Demand-deficient Unemployment article commentary.

Graph showing a decrease in AD (Fig 1)                    Demand-deficient unemployment (Fig 2)

Average    AD    AD        LRAS                  Average                        AS

Price                Real

Level                                                                         Wage

         Pl        W        a        b

         Pl        W

                                AD         AD

                  Y   Y Y                                      Q       Q

        Real Output (Y)                                Number of workers

        In a period of recession, consumers are less willing to spend their income, which leads to a fall in aggregate demand, as can be seen in Figure 1. The aggregate demand curve shifts to the left from AD to AD along the long-run aggregate supply curve, LRAS, causing a reduction in the real output of an economy. The average price level also decreases from Pl to Pl. This reduction in real output may lead to a diminishing demand for labour leading to demand-deficient unemployment, as illustrated in Figure 2. If the economy is working at a high level, the labour market is in equilibrium, with wages at W for Q workers. If there is a recession, firms will decrease their demand for labour from AD to AD. However, as minimum wages are unlikely to decrease, the average real wage will remain at W meaning that the aggregate supply of labour, AS, is greater than the aggregate demand for labour, creating unemployment a-b.

        When evaluating the economic theory, it can be seen that keeping minimum wages low has a positive effect on unemployment in an economy in recession. Although aggregate demand may decrease, lowering the real output of the economy, firms may be more willing to retain labour if there are no extra costs of production associated with it. If the minimum wage were to be raised, however, the costs of production would also increase, forcing firms to lay-off workers. As stated in the article, ‘wage increase could see businesses fold as a result’, meaning that even more employment would be lost, as fewer jobs are available. Despite this, for the workers a low minimum wage which does not keep pace with inflation, decreasing the real value of money, may affect their standards of living. Also, the low minimum wage could ‘affect the economy and jobs by depressing confidence and the purchasing power of the low-paid workers.’ Workers have less disposable income which they can spend in different areas of the economy, further weakening it. A solution for this demand-deficient unemployment would be to increase aggregate demand by using expansionary fiscal policy, by altering taxation rates, and monetary policy, by decreasing interest rates. Using fiscal policy, income taxes can be decreased, increasing the disposable income of the consumer, or decrease corporate taxes, leaving firms more of their profits which they can reinvest in the economy. Using monetary policy, the interest rates can be decreased, reducing the cost of borrowing and increasing consumption and investment. If the aggregate demand increases due to these policies, production would increase as well and more workers would be needed, decreasing the level of unemployment. Moreover, if the Australian economy started doing well again, the freeze on minimum wages would most likely be revoked, giving the low-paid workers more disposable income and increasing their standards of living. However, these policies would only work in the long-term, because a change in the aggregate demand cannot occur from one day to the other, making these policies ineffective in the short-term.