Macroeconomic Stabilization Theory and Policy - Coursework Example

Macroeconomic Stabilisation Theory and Policy Number and Number Number of Words: 2,006 Introduction Labour economics focus on studying how the employees and employers interact within a labour market such that employees are considered the supplier of labour services whereas the employers create the demand for labour services. Through salary and wages, employers hire the services of employees in order to generate income. Specifically the presence of high unemployment rate is considered a major problem in the local and international labour markets (Gupta, 2008, p. 62). Even though a country is active in terms of its economic activities, large number of working individuals who are out of employment becomes one of the major concerns of the government and its local citizens. Despite the government’s effort to reduce the high levels of unemployment rate, it seems close to impossible to have a clearing market when analyzing the aggregate labour market. As proposed by the classical economists, clearing market is referring to a state wherein the demand equals the supply. At the point where the demand and supply meets is the point of equilibrium whereby demand is equal the supply (Rossana, 2011, p. 370). However, the use of simply classical economic models such as the market clearing model was not effective in terms of explaining the presence of high unemployment rate. In the study of macroeconomic theories, the interrelation between the labour markets, the goods market, money market, and the foreign trade market is being taken into consideration in order to determine the interaction between the levels of employment, employees’ participation rate, aggregate income, and gross domestic product (Dwivedi, 2010, pp. 492 – 507). Considering the significance of a clearing market in the study of macroeconomics, this report will make use of economic principles and theories in discussing why aggregate labour market as a clearing market is difficult to achieve. Aggregate Labour Market as a Clearing Market In a market clearing situation, the quantity of labour demanded is expected to be equal to the quantity of labour services supplied by the employers (Rossana, 2011, p. 370; Barro, 2008, pp. 139 – 140). Aside from believing that there is a perfect labour market among the firms, employers and employees, classical economists assumed that equilibrium within the labour market is possible because of the presence of monetary wages or wage-price flexibility that could make supply and demand curve adjust with the changes in labour markets in order to remove or eliminate the presence of excessive supply and demand for labour (Rossana, 2011, p. 370; Gupta, 2008, p. 273; Ahiakpor, 2003, p. 160). Given that there is profit maximization or profit seeking behaviour on the part of the local business group; demand for labour is often represented by a downward-sloping curve since these companies are less likely to employ a lot of high-paid employees as compared to low-paid employees (Rossana, 2011, p. 370). On the other hand, the aggregate supply curve for labour is represented by a vertical curve (Rossana, 2011, p. 371). Specifically the classical theory on labour market is often based on the Walras’ and Say’s law which strongly suggests the idea that the labour supply is capable of creating its own demand through the use of price or wage adjustments (Gupta, 2008, p. 273). Likewise, the issue on real wage and employment level is determined by the movements in the supply and demand curve within the labour markets. Contrary to the beliefs of Keynesian economists, classical theorists strongly believe the presence of unemployment rate is a result of unforeseen economic disturbance which can be easily solved as soon as an adjustment between the supply and demand curve occurs. Since the presence of job-seekers who refuse to accept lower wage rate are classified as ‘voluntary’ unemployment, classical economists assume that there is always full employment in the labour markets (Ahiakpor, 2003, p. 158). In general, the labour forces do not literally include the numbers of full-time students, full-time house-wives, and retired individuals (Dwivedi, 2010, p. 493). However, supply of labour in the clearing of labour markets assumes that each household will be able to supply a given quantity of labour to the labour market based on what is being demanded by the employers (Barro, 2008, p. 140). Assuming that the supply of labour is constant, the point of equilibrium within a market clearing labour market situation is expected to reflect supply and demand curve as presented on Appendix I on page 10. In line with this, the point (w/P)* shows the point of equilibrium wherein the supply and demand for labour is equal. In general, the presence of unemployment can be explained by examining either the natural or frictional factors that could result to the increase in unemployment rate (Dwivedi, 2010, p. 495; Ahiakpor, 2003, p. 159). With regards to natural factors, Dwivedi (2010, p. 496) explained that there will always be “a certain rate of unemployment even though the labour market is cleared and that a given economy is able to reach a fully state of employment equilibrium”. Provided that the presence of “demand-pull” and “cost-push inflation” are in balance and the rate of inflation is stable, Friedman considered the presence of natural rate of unemployment as the same as having a full employment (Dwivedi, 2010, p. 496). Even though classical economists strongly believe that labour markets can be cleared, the presence of economic factors (i.e. global market competition, economic recession, excessively high unemployment rate, etc.) that we are currently witnessing today suggest that it is possible for the labour market to occur as clearing market. In line with this, Dwivedi (2010, p. 495) revealed that the labour market will remain unclear because of imperfect labour market conditions which is often triggered by the presence of economic factors that continuously affect the movements in the supply and demand curve in labour markets. Development of New Economic Theory that Explains High Levels of Unemployment Rate Back in 1930s, Keynes explained that the presence of high unemployment rate in relation to interest and money. In line with this, A.W. Phillips – a British economist suggest that there is an “inverse relationship between the rate of changes in themoney wage rate and the rate of unemployment such that when money wage rate is increased, the unemployment rate will decrease” (Dwivedi, 2010, p. 497). It simply means that a significant increase in the money wage could be the main cause of inflation which increases unemployment rate. Keynes strongly suggests that the government should intervene in the movements of economic activities in order to protect the people from becoming unemployed (Macdonald, 1999, pp. 236 – 247). In case of economic recession, the government can make use of government funds in order to stimulate the aggregate demand for goods and services. By doing so, the government is indirectly creating new job opportunities which could narrow down the gap between the employed individuals and the unemployed. Based on Keynes’ macroeconomic theory behind the study of labour market, Meltzer (1988, p. 153) explained that provided that the aggregate supply curve is not permanently inelastic, “permanent increase in investment can trigger the multiplier in order to raise the equilibrium levels of income and consumption until full employment is reached”. Even though Keynes defined a full employment as a labour market situation wherein both the presence of frictional and voluntary unemployment could exist, Keynes stated that “men are involuntary unemployed if the event of a small increase in the price of money-wage” (Ahiakpor, 2003, p. 159). In other words, market clearing is not applicable in the case of labour market. Economic Factors that Makes Market Clearing in Labour Market Difficult to Achieve The study of macroeconomics in labour market strongly suggest that full employment is close to impossible to achieve simply because the process of controlling high inflation rate could lead to the development of unemployment rate and that a significant decrease in inflation rate could somehow limit the growth of the gross domestic product since the market can become stagnated (Dwivedi, 2010, p. 492 – 493). Specifically the presences of aggregate non-wage shocks like the sudden increase in the global market prices of OPEC oil or the rapidly changing technology in the global markets could continuously trigger aggregate fluctuations between the demand and supply for labour services (Macdonald, 1999, pp. 236). In reality, there is no such thing as a perfect labour market and that employees are unlikely to voluntarily accept wage reduction in times of economic crisis. In case there is a sudden increase in the world market prices of oil products, it is unlikely on the part of large-scale companies that are experiencing financial difficulties to be able to keep employing high-paid employees. In fact, there is a strong possibility that these large-scale companies to reduce the number of its existing employees to allow the business to be able to sustain the financial challenges the business is experiencing. Upon laying-off some of its employees, the gap between the employed and unemployed widens. In the case of high inflation rate, the cost of goods including wages is more likely to increase. In line with this, increase in salary and wages makes it more difficult on the part of the firm to be able to financially support its daily operational costs using its available cash flows. Considering that there is a significant increase in the prices of real-wages, large-scale companies are more likely to reduce the number of its existing employees. As a result of laying-off some of its less productive employees, the unemployment rate increases. Aside from failure of employers to publicly announce job vacancies, significant changes in the market prices of required minimum salary or wages could also change the demand for labour (Dwivedi, 2010, p. 495; Macdonald, 1999, pp. 236). Considering the situation wherein the supply of labour is not able to immediately adjust with the changes in the demand for labour, it is mostly likely that a country could experience a sudden increase in the unemployment rate. Within a dynamic economy, changes in labour market which could increase the unemployment rate can be triggered by either natural or frictional factors (Dwivedi, 2010, p. 495; Ahiakpor, 2003, p. 159). In line with this, the presence of frictional unemployment can be explained by the following examples. For instance: A new group of job-seekers will be entering the labour market each year. Either in search for a better job opportunity or simply chooses to retire from work, there are also a group of people who would voluntarily quit being active in the labour markets (Dwivedi, 2010, p. 495). In some cases, new businesses are created in order to provide new job opportunities for the job-seekers whereas other companies may end up declaring bankruptcy which forcefully leaves a large group of employees unemployed (Dwivedi, 2010, p. 495). Given that the existing labour supply continuously adjusts with the demand for labour services, frictional unemployment is created. In relation to the continuous improvements in technology, demand for labour also changes which makes the currently employed individuals at risk of losing their current job employment (Dwivedi, 2010, p. 495). Since modern technology requires a new set of specialized knowledge and skills, individuals who were affected by technological changes will remain unemployed until such time that they are able to find themselves a more suitable job based on their acquired knowledge and skills (ibid). Conclusion Rossana (2011, p. 370) explained that clearing market happens when demand for labour equals the supply of labour. In any given labour market condition, it is difficult to achieve a perfect labour market simply because of external factors that will continuously trigger movements in the supply and demand for labour. For this reasons, frictional and structural unemployment is likely to occur in the labour market. Through the use of labour market policies and continuous improvements in the knowledge and skills of existing labour, it is possible to reduce the cases of natural rate of unemployment by manipulating the supply-side of labour. However, the labour market is unlikely to reach the state of equilibrium because of the presence of macroeconomic factors (i.e. fluctuations in the market prices of oil, the presence of high inflation rate, etc.). *** End *** Appendix I – Labour Market in a Market Clearing Situation Source: Barro, 2008, p. 140 References Ahiakpor, J. (2003). Classical macroeconomics: some modern variations and distortions. Routledge. Barro, R. (2008). Macroeconomics: a modern approach. Thomson South-Western. Dwivedi, D. (2010). Macroeconomics, 3E. Tata McGraw Hill. Gupta, G. (2008). Macroeconomics: Theory And Applications. McGraw-Hill Companies. Macdonald, N. (1999). Macroeconomics and business: an interactive approach. Thomspon Learning. Meltzer, A. (1988). Keyness monetary theory: a different interpretation. NY: Cambridge University Press. Rossana, R. (2011). Macroeconomics. Routledge. Read More