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Unemployment - Aggregate Demand Supply

Unemployment - Aggregate Demand and Supply Assignment / Homework Help

Unemployment is comprehended as a state of a person, who has attained the working age but is jobless or unforeseen laying-off of jobs of active workers. It mainly occurs due to the economic recession of the country. Only when a person who is looking forward to take-up a job but is currently jobless, is known as unemployed and those of whom who has attained the age of working but is not willing to work are not termed as unemployed. Hence, willingness of employment is the key factor of the person who is unemployed.

There are two policies by which unemployment may be reduced to a certain extent. The first one is Fiscal Policy, wherein the Government minimises taxes and expenses and maximises the aggregate demand. The disposable income increases when the taxes are reduced which creates increased consumption. The other policy is Monetary Policy wherein the interest rate is lowered sequentially increases consumption. When the aggregate demand for consumption increases, the aggregate demand for workers will also increase and thereby unemployment gets lowered.

Unemployment - Aggregate Demand and Aggregate Supply:

Aggregate Demand is the total of demand of goods and services at any period of time by all the groups within a country's economy that forms the GDP (Gross Domestic Product). It includes net exports and expenditure relating to investment, government and consumption. It is represented as aggregate demand curve, which correlates quantity of output with price levels. It is given by

AD=I+G+C+X-M , Where, I = Investment, G= Government spending, C= Consumption, X= Exports and M = Imports.

Increase in GDP will increase the demand for workers and helps reduce unemployment.

Aggregate Supply is the total of supply of goods and services at an overall price level in a given period within a nation's economy. The increased supply of products requires more workers resulting in decreasing unemployment to a certain extent. It is represented as supply curve, where aggregate supply and price level have a positive correlation.

Aggregate Demand Curve, Aggregate Supply Curve and the Philips Curve:

Philips Curve presents the combination of unemployment and inflation that arise in short-run as shifts in the aggregate demand curve and move the economy along the short run aggregate supply curve. Increase of aggregate demand for products in a short-run leads to higher output with higher price. More output means less unemployment. Thus, the shifts in aggregate demand push the inflation and unemployment in contra directions in the short run.


In the below diagrams, let us assume the price level as 100 in the year 2012 and probable outcomes that might occur in the subsequent year 2013. Let us call aggregate demand and supply as AD and AS.

Panel i shows the model of aggregate demand and supply. If AD is low, the economy is at Point M and output is low (10000 units) and the price level is low ($104). If AD is high the economy is at Point N and the output is high (11000 units) and so the price ($108). Panel ii shows the Philips Curve, where Point M arises when AD is low and has high unemployment (6% and inflation 4%). When AD is high, Point N arises and has low unemployment (3 % and inflation 8%).

Panel i depicts probable outcome and price level in the year 2013. If AD of products is low, the economy experiences outcome M. The economy produces output of 10000 units and the price level as $104. On contrary, if AD is high, the economy experiences outcome N. Outcome is 11000 units and the price level is $108.

With this illustration we can come to a conclusion that When the aggregate demand is higher, it moves the economy to equilibrium with higher price level and output.

Panel ii presents probable outcomes of unemployment and inflation. This is due to when the companies produce more output, they recruit more workers. Unemployment is lower in outcome N when compared to that of M. When output production is increased from 10000 to 11000 units, unemployment gets reduced to 3% from 6%. The price level is higher at the outcome N than in M and hence inflation is higher too.

To conclude, Philips Curve shows two probable outcomes for economy and can be compared either in terms of unemployment and inflation (using Philips Curve) or in terms of output and the price level (using model of aggregate demand and supply).

Beta used in real world - Beta as a measure of Unemployment:

Beta, generally is a measure of systematic risk in a portfolio when in comparison to the market as a whole. In economics, it is used to calculate the elasticity of unemployment rate with respect to output. Using Okun Law, change in unemployment rate is calculated by: α - β x change in the real output, where α is the intercept co-efficient and β is the elasticity of unemployment rate with respect to output.

For Example: Let us consider relationships between unemployment and output over time for two countries at the time of recession. (For a period of 20 years)
  • Norway has no discernible trend.
  • For Sweden, the elasticity of unemployment rate (Beta) has trended upward.
  • Higher Beta would lead to larger probable increase in unemployment.
  • Variations in Betas, reflects the labour during the recession.
(Beta^1 is the Aggregate value of elasticity of unemployment with respect to output).

There can be wage adjustment, lowering of benefits to existing employees, contractual hiring of workers etc., in order to reduce unemployment.

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