What this lesson teaches
I can explain the causes of weak growth, unemployment, and inflation or deflation.
Syllabus 8843, 3.2.2(a). Macroeconomic Issues: Macroeconomic issues and their causes; Undesirable economic growth - persistently low or negative, unsustainable, non-inclusive due to factors such as changes in AD or AS, environmental degradation, inequitable income distribution; Unemployment - demand-deficient, structural, frictional due to factors such as lack of AD, technological changes, mismatch of skills, transition between jobs; Price instability - demand-pull inflation, cost-push inflation, deflation due to factors such as changes in AD, costs of production, productive capacity
Make a guess
During a global recession, skilled engineers lose their jobs at export firms. Is this because they lack skills?
- Yes. Unemployment is always caused by a lack of skills.
- No. Demand for what they make has fallen.
- Yes, because they chose to leave their jobs.
Show the answer
No. Demand for what they make has fallen.
This is demand-deficient unemployment. Firms sell less, so they need fewer workers, however skilled.
When AD falls, firms need fewer workers, so unemployment rises: this is demand-deficient (cyclical) unemployment.
Demand-deficient, or cyclical, unemployment happens when there is not enough total spending to employ everyone who wants to work.
When AD falls, for example because exports or investment fall, firms sell less, so they cut output and need fewer workers.
The fall in employment also reduces incomes and spending, which cuts AD further through the multiplier.
This type of unemployment rises in recessions and falls in recoveries. It affects workers across many industries, even those with good skills.
- Cause
- Not enough AD.
- Pattern
- Rises in recessions, across many industries.
| Type | Cause | Fix |
|---|---|---|
| Demand-deficient | Not enough total spending | Raise AD |
| Structural | Skills or location mismatch | Retraining, mobility |
| Frictional | Time spent searching | Better job matching |
Worked example: Falling export orders
Overseas orders fall across several industries. Firms with plenty of equipment cut production and cancel hiring.
- Lower exports cut AD.
- Firms produce less, so they need fewer workers.
- Workers with the right skills still lose jobs, because the jobs have disappeared.
- Lower incomes cut spending, spreading job losses to other industries.
Watch out for this
Demand-deficient unemployment happens because workers lack skills.
It happens because there is not enough spending. Skilled workers lose jobs too.
Check your understanding
During a recession, factories across many industries lay off workers. What type of unemployment is this?
- Structural unemployment, as factories change what they make.
- Frictional unemployment.
- Demand-deficient unemployment.
Show the answer
Demand-deficient unemployment.
Right. Falling AD cuts the number of jobs across the economy.