 18 Pajholden video on youtube