A2 Econ Unemployment version 2 (adapted from IB)

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Teacher Presentation - A2 Econ Unemployment

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Unemployment A2 Economics:

Unemployment A2 Economics

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What is unemployment? The labour force is essentially the economically active population Legal ages to start work and to retire vary with countries Those not part of the work force children Students Stay at home parents Retired people Those who choose not to work Those who cannot work (e.g. disabled) It is surprisingly difficult to measure the size of the labour force and the unemployed Every country has its own system Information 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

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

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

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Distribution of unemployment The national unemployment rate is only the average for the whole country It does not show inequalities among different groups within an economy Geographical – UK higher in the north Age disparities – youth very high in Europe Ethnic disparities due to lack of opportunities or prejudice Gender disparities – unemployment among women tends to be higher in many industrialised countries

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

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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

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The labour market AS L - 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 AD L - 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 Slopes upwards because as wages increase workers will be willing to work Remember that demand for labour in an economy is dependent on demand for goods and services (aggregate demand)

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Causes of unemployment – Disequilibrium unemployment This happens when there are 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 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) Unemployment is Q2-Q1 or a-b

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

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Causes of unemployment – Demand deficient or cyclical unemployment (also called Keynesian unemployment) As the economy moves into a period of slower or negative growth AD falls (AD1 shifts to AD2) Less goods and services are demanded (Y1 to Y2) Labour is a derived demand Less labour is required to make the goods and services (ADL to ADL 1 ) Wages should reduce to W1 but wages are ‘ sticky downwards ’ The aggregate supply of labour at We is higher than aggregate demand leading to unemployment of a-b (or Qe-Q1) unemployment

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

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

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

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Types of natural employment – Seasonal unemployment Demand for certain workers falls at certain times of the year Examples Tourism industry Farming Solutions? Encourage people to take different jobs in their off season Reduce unemployment benefits Greater flow of information

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

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

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Solutions – Structural unemployment – market based/free market supply side policies Reduce unemployment benefits to give unemployed people to take available jobs Reduce labour market regulations which increase labour market flexibility 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 Evaluation People that lose benefits will have lower living standards (increasing inequity) Labour market regulations are in place to protect workers from unfair treatment and guarantee working conditions Unemployment might fall but there may be a high cost to the workers themselves.

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

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

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Crowding out To spend government wants to stimulate the economy and reduce unemployment it may have to borrow Some economists say that there is a problem with government running budget deficits called ‘ crowding out ’ Government sells bonds to financial institutions who then sell them on to people who want to save their money By borrowing they push up the interest rates When interest rates increase investment (I) falls There is plenty of argument for and against Keynesians say that it will not occur if the economy is producing at less than full employment 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=svOsKnWlW-g

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Is there a trade off between inflation and unemployment? More evaluation One of the main areas of evaluation when we are discussing solving unemployment is the Phillips curve Professor Phillips noticed that there was an inverse relationship between wage inflation and unemployment We can substitute wages with inflation because wages are the main cost for a business if wages go up then firms will put their prices up which leads to inflation Therefore 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 It will need to make a trade off between inflation and unemployment

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With an increase in output from Y1 to Y2 there must be an increase in the amount of labour used (less unemployment)

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Is there a trade off between inflation and unemployment? Monetarist view Monetarists have a different point of view and argue that any manipulation of AD will only cause inflation with no change in unemployment Watch this video http://www.youtube.com/watch?v=- Fk_2iRfC18 The main point to be taken from this is that it is better to use supply side policies than AD policies to fix unemployment because this will be non inflationary Don’t worry if you don’t really understand the Phillips curve and find it difficult to draw. You can use the AD/AS diagrams instead (see next slide)

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Equilibrium is at A and inflation is at P1 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 Monetarist View of the Phillips Curve 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

Phillip’s Curve for dummies!:

Phillip’s Curve for dummies!

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

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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

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What is AD? 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

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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

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Real wages?! What, as opposed to imaginary wages! Is your friend ok? Apparently there are nominal wages or real wages and if we don’t think about inflation we could be no better off!

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You need to explain that one! Well if we ask for a rise of 2% and inflation has risen 2% our nominal wages will have stayed the same

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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!!

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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!

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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 Three Months Later

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

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It’s ok…My neighbour, Mrs Peters 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

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

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Back in Time….50 Years ago! 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 Change in wages

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

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Back in Time….50 Years ago! 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 Change in wages

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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

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

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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!!!

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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 government just hate that…they will not be able to do both things

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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!

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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

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

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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!

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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?

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

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

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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

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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

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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 PC2 The Monetarists create Phillips for Dummies

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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

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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

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We need to remind them that although inflation is not changing that prices are still rising (they are going up by 10%) The Monetarists create Phillips for Dummies 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

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

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

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

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

And so the argument goes on ……. http://www.youtube.com/user/pajholden?blend=1&ob=5#p/search/0/-Fk_2iRfC18 :

And so the argument goes on ……. http://www.youtube.com/user/pajholden?blend=1&ob=5#p/search/0/-Fk_2iRfC18 Pajholden video on youtube

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