Unemployment Report

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Unemployment is defined as people who are registered as able, available and willing to work at the going wage rate in a suitable job but who cannot find paid employment despite being actively involved in search for work. Unemployment falls when people leave the jobless register (they either find work or leave the labor market) than sign on each week1. Unemployment is measured either according to the claimant count or the Labor Force Survey. The former counts only those people who are eligible to claim the Job Seeker’s Allowance and the later is based on the International Labor Organization definition of unemployment.

It covers those who have looked for work in the past four weeks and are able to start work in the next two weeks. Keynesian Unemployment (Demand Deficient): Keynesian unemployment refers to, when AD falls and wages and prices do not adjust immediately to restore full employment. This is because of the sluggish expectations and contracts (verbal or written) between employers and employees. AD is deficient because it is lower than full employment AD. As a consequence some workers will be willing to work at the going real wage but will be unable to find jobs.

Only in the long run will wages and prices fall enough to boost the real money supply and lower interest rates to the extent required to restore AD to its full employment level and only then will demand deficient unemployment be eliminated. New Keynesian: This theory present an additional cause of wage rigidity, to the two described above. It proposes that high wages create a greater incentive for workers making them more productive. This prevents firms from cutting their wages at a time when there is excess supply of labor.

This is in spite of the fact that by lowering the standard wage the firm will be able employ a greater number of workers and maybe even lower its wage bill, without sacrificing output. Although, according to the theory lowering the wages will actually lower worker productivity and firm’s profits. The reasons why the theory argues that lower wages lead to lower worker productivity is because of the following: * A firm that offers lower wages will fail to attract the best employees, which will gradually diminish its productivity levels.

Furthermore, by offering high wages the firm can also prevent its best employees from leaving, this would not only benefit productivity but also save the company resources in trying to locate a replacement and then retraining him/her. * Workers cannot be monitored at all times. Its up to them if they choose to work or shirk. If they choose to shirk they risk getting caught and fired, and if they get paid higher wages the opportunity cost of losing the job will be higher, and hence a greater incentive for them to work harder. * The level of wage is partially determined by social norms.

A company will look to maintain parity with other companies in the market as means of establishing a reputation of equity. Classical Unemployment (Real wage Unemployment): Since the classical model assumes that flexible wages and prices maintain the economy full employment, classical economists faced difficulties in explaining the high unemployment levels of the 1930’s. They argued that the problem was partially caused by the union powers which were keeping wages above its equilibrium level and preventing the required adjustment from restoring full employment.

Classical unemployment describes the unemployment created when the wage is deliberately maintained above the level at which the labor supply and labor demand schedules intersect. This can be either caused by trade union power or by the introduction of a minimum wage level above the labor market clearing wage level. Neo Classical Unemployment (Business Cycle theory): This model emphasizes real, rather than monetary shocks. Real shocks are actual events which have a significant impact on the supply side. This impact may be bad, e. g. the oil crisis or good such as the advent of new technology.

The crucial element of the model is that all movements of the output are movement of the natural rate. As we are dealing with real rather than monetary shocks we would have to consider interest rates and real wages. For e. g. an adverse supply shock will shift Aggregate Supply curve inwards, causing employment to go down and interest rates to go up. This will lead to a fall in consumption and investment in the economy. The Natural rate of Unemployment: The Natural Rate of Unemployment (NRU) is the rate of unemployment where the labor market is in equilibrium.

At a given wage rate the supply of labor will equal the demand. The NRU is also often referred to as the level of full employment. However, this does not mean zero unemployment in the economy. There will always be some level of unemployment present in the economy, either frictional or structural. The NRU is currently estimated to be around 6%2. It varies from one country to the next and changes over time. It is effected by the technological change, participation rate, government policies effecting labor mobility, job vacancy information and labor retraining programs. The Phillips Curve and the NAIRU:

The Non Accelerating Inflation Rate of Unemployment is the level of unemployment at which inflationary pressures in the economy are stable. According to supply-side economists, unemployment cannot be held permanently below its natural rate. If actual unemployment falls below its natural rate (equilibrium unemployment) there is upward pressure on wage inflation that then feeds into general price inflation. As unemployment falls towards the NAIRU skill shortages exert upward pressure on wages and producer prices, until any further falls in unemployment lead to future higher inflation.

This relationship between the levels of unemployment and the inflation rate is can be represented by the Phillips curve. Diagram 1 The short run Phillips curve becomes inelastic and the trade off between unemployment and inflation worsens. Each short-run Phillips Curve is drawn on the assumption of a given expected rate of inflation. If there is a change in inflation expectations in the economy then the whole curve will shift upwards, as shown in the diagram above. Most economists believe that the natural rate of unemployment has fallen in the UK over the last decade.

This means that the economy can sustain a lower rate of unemployment without causing wage inflation3. The evidence from recent months proves this view of an improving trade off between unemployment and wage/price inflation. The inflation rate is within the governments target of around 2. 5% and the unemployment has fallen to just over a million recently4. Since 1993 the underlying rate of inflation has been stable and the unemployment rate has fallen steadily. There has undoubtedly been an improvement in the trade off between unemployment and inflation resulting from a reduction in the natural rate of unemployment and the NAIRU.

This is partly the result of lower price inflation itself, because a fall in inflation means that workers are more likely to accept basic pay settlements that do not threaten a resurgence in prices. Another factor has been the beneficial effects of a more flexible labor market and the long-term effects of increase in education and training spending plus special employment measures in getting some of the structurally and frictionally unemployed back to work. Unemployment Study:

Male unemployment in Britain has risen from around ILO 2% in the 1950’s to around 11% in the 80’s (see below). According to the Classical viewpoint unemployment was too high because real wages were too high. Alternatively the Keynesians argue that wages are not binding and unemployment was high because the product market did not clear, with prices above the market clearing rate. However, markets are assumed to be competitive and prices within these markets must be determined by external forces, if at the existing prices fails to clear the markets.

So therefore it is likely that unemployment was rife because wages were maintained artificially above the equilibrium level, thus preventing firms to hire more labor. This argument is supported by a study of the labor market in the early 60s and 70s. Then it was widely believed that Britain was suffering from a shortage of skilled labor. This was most evident when governments were trying to raise the levels of economic growth but found that growth was inhibited by the skill gap.

Employers complained of skill ‘bottlenecks’ which compelled them to pay higher wages in order to keep their best employees. As a result wage rates rose, causing unemployment and loss of competitiveness in trade. Furthermore, the economy suffered, as others, from the oil shocks in the 70’s. The Business Cycle theorist argue that 70% of post war business cycles were caused by supply shocks. Supply shocks have an adverse effect on AS. This caused unemployment to rise, which led to a fall in consumption and investment, causing a shift in AD.

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