Chapter 9 Answers
1 What is used as the official unemployment rate and how accurate do you think it is
in measuring the extent of the problem of unemployment in the economy?
Refer text page 271
The official unemployment rate is the number of unemployed workers who
are available for work and who have either actively looked for work in the last
four weeks or have a new job to start within four weeks as derived from the
Household Labour Force Survey (HLFS).
The official rate may not accurately reflect the true extent of unemployment in
the labour market because any people may be underemployed and yet counted
as employed in the statistics because they are working some hours a week. The
HLFS joblessness measure may provide a more complete picture of how far
community employment aspirations are not being met. Typically then the
joblessness rate is substantially higher than the official unemployment rate.
Refer text pages 271-274.
2 a
Define frictional, structural, and cyclical unemployment.
Refer text pages 283–284.
frictional: A level of unemployment which corresponds to the normal degree
of turnover in the labour market, those in between jobs, and which reflects the
ongoing relocation of resources that would be expected in a healthy, dynamic
economy.
structural: Unemployment that occurs because job seekers and available jobs
are mismatched. The mismatch may be due to inappropriate workers’ skills
and/or geographical location.
cyclical: Unemployment that occurs when the output of goods and services
falls below the level where all resources including labour are being fully
utilised, i.e. it includes those people out of work due to insufficient aggregate
demand (demand deficient unemployment because Y<Yf) and/or SAS shifts left
(supply-side unemployment).
2b
What does ‘full employment’ mean?
Refer text page 270
Full employment does not mean everyone who wants to work is employed. It
is sometimes called potential GDP and occurs when the only unemployment is
frictional and structural. This unemployment rate may be called the natural rate
of unemployment. The full employment level of income or potential GDP can
also be defined to be where unemployment equals job vacancies (see pages 285287).
3 What reasons did Keynesians advance to explain the observation that labour
markets in modern economies do not appear to clear at anything like full
employment equilibrium?
Keynesians hypothesised that wages and prices are sticky, particularly in the
downward direction, and are hence not likely to adjust downwards quickly
enough to prevent unemployment rising. The stickier wages and prices are, the
longer the unemployment will last. (also see discussion on schools of thought in
chapter 12)
4 a
Use AD/AS diagrams to show how cyclical unemployment can be explained
by:
i The theory of supply side unemployment.
Refers to real wage unemployment caused by nominal wages rising faster than
productivity increases. (SAS moves left due to higher costs of production.)
LAS
P
LAS
P
SAS2
SAS1
SAS
AD
AD2
AD1
Y
Y
(i ) Supply side unemployment
(ii ) Demand-deficient unemployment
ii The theory of demand-deficient unemployment.
Demand-deficient unemployment caused by insufficient aggregate demand.
(AD moves out only slowly, or AD shifts in.)
4 b
What policy would each theory suggest for reducing this unemployment?
Real wage unemployment (supply side): Solution, competition in the labour
market. This should reduce wage levels, thereby reducing costs to business and
see a shift out of the SAS2 to SAS1 (see previous diagram).
Demand-deficient unemployment: Solution, expansionary monetary and/or
fiscal policies or wait for the market. AD2 shifts out to AD1 (see previous
diagram).
4 c
What happens to real wages in each case?
Both adjustments result in a reduction in real wages (see text pages 292-294).
Supply-side: The movement in the short-run supply curve (SAS2 – SAS1)
reverses the original cause of this type of unemployment, and is achieved by a
reduction in nominal wages, hence real wages must fall (from their initial level).
Demand-deficient: The increase in AD causes the price level to rise; hence if
nominal wages remain fixed, real wages must fall.
5 What makes up the ‘natural rate’ of unemployment? Can this ‘natural rate’ be
changed, and if so how?
The natural rate is made up of structural and frictional unemployment.
Investment in education oriented towards producing a working population
with the capability and attitude to adjust to economic changes should reduce the
long-term structural component, while new education/training initiatives for
long-term unemployed (micro policy) should alleviate current levels of
structural unemployment. While faster job search facilities and job placement
services (micro policy) should alleviate any excessive duration of frictional
unemployment.
6 What would the following tell you about trends in unemployment?
a The number of vacancies exceeds the number of unemployed.
The economy is at greater than full employment. There may be some frictional
unemployment and some structural unemployment, but demand/supply
conditions in the economy are more than adequate to eliminate cyclical
unemployment.
b The number of vacancies and the number of unemployed fall by the same
amount.
Employment has increased by the number of vacancies filled (equal to the fall
in the number unemployed). There has been a decline in frictional or structural
unemployment.
c The number of vacancies equals the number of unemployed.
The economy is at full employment. All unemployment is either frictional or
structural; none is cyclical.
d The number of unemployed exceeds the number of vacancies.
There is some cyclical unemployment due to demand/supply conditions.
Show how you would depict each of these situations in an UnemploymentVacancy (U-V) diagram.
The unemployment-vacancy relationship
Vacancies
U = V (c)
UV1
(a)
(b)
UV2
(d)
Unemployment
7 Concern is often raised about disproportionate rates of unemployment in particular
sectors of society such as Maori, Pacific Islanders, young persons, the unskilled,
and the disabled. Should we be concerned about such matters and what if any
macroeconomic policies might have a beneficial effect on particular sectors of
society?
This should be treated as an essay type question. Consider such things as
government spending, education, taxation and economic growth. Clearly, it is
difficult for macro policies (in terms of aggregates) to be beneficial to particular
groups. It is hence necessary to somehow target specific policies to the relevant
group, which may be achieved using tools such as transfer payments, taxes,
education initiatives, business development programmes, training programmes,
etc.
Note: This is not a problem that is unique to New Zealand. In the USA, the
disproportionate numbers of unemployed appear among Blacks, Hispanics and
Native Americans.
8 Define unemployment hysteresis and suggest what may account for such a
phenomenon.
Hysteresis is a phenomenon whereby markets, which are disturbed from
equilibrium, may not return to the initial equilibrium when the conditions, which
bought about the initial disturbance, are reversed, because of the changes that
occur during the movement away from the initial equilibrium. For example,
people who become unemployed during a lengthy recession may not regain
employment during the following economic expansion if their work skills have
deteriorated in the meantime. Hysteresis is a possible explanation for the long-
term persistence of mass unemployment.
9 Discuss arguments for and against the view that there is not a trade-off between
unemployment and inflation even in the short-run.
See text pages 297-306
The arguments for the trade-off are encapsulated in the Phillips curve, based
on the observational study by A.W. Phillips. The implication of this relationship
was taken to be that governments could manipulate monetary and fiscal policy
to achieve whichever combination of unemployment and inflation on the
Phillips curve they preferred. The relationship began to breakdown in the 1970s
and 1980s leading to considerable modification of the trade-off incorporating
research on the ‘natural rate of unemployment’ and ‘adaptive expectations’.
Although this did add further dimensions to the model evidence in more recent
decades does not support the hypothesis of a trade-off, which is further
undermined by the behaviour of business cycles.
What views of the trade-off are reflected in current policy approaches in New
Zealand?
See text pages 297-306.
The 1990s saw greater emphasis on labour market flexibility, only limited
active labour market policies, limited demand management policies, limited
incomes policies, and possible supply-side effects through research and
development (R&D) tax policies. In relation to the trade-off between inflation
and unemployment this suggests that the costs in terms of higher inflation of
pursuing lower unemployment through expansion of aggregate demand were
seen as unacceptable, and/or a belief that the economy’s ‘self-correcting
mechanism’ could be relied upon to keep unemployment at or close to its
‘natural rate’.
10
Explain what is meant by labour market flexibility and why it is considered
important?
Flexibility in the labour market is typically associated with greater labour
mobility in the economy. Labour mobility is the ability of labour to move freely
in response to market signals provided (chiefly) by wages. If there is a high
degree of labour mobility in the economy adjustment may take place primarily
though through movement of labour between the expanding and declining
sectors without significant change in wages. Immobility may be geographical,
structural or occupational. Mobility of labour can be enhanced by measures
which encourage relocation of workers and retraining in skills needed in the
expanding industries.