(a) What can the government do to reduce unemployment? (10)
The unemployed refers to the people in the working population who are available for work and are actively looking for a job but cannot fid a job. The unemployment rate can be measured via this formula: Unemployment Rate (%) = {[unemployed ÷ (employed + unemployed)] × 100%}. The types of unemployment include demand-deficient unemployment, frictional unemployment, structural unemployment and seasonal unemployment. Thus, in order to reduce demand-deficient unemployment, demand management policies are implemented by the government. To reduce frictional, structural and seasonal unemployment, supply-side policies can be utilised by the government.
An expansionary monetary policy aids in increasing Aggregate Demand (AD) in order for the economy to reach full employment level. With reference to Figure 1, the economy initially operates at A, which is below full employment level Yf. The Central Bank can adopt an expansionary monetary policy. An increase in money supply will lead to a decrease in interest rates. Since, the cost of borrowing is now lower, households and firms will borrow more for consumption and investment. This increase in consumption (C) and investment (I) expenditure will cause an increase in aggregate demand from AE0 to Ae1 as shown in Figure 1 as AE=C+I+G+(X-M). This raises national output form OY1 to OYf and employment via the multiplier process. Hence, expansionary monetary policy brings the economy to full employment.An expansionary fiscal policy also aids in increasing Aggregate Demand (AD). With reference to Figure 2, the economy initially operates at A which is below the full employment level Yf. The government could adopt an expansionary fiscal policy. The government can increase government expenditure (G) or reduce taxes. An increase in G will cause an increase in aggregate demand directly since AD= C + I + G + (X-M). Alternatively, the government can also reduce taxes. For example, if the government can also reduce taxes. For example, if the government reduces corporate tax rates, investment (I) would increase and thus cause an increase in AD. The increase in AD as shown from AD0 to AD1 in Figure 2 will raise national output from Y0 to Yf. Hence, employment will also increase and the economy is at full employment.
However, expansionary monetary policy and fiscal policy may be ineffective due to certain reasons. Expansionary monetary policy may be ineffective if consumption (C) and investment (I) are interest elastic. In times of severe recession, even though interest rates are attractive, businessmen may not invest due to the gloomy business outlook. Inflation may also result in both cases when the increase in AD overshoots.
Supply-side policies that the government can adopt to reduce unemployment include reducing labour market rigidities as well as establishing pro-business policies. With reference to Figure 3, the economy initially operates at the level of Y0, which is at the full employment level. There is equilibrium unemployment. The supply-side policy aids to increase the labour market flexibility. The increase in aggregate supply from AS0 to AS1 as shown in Figure 3 will raise the national output from 0Y0 to 0Y1 without an increase in GPL. Hence, employment will also increase.
To solve search unemployment, better job information can be provided via mass media and job agencies. This would thus enable unemployment to decrease as the unemployed workers will be matched to jobs that suit their capabilities effectively. By also providing more education and opportunities to upgrade the skills of workers, it increases the employability of workers by equipping workers with the relevant skills to switch between jobs. Moreover, pro-business policies such as tax holidays for companies and having a good infrastructure would reduce unemployment as other firms would find the host country attractive and thus increases employment. However, supply-side policies are costly, have large time-lags and have unpredictable outcomes.
Thus, in conclusion, a combination of demand and supply-side policies can be used in order to reduce unemployment. Thus, when aggregate demand rises by too much, aggregate supply can also be increased to effectively curb the onset of inflation. And, also, when AS increases by too much, AD can also be increased to curb unemployment.
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