Diagram 1: Shifts in AD and SRAS for Airplane Production
As can be seen on Diagram 1, because the aggregate demand (AD, C+I+G+(X-M)) in the airplane market has decreased for airplane production. To maintain a somewhat stable price, jobs will be reduced, shifting the short term aggregate supply curve (SRAS) inwards. The objective of most firms is to gain maximum profit, and if Rolls-Royce is thought to be amongst the majority they will be concerned about ways of cutting costs. The easiest factors of production (FoP, resources used in production of goods and services, i.e. land, capital, labour and entrepreneurship) to cut costs is labour costs. Labour is a variable cost that can vary in proportion to the quantity produced. Meanwhile the other FoP’s such as land and capital are fixed costs that must be paid regardless of the rate of production in the short run. Therefore to cut short run costs, the number of jobs have already been reduced and is scheduled for further decrease in 2009.
The UK is currently in a recession caused by the financial crisis. With this and the recent surge in unemployment, people have become more afraid. Therefore those who are still employed at Rolls-Royce will work more efficiently to keep their jobs, allowing the firm to operate with even less labour. This could result in further cuts in labour. It can also explain the additional employment reduction made even after the cuts in 2008. Since costs are lowered, this could benefit the firm, but to the labourers this could increase the threat of losing their position. Moreover because people are worried about their future, they will consume and invest less and begin to save instead, decreasing the aggregate demand, decreasing economical growth of the United Kingdom.
According to the article, the firm is the “latest leading British company to impose heavy job losses.” This can be interpreted as that the demand for Rolls-Royce engines and thus airplanes are quite elastic, quantity demanded is sensitive to the change in price, confirmed by the large cut made by Rolls-Royce in their employment sector. Moreover, old planes can be used if the demand for transportation on airplanes decreases. They may not have the same updated facilities but the existing planes will be sufficient enough. Also it is a form of transport which is used mostly when going on vacation, which people consume when they have money to spare. Therefore the airline firms can survive without new airplanes. So, there will not be any need for the production of more airplanes. Thus less will be invested into the industry. However this reduction in investment will lead to a decrease in production rates. Investment is always needed to replace old machinery, therefore even a small decrease in investments could decrease the production rates proportionally more. This will create a negative accelerator effect, where the reduction in investment will make the firm produce much less goods, gradually making the economy worse and less efficient.
During this process, the government must finance transfer payments to those who are unemployed so that they are able to spend some money. However, they do not have enough resources to overcome this increase in government spending, since they are already on a tight budget which is already concerned with the financial crisis. Moreover, it is the whole of Britain that is facing high labour cuts. “In October the number of people out of work grew by 140,000 to 1.82 million” as can be seen below from the movement from point A to point B
Diagram 2: PPF curve of Airplanes and Airplane engines, before and after the reduction in employment
Combating this unemployment will be difficult. Less people are working reducing taxes and government budget. Therefore the government’s only option is to create jobs. Perhaps some sectors of the economy should be bought by the state. These state firms will provide jobs for people since their objective will not be to maximise profit but to keep unemployment low.
