OP JINDAL

GLOBAL UNIVERSITY

UNMEMPLOYMENT

JGU ID: 20090045

Course: B Com (hons)

Submitted to: Professor Amlan Das Gupta

Due Date: December 19,2020

The following research paper is on Unemployment and addresses the questions that why do most

countries face involuntary unemployment, how full employment will be achieved only in special

circumstances and why economies are not in a full employment equilibrium forever. Section 2 gives

the history and gives a detailed information about what the issue is. Section 3 shows an analysis on

why the countries face involuntary unemployment. Section 4 shows an analysis on why countries

can’t be in a full employment equilibrium forever and when can they achieve this full employment

equilibrium and then section 5 is the conclusion of the paper.

2. INTRODUCTION

The unemployment rate is the most generally used measurement of the welfare of the labour

market and in general, a significant indication of the state of the economy. While the unemployment

rate is theoretically clear, it is difficult in practice to identify working-age people as either employed,

unemployed, or out of work.[1]

According to the standardized definition of the International Labour Organisation, the unemployed

are the people who: (1) were without work during a reference period (usually four weeks), which

means they were not in paid employment or self-employment, (2) were available for work, (3) were

seeking work, which means they had taken specific steps in that period to seek paid employment or

self-employment. According to an article published by Kimberly Amedeo, “Unemployment typically

rises during recessions and falls during periods of economic prosperity. It also declined during five

U.S. wars, especially World War II. The unemployment rate rose in the recessions that followed

those wars.” The economic cycle is tracked by unemployment. High unemployment is caused by

recessions. As a consequence, employers lay off staff and jobless workers with less to spend. Lower

customer demand decreases total profit, causing firms to slash more payrolls. This cycle of

descendance is devastating. [2]

is calculated which are, how would seeking work be defined? Would discouraged workers be counted

as unemployed? People having part-time or temporary jobs aren’t differentiated from the ones who

have full-time jobs.

3.Why do most countries have involuntary unemployment?

Involuntary unemployment is defined, as the situation in which unemployed workers are willing to

accept employment at currently prevailing real wages (or slightly lower wages) or as the situation in

which employment can be increased by increasing effective demand with an unchanged level of real

wages.[3] These are the reasons why most countries face involuntary unemployment:

 IMPLICIT CONTRACT THEORY: Risk-neutral firm owners and risk-averse workers

negotiate contracts in Implicit Contract Theory before the firm's productivity (marginal

revenue product) is known. So basically, it makes difficult for the employer to cut wages. In

the partial equilibrium context described by the original implicit contract papers where

workers cannot be bid away by other firms it is easy to see that any optional " ex ante implicit

contract" must specify the same (fixed) real wage in every state of nature. (An ex-ante

implicit contract (Ws, Rs) specifies for each state of nature, or firm productivity, s, the wage Ws

that will be paid and the fraction Rs of the labour pool that will be retained by the firm. It is

simple to show that unless Ws is constant for all s there is another contract which offers a

representative worker the same expected utility while increasing the firm’s profits). This

argument was used to explain why the wage would not move to equal the marginal product of

the last member of the labour pool once the productivity of the company is known. This is

how implicit contract theory provides a basis for fixed wages and involuntary unemployment.

[4]

 EFFICIENCY WAGE THEORY: The concept of the efficiency wage theory is that

increasing wages will contribute to improved productivity of labour because employees are

more driven to work for better pay. Therefore, if firms increase wages, some or all of the
 higher wage costs will be recovered through increased retention of employees and greater

productivity of labour. Moreover, if an employee is paid higher wages, they will be expected

to give higher efforts. For them the cost of effort is disutility but the benefit is that it increases

the prospect of keeping the jobs and high employment rent.

This is also because they believe that higher wages would attract high quality workers who

would have specialization in a certain field. Also, higher wages would lead to higher living

standards which means better nutrition and health leading to higher effort. Thus, employers

will also have the incentive to pay wages which are even above the market equilibrium level.

And if the wages go above the market equilibrium level the number of workers that a firm

will keep will decrease leading to involuntary unemployment. [5]

 DEFICIENT DEMAND OR REDUCTION IN AGGREGATE DEMAND: Deficient demand

is the situation when aggregate demand falls short of aggregate supply corresponding to full

employment level in the economy. This situation of deficient demand gives rise to a

deflationary gap. The Deflationary gap is the gap between actual aggregate demand and

aggregate demand at full employment level.

This mainly occurs in the phase of recession when the aggregate demand will be less because

consumers will be buying fewer goods and services. This means that the firms will be selling

fewer goods and services. This will lead to reduction in production and output level. If a firm

is producing less this may lead to lower demand for workers which may cause the firms to
either fire existing employees or stop recruiting more workers. For an example during Great

Depression unemployment soared in the US because of great fall in demand and market

supply.

The diagram shows the fall in real GDP with a fall in the Aggregate demand level. LRAS is

the long run aggregate supply curve. When AD1 intersects LRAS the price level is P1 and the

GDP level is Y1. When there is a fall in aggregate demand AD2 shifts towards left

intersecting the LRAS curve at a price level P2 and GDP level Y2. Thus, the GDP also falls

which leads to high level of involuntary unemployment. In some cases, a further increase in

demand deficient unemployment can reduce the aggregate demand further making the

recession worse. Rising unemployment again leads to lower demand and lower output level,

which causes a further decline in the demand for workers. This can create a cycle of falling

demand and rising unemployment. [6]

BE ACHIEVED AND WHY ECONOMIES ARE NOT IN A

FULL EQUILIBRIUM FOREVER?

Full employment is when the economy works at an optimal level of employment i.e., anyone

willing to work is working and the economic output is at its highest potential. If we consider

frictional unemployment it will be very less in practise. In other words, we can also say that in

case of full employment the firms should be working close to their production possibility

frontier i.e., working at their full potential.

It is a state of balance in which savings is equal to investment and the economy is neither

expanding too rapidly nor falling into a recession. This level of economic output which is

measured by GDP is neither too high to cause inflation nor too low which would lead to a fall

in prices. The two economic forces that must be in equilibrium to achieve the full

employment GDP are unemployment and inflation. When unemployment goes down inflation

tends to go up and when unemployment goes up inflation tends to fall.[7]

If by increasing aggregate demand, full employment is reached, then the economy is likely to

experience inflation. Companies face a shortage of staff when the economy approaches full

employment and thus have to raise wages to recruit employees to take jobs; this wage

inflation leads to higher prices and higher consumption which are the two main factors that

contribute to inflation.
Initially, the increase in AD does not cause prices to rise much. But an increase in AD at Y3

(where the economy is near full employment, causing a rapid rise in prices from P3 to P4)

causes a rapid rise in prices. Thus, reaching full employment by increasing aggregate demand

will lead to inflation.

This model implies that aggregate demand is increasing at a rate more than long run aggregate

supply. In principle, however, both an increase in aggregate demand and long-run aggregate

supply can be achieved. If productive capacity meets aggregate demand growth, then without

inflation, the economy will achieve full employment. This basic diagram of AD and AS

suggests economic growth without inflation.

could be a sharp fall in unemployment if there is a burst in economic growth. However, if

demand rises at 5% a year but LRAS increases at 2.5%, this would cause inflationary

pressures. But if economic growth is close to a sustainable rate, then without inflationary

pressures, the economy will get close to full employment.

However if inflationary pressures (e.g. increasing oil prices) or low productivity growth are

cost-driven, then it is more difficult to achieve full employment without inflation. However, if

productivity growth is strong and inflation is low on a cost-push basis, then it is more likely to

happen.

A trade-off with the current account on the balance of payments is therefore expected to arise

when the economy approaches full employment. Consumer spending is likely to increase with

economic growth, and import spending is likely to rise. Consumers would tend to purchase

cheaper goods from abroad in the face of domestic inflation, leading to an increase in imports

and a decline in the current account balance of payments.

It depends on the nature of economic development, however. If by the expansion of the export

sector and investment-led growth, the economy achieves full employment, then full

employment can be accomplished without worsening of the current account. For example,

with a current account surplus, export-led economies such as Germany and China have

frequently achieved high rates of economic growth. The UK is more prone to a current

account deficit because there is a strong marginal import propensity in the UK. There is a

greater percentage increase in demand for foreign goods as wages rise.

We would expect unemployment to decrease as the economy expands and gets close to the

maximum level of employment, reducing the negative output gap. Higher production

contributes to more worker demand. Unemployment should then fall and we should get an

unemployment rate of close to 3%. If there is structural unemployment, however, then it

doesn't matter what the rate of economic growth, unemployment will continue. If for instance,

unskilled employees are made redundant, they will not be able to take up employment

because they lack the necessary qualifications. In this scenario, in order to achieve full
 employment, supply-side policies would be required to address structural unemployment and

enable the natural unemployment rate to fall.

In conclusion, without trade-offs from other macroeconomic goals, full employment can be

accomplished, but it requires a certain form of economic development. In particular, the

economy needs increased productivity, stable labour markets, and an ability to increase

production without creating shortages. Thus, growth needs to be sustainable and not

inflationary. If we have this growth driven by productivity, then unemployment will fall,

government borrowing will fall, and without inflation and a current account deficit, the

economy will reduce the negative output gap. Although, if there are structural inflationary

pressures, then it can lead to trade-offs such as inflation to achieve full employment.

5.CONCLUSION
Therefore it is consluded that countries will have soome involuntary unemployment for sure

because it will cause the workers to work more efficnetly because they will have some

employment rent and will prefer not to lose their wage. Also the employers would get the

employees who are qualified and more efficient. Even if the economy reaches to full

employment level the rise in prices would lead to inflation and a current account deficit which

will again reduce the aggregate demend and the econony will come to the involuntary

unemployment phase. However, full employent can be achieved if some measures are taken

like reducing the working time without any loss of income, bringing into effect active labour

market policies, using the fiscal and monetary measures to sustain the needed level of

aggregate demand, military spending be reduced and replaced by socially and economically

productive expenditures and there should be a reform of the monetary policy to minimise

unemployment. [8]
References AND CITATIONS

[1] D Byrne, E Strobl - Journal of Development Economics, 2004 – Elsevie PDF from econstor.eu

[2] Article named “Unemployment rate by year since 1929 compared to Inflation and GDP” by

Kimberly Amadeo ( https://www.thebalance.com/unemployment-rate-by-year-3305506)

[3] Definition from the Economics Help Article [

https://www.economicshelp.org/blog/glossary/involuntary-unemployment/#:~:text=

%E2%80%9CKeynesian%20involuntary%20unemployment%20is%20defined,an%20unchanged

%20level%20of%20real]

[4] Cowles Foundation, Yale University discussion paper 640

[https://cowles.yale.edu/sites/default/files/files/pub/d06/d0640.pdf]

[5] Diagram and definition from Economics help Article

[https://www.economicshelp.org/blog/glossary/efficiency-wage-theory/#:~:text=Shirking%20models

%20of%20efficiency%20wage,above%20the%20equilibrium%20and%20wages.]

[6] Diagram taken from Economics help diagram [

https://www.economicshelp.org/blog/1993/economics/demand-deficient-unemployment/]

[7] Video from study.com [https://study.com/academy/lesson/full-employment-gdp-definition-and-

examples.html]

[8] Article by S M Rosen [https://pubmed.ncbi.nlm.nih.gov/7499512/#:~:text=Among%20these%20the

%20most%20important,capital%2C%20(5)%20social%20investment]

[8] Barro, R. and H. Grossman (1976), Money, Employment and Inflation (Cambridge University

Press).CrossRefGoogle Scholar

[9] Diagrams taken from the book Unemployment: An Economic Analysis

[10] Chapter 6th of the textbook The Economy: Core [https://www.core-econ.org/the-

economy/book/text/06.html#figure-6-4g]

[11] Publication from Journal of Development by Byrne D on “Defining unemployment in developing

countries: evidence from Trinidad and Tobago”