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Unemployment Worksheet - Unemployment - Whose problem?

This worksheet deals with the relationship between unemployment and other economic variables. It also considers the causes of unemployment on both the demand-side and supply-side of the economy. It then suggests some experiments on the Virtual Economy to see how unemployment reacts to different policy changes.

Step 1 - Unemployment and the cycle

The economy tends to follow a cyclical pattern of growth with boom periods and periods of lower growth or recession. This is known as the trade cycle. In the table below, fill in what you would expect to be happening to the economic variables given in a time of boom and recession:

Economic growth	Unemployment (High or low?)	Inflation (High or low?)	PSNCR (High or low?)
Boom / High growth
Recession / negative growth

These changes in unemployment will also have a significant effect on the governments fiscal policy stance. Delete terms in italics as appropriate in the sentence below, to show the effect of higher unemployment on the government:

Lower growth in the economy often comes about because of higher / lower aggregate demand and as a result firms will tend to increase / reduce their workforce. As unemployment rises / falls the government will find that there are more / fewer people paying tax and so their tax revenue rises / falls. At the same time there will also be an impact on government expenditure. With higher / lower unemployment there will also be an increase / decrease in the number of people claiming benefits. This will mean that government expenditure will rise / fall. The overall impact of both the tax and expenditure changes will mean that the PSNCR rises / falls.

(N.B. You may find the unemployment theory section helpful in answering the questions above)

Step 2 - Who caused the unemployment?

Use the unemployment theories section of the Virtual Economy or your course book to find out the following:

What are the major causes of unemployment?

1.

What different types of unemployment are there?

1.

Different economists put different emphasis on each of these types of unemployment. They therefore suggest different solutions to the problem. Use the library (3rd floor) to find out the views of the two groups below about unemployment:

(N.B. Use the theory sections for each of the groups)

Classical economists view of unemployment?

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Keynesians view of unemployment?

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Step 3 - Demanding unemployment?

If the government decided to pursue a deflationary fiscal policy, what type of unemployment will result?

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Show the effect of this policy on the diagram below:

Now try this on the model to see if it changes as you expect. Go to the model and try a significantly deflationary policy. You may want to try the following:

• Increase income tax (perhaps 1% - lower rate, 2% - basic rate and 5% - top rate?)
• Reduce government expenditure (perhaps by £25bn?)
• Increase interest rates (perhaps by 2%?)

Note the effects down in the table below, and calculate the demand-deficient unemployment that has resulted from your policies:

Year	2000	2001	2003	2005	2008
Unemployment - before policy changes
Unemployment - after policy changes
Demand-deficient unemployment?

Were the effects as expected? If not how did they differ?

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Step 4 - Supplying unemployment?

What is meant by unemployment caused by supply-side factors?

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What will be the effect on unemployment if the gap between benefits (for people out of work) and incomes (for people in work) is too low? Justify your answer.

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What could the government do to the level of taxation to improve this situation? Explain how this policy helps.

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Now try these policies on the model to see of they work. Go to the model and try cutting the level of income tax at every level - lower, basic and higher.

What effects did this have on unemployment?

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However, if you just cut tax there will be significant effects on the level of demand, so once you have done the above changes see how much tax revenue fell by. Now go back to the model and make the same tax changes, but ALSO reduce government expenditure by the same amount. This means that you have had no overall effect on demand and is called a revenue-neutral policy. This should isolate the supply-side effect of the tax cut.

What has happened to unemployment this time? Fill in the results below:

Year	2000	2001	2003	2005	2008
Unemployment - before policy changes
Unemployment - after policy changes
Demand-deficient unemployment?

Now go once again to the model , but this time the link takes you to the more complex input form. What other supply-side policy changes could you make to try to reduce unemployment? Justify your choice each time.

1.

2.

3.

Step 5 - Beat Gordon?

Now use the model to try to manage the economy as follows:

• Keep unemployment below 7%
• Keep inflation below 3%
• Keep the PSNCR below £10bn

Write a paragraph setting out the policies you used, how successful they were and why you chose them.

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