Unemployment | A-Level Economics Model Essays
Discuss the view that falling unemployment will inevitably lead to trade-offs with other macroeconomic policy objectives (25 marks)
Unemployment is the percentage of people who are willing and able to work but are unable to find work. Trade-offs from lower unemployment can include some of the other policy objectives, such as a stable price level and a stable balance of payments on the current account.
If there is lower unemployment, it is likely that AD has shifted to the right. This is especially the case if cyclical unemployment has fallen, as it is the unemployment caused by a lack of AD in the economy, for example during the financial crisis or COVID. If AD shifts to the right, real GDP rises and unemployment falls, but there would be an increase in price levels, from P1 to P2, as seen below.
Inflation (rise in average price levels) happens because higher AD (C+I+G+X-M) is linked to more spending from consumers, firms and the government. For example, if more people have jobs then more people will have a higher disposable income, which will lead to greater spending in the UK economy. Also, to reduce cyclical unemployment in the first place, it is possible that the government introduced fiscal policy, which means more government spending, also leading to higher AD and higher inflation. Also, if there is higher inflation, relative prices will be lower abroad, so more people may buy goods and services from abroad, leading to higher imports and lower exports (as goods are more expensive in the UK). This means that the current account deficit may also worsen due to lower unemployment. Overall, lower unemployment has trade-offs with the inflation and balance of payments objectives.
In evaluation, we only considered reducing cyclical unemployment by increasing demand so that doesn't mean that trade-offs are inevitable. Also, if there is a high amount of cyclical unemployment, there may have been a recession before, suggesting we are in a negative output gap and have high spare capacity. Increasing employment from a low output does not cause a large increase in inflation, as inflation was already low.
Unemployment can also be reduced in another way without causing any major trade-offs. This can be done by using supply-side policies. Supply-side policies are policies that aim to increase LRAS by improving incentives. For example, if new infrastructure and roads are built, then this can lead to an increase in LRAS. This is the case in real life with HS2, which itself creates jobs to implement, but increases mobility of labour even further by easily allowing people to travel across the UK. If the government are able to increase LRAS at the same time that AD rises, then this will reduce the strain on the economy as there would be greater capacity and productive potential.
The diagram above shows that we would be able to increase employment from y1 to y2, while only seeing a small rise in inflation because the supply-side policies can complement short-run economic growth by increasing capacity and reducing strain on price levels. Overall, there would be little conflict between macroeconomic objectives.
However, it is important to consider that supply-side policies are not easy to implement as they require a lot of spending and time. This means there is a high opportunity cost, which can lead to worse outcomes in relation to health, policing, or equality. Also, supply-side policies can take years to put in place, with HS2 being planned to launch after roughly 10 years.
Overall, lower unemployment can often lead to other issues such as inflation or worsened balance of payments but this is not inevitable, as the conflict can be prevented by using supply-side policies.
Essay Plan
Intro: definitions and objectives
AD goes up. Diagram. Main trade-off is inflation. Inflation can lead to more imports.
Evaluate
We only considered reducing cyclical unemployment (AD going up), we don't know where the economy was before (was there spare capacity?)
Argument 2: lower UE does NOT always lead to trade offs e.g. ...
Evaluate
Conclusion
Overall, falling unemployment often leads to trade-offs such as higher inflation but this is not inevitable, for example (refer to something that you said).