The Current and Ongoing Recession in the Global Financial Markets and Economies - Essay Example

Running Head: Unemployment & Aggregate Demand Unemployment & Aggregate Demand [Institute’s Unemployment & Aggregate Demand Introduction Most of the macroeconomists agree that inflation level and employment level are the prime indicators of the performance of an economy. These variables provide a clear picture of the implementation of policies, and whether they are hitting the bull’s eye or not? Any economy would want the inflation to be as low as possible and would like to achieve a high rate of employment or in other terms the low rate of unemployment (Gilpatrick, pp. 256-278, 1966). There are arguments that both of these are not possible at the same time. For this purpose, the argument presented is that if an economy is witnessing high level of employment, which means that most of its labor force is employed and then if the producers want to increase the production level or the output, they will have to employ the rest of the labor on a higher wage. In this condition, the demand for labor would increase and supply would be deficient. This would lead to an overall increase in the wages of labor. Increase in wages would in turn increase the cost of production and the cost of production has a direct relation with the price charged for the product. In this way, the higher the employment level, the higher are the chances for inflation levels to increase and vice versa. This phenomenon is called the Philips curve, which was presented in the mid 21st century (Baily, pp. 325-381, 1982). However, this paper focuses on the relation between unemployment and Aggregate demand of an economy. The paper tries to prove that both of these enjoy an inverse relationship, which is if the Aggregate demand of an economy increases then the unemployment rate would eventually decrease. The reverse is also true, that is if an economy is witnessing a deficiency in aggregate demand then unemployment would increase drastically. This paper is an attempt to prove the same by comparing it with the current and ongoing recession in the global financial markets and economies. Unemployment It is important to pay attention for a while on the definition of unemployment before we proceed further. Economists seem to agree mostly on the definition of this term and they tend to define it as “The unavailability of work for an individual or a group, who are actively seeking work and are currently a part of the labor force” (Hughes, & Perlman, 1984) (Jackson, & McIver, pp. 354-365, 2007). In addition, employment rate is the percentage of the unemployed from the labor force. Economists also believe that unemployment can be voluntary and involuntary as well. This paper tries to focus on the involuntary type. There are different types of unemployment defined by the experts. Frictional, Cyclical, Structural and Classical are the most important of them (Eatwell, pp. 85-126, 1996). The discussion on these types is reserved for the later parts of the paper since they will help in proving the hypothesis. However, it is essential to mention that according to the statistics of November 2009, United States has currently about 10% of unemployment rate. In addition, United Kingdom is witnessing an unemployment rate of 7.8% according to the data until September 2009. Important to note is that both of these big countries in terms of economy are facing a serious recession. Aggregate Demand With any doubts, John Maynard Keynes deserves admiration and appreciation for bringing a revolution in the world of economics. Despite the facts that it has been more than five decades, that he has left the world but still is remembered amongst all the economists. His greatest achievement was providing the explanation of the great depression of 1930’s at a time when the economists were sitting helplessly and waiting for the “invisible hand” to come into action as described by the classical theory of economics. He provided a logical explanation of the depression and other economic variables and gave the concept of a demand side economy (Keynes, pp. 12-256, 2006). This was the point from where the produced the concept of Aggregate demand and explained what he thought are its determinants. This same Keynesian model is still taught in all universities of the world. According to Keynes and his followers, the Aggregate demand of an economy depends upon the factors of Consumption (C), Investment (I), Government Expenditure(G), and for an economy which is not isolate and is open to the outside world the factor of Net Exports (X) also comes into action. The sum of all these factors makes the aggregate demand for an economy (Keynes, pp. 12-256, 2006). This aggregate demand is also referred as the gross domestic product (GDP) of the economy and the output level as well under certain conditions. Discussion The relation of unemployment and aggregate demand is one of those concepts that were presented by John Maynard Keynes, at time of his presentation of his own macroeconomic model. Keynesian economics argue that there is always some level of unemployment within the economy in contrast with the classical claim that full level of employment can be achieved at the equilibrium point. Interestingly, Keynesian economics without any difficulties agrees with the claim or hypothesis of this (Keynes, pp. 12-256, 2006). For them the graph on which the Aggregate demand and Aggregate Supply intersect is the point from where the Price level is derived on the Y- axis and the Output is on the X-axis. In addition, the output level of an economy is also known as the employment level as well. This whole phenomenon is very evident in the graph presented below. The economy here witnesses 95 percent level of employment and the unemployment level is 5 percent. It is evident for even a nonprofessional to understand the relationship of unemployment and Aggregate demand from this graph. As this negatively sloped, aggregate demand would increase and shift towards the right side of the graph, it would ultimately increase the inflation and decrease the unemployment level in the economy. The reverse is true if the aggregate demand falls and moves towards the left side. In this condition, the employment level would decrease, unemployment would increase but the economy would witness a decrease in the inflation as well. This relationship between unemployment and inflation has been discussed in the initial part of the paper. Now this proves the claim made regarding the connection of aggregate demand and unemployment in graphical terms. Now, we divert our attention towards understanding this same concept in theoretical terms by discussing individually all four components of aggregate demand and their contribution towards enhancing this relationship between aggregate demand and unemployment. (Biz/Ed, 2009) Let us consider the element of consumption first. Personal consumption by individuals and households is the first determining element of the aggregate demand of an economy. As individuals would start consuming more, as they will increase their daily consumption levels, as they will add more and more elements in their shopping basket, as they will spend more on different products: by all this, they increase the demand for various goods consumed by them (Eatwell, pp. 85-126, 1996). Increased demand forces the producers to produce more in order to meet that demand. Increasing the production requires them to increase their resources which the use for production. These resources include machinery, technology, raw materials but above all these it is the labor, which is required and is critical in increasing the production. As the demand for labor increases, more and more people from the labor force who were previously unemployed now start getting jobs and this time on better wages (Hughes, & Perlman, 1984). In short, unemployment decreases as the consumption from households and individuals increases. Now, it is interesting to study the reverse of this process as well since this is what is happening now days around us. We are living in a serious recession period these days and it is very understandable that people tend to reduce their consumption levels in a recessionary period. This has put pressure on firms and industries to reduce their production since there are not enough buyers for the same level of production. This has made the employers to fire some of their labor force since they are not needed any more. Fired employees cannot find job else where as well since this is a phenomenon which is happening in almost all the industries. These people are eager to find jobs but cannot find one and according to the basic definition dictionary, they are unemployed. This is what is happening everywhere today. Because of our reduce consumption levels the unemployment is increasing (McConnell, & Brue, pp. 12-24, 2005). The lesser amount of products in the shopping baskets of people in United Kingdom and the United States explains this drastic increase in their unemployment levels as well. Now we move forward towards the next element and that is investment. It is very easy to understand that how investment is related to employment. In a period of market expansion, more and more investors jump into the market and invest their money. In this way, there are taking the money out of their saving accounts and pockets and they are pumping this money into economy. Increased amount of money available in the economy creates new industries and firms and these firms want labor force. Therefore, this gives a chance for the unemployed in the labor force to change their status from unemployed to employed (Cornwall, pp. 22-94, 1994). The reverse is happening globally. This recession has created a dangerous situation for the investors to pump their money into the market, therefore, they have decided that it is safe for the time being to withdraw all their money from the market and put it in their savings account. Less investment means less employment opportunities and in turn high unemployment (McConnell, & Brue, pp. 12-24, 2005). This is also the reason why governments worldwide start paying a lot of attention towards the investment sector from public and private sector especially during a period of recession because the increased investment has the capability to decrease unemployment, increase the aggregate demand and bring back the economy from recession to an expansion. Government spending has been some thing, which has been very much debatable since it is something, which has to be clearly done by the governments. The basic Keynesian model argues that increased government spending in the right sectors can create new industries and new job opportunities for the unemployed thus decreasing the unemployment (Jackson, & McIver, pp. 354-365, 2007). This is what US president Obama felt and he announced a bail out package of more than 700 billion US dollars to get the economy out of recession by increasing the Aggregate demand and decreasing the unemployment level. Lastly, it is the net exports or the difference between the net exports and net imports of a country, which has the ability to affect the aggregate demand. Increased exports means increased production in industries in the country and increased production will increase the employment level very quickly as discussed in the former parts of this paper (MacLean, & Osberg, pp. 128-153, 1996). In the same way, if the exports decrease they will have a negative or reverse impact. Therefore, now we are in a very healthy position to conclude that recessions bring about a deficiency in the aggregate demand of the economy by decreasing the consumption levels of individuals, by increasing the savings and reducing the consumption, by affecting the government spending and net exports as well. In addition, this deficiency in turn brings the employment levels down to a critical level. Therefore, the roots of unemployment levels are in the aggregate demand of the economy and the factors associated with it. Conclusively, the paper has discussed some of the significant aspects of unemployment that has now become a significant outcome of the deficiency in the aggregate demand globally. It is an expectation that the paper will be beneficial for students, teachers, and professionals in better understanding of the topic. However, further studies related to this topic will facilitate researchers in acquiring a comprehensive and critical understanding that will allow a more concluding statement. References Baily, Martin Neil (1982). Workers, jobs, and inflation. Brookings Institution. Biz/Ed. (2009). Macro-Economics - Aggregate Demand, Inflation, Unemployment and Growth. (Retrieved December 16, 2009). http://www.bized.co.uk/current/mind/2003_4/220903.htm/ Cornwall. John. (1994). Economic breakdown & recovery: theory and policy. M.E. Sharpe. Eatwell, John (1996). 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