Governments set economic objectives - Discuss the relative importance of each of these objectives - Can governments meet all these targets at once

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Q. Governments set economic objectives. Discuss the relative importance of each of these objectives (discussed so far). Can governments meet all these targets at once?

The economic objectives the UK government aims to achieve, which have been discussed so far, include maintaining a low level of unemployment, price stability and steady level of inflation and high yet sustainable levels of economic growth. Each economic objective will be analysed in turn and discover its importance in the UK economy.

Unemployment measures the amount of people that are actively seeking employment at a point in time. Typically in the UK, unemployment is measured by the number of people claiming benefits, even though there are other techniques of measuring unemployment. Equilibrium in the labour market exists when the demand for labour is equal to the supply of labour.

Figure 1.0 - Labour market in equilibrium

Even in equilibrium, there may be some level of unemployment, such as frictional and search unemployment, seasonal unemployment and structural unemployment. Sometimes, the labour market moves out of the equilibrium.

Figure 2.0 - Disequilibrium in the labour market

In Figure 2.0, the wage rate is above the market clearing wage rate, P, thus, causing fewer workers to be demanded by employers because the wage rate is too high, yet an extension in the supply of workers because the wage rate is so high. This has resulted in unemployment, which is the distance from QD1 to QS1. If the wage rate fell back to price P, then the labour market would be back in equilibrium as firms would demand more workers and some workers would have dropped out of the labour market, not working due to the lower wage rates.

There are several types of unemployment: cyclical, real wage [also known as classical], frictional and search, seasonal, structural and voluntary.

Cyclical unemployment is closely linked to the business cycle.

Figure 3.0 - The business cycle

There are four parts to the business cycle: the boom/peak, recession, slump and recovery/expansion. At the boom, GNP will be high, as will consumption and investment. Due to high demand, disposable income is high, as are profits and wages. Recessions occur when incomes and output begin to fall. Demand for goods and services fall, thus workers start to be laid off. This is illustrated in Figure 4.0 below.

Figure 4.0 - Cyclical unemployment

In the slump, unemployment levels are the highest and business failures increase, In the recovery stage, income and output begin to increase, firms invest more, consumers spend more, firms are able to take on more workers, therefore unemployment falls and employment rises. For instance, after the recession of 1980 - 1982, unemployment fell from 3.3 million in 1986 to 1.7 million in 1990, based on a claimant count.

Real wage unemployment occurs when the wage rate is too high [see Figure 2.0]. If the real wage rate rose to P1, this would lead to the supply of labour greater than the demand for labour. People are willing to work at that wage rate but are unable to find employment, thus unemployment exists. In the 1970s and 1980s, many semi-skilled and unskilled male workers were caught in the poverty trap: taking on a low paid job would lead them to lose as much or even more in state benefits than they would gain in ages after tax. Although successive reforms of the tax and benefits system in the 1980s and 1990s led to some improvement in this situation, effective marginal rates of tax and withdrawals in benefits remained high at low incomes. Trade unions have also been blamed for creating real wage unemployment during the 1960s and 1970s. They were able to raise wages for their members above the market clearing rate for the labour market, but only by reducing the supply of labour and thus reducing the number of jobs on offer,

Frictional unemployment occurs when people are moving in-between jobs. It may only last a few weeks, however, if it over a longer period, it is known as search unemployment. Frictional and search unemployment rose in the 1960s and 1970s because of the significant rise in the late 1960s of the replacement ratio, the ratio of unemployment benefits relative to wages. This meant that workers could now afford to remain unemployed longer, searching for the right job.

Examples of seasonal unemployment include construction work, agricultural and holiday industries where demand is less in the winter months - these workers are only unemployed at certain times of the year. This is why unemployment figures are seasonally adjusted.

Structural unemployment occurs when there are changes in the whole structure of the economy. This usually occurs when there is a decline in a leading industry. Structural unemployment tends to affect certain areas of the country e.g. Wales has been hard-hit by the decline of the coal mining industry; Yorkshire and Humberside have similarly experienced a decline in several primary industries, including steel.

Voluntary unemployment occurs when people are unwilling to work at the current wage rate. This suggests that in an economy, we will not get to the point of full employment. Instead, we can lower the natural rate of unemployment. The natural rate of unemployment is the proportion of the workforce which chooses voluntarily to remain unemployed when the labour market is in equilibrium.

The government chooses to tackle unemployment as there are many costs of unemployment. The costs to the unemployed include the loss of potential income; some feel degraded by the whole process of signing on to receive benefits; studies suggests that those that are unemployed suffer a wide range of social problems, including marriage breakdowns, as well as health and mental problems; evidence suggests that the longer the period out of work, the more difficult it will be to become employed again. Costs of unemployment will also be carried by the taxpayers: governments will have to pay out increased benefits and taxpayers will have to pay more to cover increased government expenditure and also to make up the taxes the unemployed would have paid if they were in work are only two costs the taxpayers will have to bear. In the UK Budget 2002, £115 billion was spent on social security out of a total managed expenditure of £418 billion compared to £65 billion spent on the NHS. Unemployment, particularly amongst the young, leads to increased crime, violence and vandalism, which destroys the local community. Areas if high unemployment tend to be run down, which would have a knock-on effect to potential businesses which may now refuse to set up in a run down area, thus reducing the opportunity of increasing employment within the area. Finally, unemployment bears a cost to the economy as a whole. There is a loss of potential output - if they were in work, more goods and services would be available for consumption. Furthermore, there are social costs such as increase violence and depression which have been already discussed.

There are two angles at which the government can achieve its objective of lowering unemployment: demand management and supply side policies.

If unemployment is caused by too little demand within the economy, then the government could choose to implement demand management policies to increase aggregate demand. The 1950s and 1960s became the era of demand management, where unemployment levels were extremely low by historical standards. If the economy was below full employment, the government intervened to raise aggregate demand and eliminate the output gap. In order for the government to increase aggregate demand, it can increase government spending, reduce taxation or relax controls on the availability of credit by loosening monetary policy.

Figure 5.0 - Demand management

The extent to which increasing aggregate demand would work within the economy would depend upon where the aggregate demand curve lies on the aggregate supply curve before the demand curve moves. Furthermore, increasing aggregate demand could have an effect on the price level within the economy. For example, if the aggregate demand curve was at AD1 to begin with and the government increased aggregate to AD2, employment has increased but price levels have remained the same. However, if the economy was currently at AD2 and wished to increase aggregate demand to AD3, not only would this create an increase in employment, but it will also create an increase in the price level. If the economy was at AD3 and wished to increase aggregate demand to AD4, similar effect can be noted: employment increases, and so does the price level. If, however, the economy was at AD4 to begin with, and wanted to increase aggregate demand, as the aggregate demand curve is now on the inelastic area of the aggregate supply curve, 'full' employment has been achieved, thus increasing aggregate demand will have no other effect other than on the price level.
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Some economists see the demand management theory as rather simplistic. It does not take into the account the natural rate of unemployment. In addition, classical economists argue that the aggregate supply curve is vertical, thus any increase in aggregate demand would only cause inflationary reactions.

Supply side policies can be used to directly target a particular type of unemployment.

The government can deal with frictional unemployment by improving the flow of information to unemployed workers, thus improving employment services. Additionally, by reducing the benefits of the short-term unemployed and improving the mobility of labour, frictional ...

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