How does level of aggregate demand affect level of unemployment

To what extent can government attempts to influence the level of aggregate demand affect the level of unemployment

The government can attempt to influence the level of Aggregate demand through Fiscal policy and Monetary policy. If unemployment is relatively high then either interest rates can be lowered to expand demand (Monetary Policy) or, alternatively, the government could lower taxes and boost government spending (Fiscal policy). These measures should expand demand and lead to a fall in unemployment but the overall impact of both policies can be quiet different.

Unemployment can be caused by both demand side and supply side factors. On the demand side unemployment is attributable to Demand Deficient Unemployment or Cyclical Unemployment. Here workers are unemployed simply because there is insufficient demand to provide them jobs. Clearly attempts by government to boost demand by either policy will lower this type of unemployment. However, supply side unemployment needs careful consideration. Supply side has several different causes such as frictional, structural and technological or real wage unemployment.

Frictional is basically workers moving between jobs and is sometimes referred to as ‘the oil that lubricates the labour market’. Although some economists may argue the fact generally frictional unemployment is unavoidable in a market economy. Structural is mismatch between the skills demanded by employers and the skills, if any, possessed by the unemployed. Subdivisions of structural include seasonal, regional and age unemployment.

Technological is where machines replace ever more expensive workers. The question is to what extent can demand management measures affect supply side unemployment.

Lowering interest rates through monetary expansion will all probability have only minimal effect. In ...

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Technological is where machines replace ever more expensive workers. The question is to what extent can demand management measures affect supply side unemployment.

Lowering interest rates through monetary expansion will all probability have only minimal effect. In fact, if the bulk of the unemployment is supply side, then such an expansion may create inflation. A fiscal expansion through tax cuts may have a similar effect. However, an expansion through specially targeted government expenditure could be effective especially with structural unemployment but the spending may take time to work.

Structural unemployment is caused by lack of skills, so heavy government spending on education and training will help close the skills gap and lead to more workers finding jobs. Similarly, if there is pronounced regional unemployment spending on regional policy will help provide it is targeted at specific causes of unemployment. Unemployment causes by age can be reduced again by targeted government spending backed up by appropriate legislation. Seasonal unemployment can be reduced by government assistance to all year round tourist projects, such as in Cornwall.

Frictional unemployment can be reduced by more efficient job finding measures, such as Job centre Plus. This the national database of vacancies maintained online by the Dept for Work and Pensions.

Technological unemployment is really a necessary step in economic evolution and there is an argument for actually encouraging it. If machines are more cost effective than labour then, in the long run, technological unemployment releases labour for more cost effective uses elsewhere in the economy. If anyone doubts this view then ask them where would be now if the railways were prevented from taking over the canals.

Clearly fiscal expansion through well targeted government spending can, after a time lag, reduce overall unemployment by reducing what is known as The Natural Rate of Unemployment. This is the rate of unemployment below which inflation will result if the government expands demand. As mentioned cuts in national tax rates and national interest rates will stimulate demand but will not directly tackle the underlying causes of much UK unemployment. That requires targeted increases in government spending.

There is finally one other cause of unemployment and that is where people are better off on benefit than in work of withdraw from the labour force. Again, specially tailored fiscal measures can reduce this problem and the UK has made more progress on this than most other major EU nations. In Holland, Germany and France benefits are far more generous than the UK.

To conclude only well directed government spending plans can reduce unemployment in the long run. Blanket expansions from lower interest rates and taxes can only directly lower cyclical unemployment but the causes of unemployment in the UK go beyond that.

Peer Reviews

Here's what a star student thought of this essay

groat

14th of Mar 2012

Quality of writing

I don't think this essay has the right structure here. The paragraphs should be analysing different policies to increase aggregate demand, and then showing why it will affect each unemployment type differently. This would've been more focused on the question, rather than going through each type separately. I like the writing style here, as it makes for a convincing argument. Sentences are concise, meaning there are less irrelevant bits! Spelling, punctuation and grammar are strong.

Level of analysis

The analysis in this essay is sound. I liked how there was awareness that fiscal policies can reduce unemployment, only if targeted. However, the foundations of analysis aren't there due to the lack of a diagram! There needs to be an aggregate supply and demand diagram showing the basic principle of an increase in aggregate demand increasing real GDP and thus reducing unemployment. In my experience, evaluative points such as "the spending may take time to work" will be redundant if the analysis isn't there! The essay tends to assert knowledge rather than fully explain it. For example "cuts in national tax rates and national interest rates will stimulate demand" is a great chance to explain the mechanism. Making a clear progression from a cut in interest rate, exploring each step, to a reduction in unemployment would be a great way to get the analysis marks. For evaluation, there needed to be some discussion of the size of the policy and as mentioned earlier, the most prominent type of unemployment in the economy.

Response to question

This essay responds well to the question, but there is plenty of room for improvement. I would've liked to have seen the extent really questioned here. If I were doing this essay, I would've explored the fact that aggregate demand is only a solution to cyclical unemployment, and structural or frictional unemployment will be unaffected. This would've allowed some discussion if the effectiveness depending upon the type of unemployment, along with other factors such as the size and significance of government policies.

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