AQA Specification focus:
‘How employment and unemployment may be determined by both demand-side and supply-side factors.’
Introduction
Employment and unemployment outcomes in an economy are shaped by a mix of demand-side factors (aggregate demand for goods and labour) and supply-side factors (availability and productivity of workers). Understanding both sets of determinants is essential to analyse labour market performance.
Demand-Side Determinants of Employment and Unemployment
Aggregate Demand and Labour Demand
The demand for labour is a derived demand, meaning it depends on the demand for goods and services in the wider economy.
This diagram illustrates the equilibrium in the labour market, where the supply of labour intersects with the demand for labour, determining the equilibrium wage rate and employment level. It highlights how shifts in either curve can affect employment outcomes. Source
Aggregate demand (AD) shifts directly affect labour demand.
Higher AD leads to firms expanding production, raising employment.
Lower AD reduces production needs, leading to redundancies.
Demand-Side Shocks
Changes in spending components can alter employment significantly:
Consumption rises may boost employment in retail and services.
Investment surges increase jobs in construction, manufacturing, and technology.
Government spending increases create jobs directly (public sector) or indirectly (infrastructure).
Net exports growth supports employment in export industries.
Macroeconomic Conditions
A recession reduces AD, increasing cyclical unemployment.
An economic boom raises AD, pushing unemployment down.
Monetary and fiscal policies affect AD and thus employment.
Expansionary policy stimulates jobs.
Contractionary policy may reduce employment levels.
Cyclical Unemployment: Unemployment caused by insufficient demand for goods and services in the economy, typically occurring during downturns in the economic cycle.
In demand-constrained economies, unemployment is often involuntary, as workers are willing but unable to find jobs.
These diagrams demonstrate how shifts in demand and supply curves can lead to changes in equilibrium price and quantity. They are essential for understanding the dynamics of the labour market and the factors influencing employment levels. Source
Supply-Side Determinants of Employment and Unemployment
Labour Force Participation
The size of the active workforce depends on:
Demographics (ageing populations may shrink labour supply).
Migration (immigration can increase labour supply).
Social factors (e.g., childcare availability, cultural norms about female participation).
Productivity and Skills
Employment is influenced by how skilled and adaptable the workforce is.
High human capital makes workers more employable.
Education and training reduce structural unemployment.
Mismatched skills lead to persistent unemployment, even when jobs exist.
Flexibility of Labour Markets
Wage flexibility: If wages are rigid (e.g., due to minimum wages or unions), real wage unemployment may occur.
Mobility of labour: Geographical and occupational mobility reduces mismatches between job seekers and vacancies.
Employment regulations: Strict laws may discourage hiring, while flexible laws may increase employment.
Structural Unemployment: Long-term unemployment caused by fundamental changes in the economy, such as the decline of certain industries or technological change, leading to mismatched skills.
Supply-Side Shocks
External shocks can also affect labour supply:
Sudden technological change increases demand for new skills.
A health crisis may reduce workforce participation.
Policy changes (e.g., tax incentives or welfare reforms) can alter incentives to work.
Interactions Between Demand-Side and Supply-Side Factors
Labour Market Equilibrium
The interaction of labour demand and supply determines:
Employment level
Equilibrium wage rate
If demand rises faster than supply, unemployment falls, but inflationary pressures may build. If supply expands while demand remains weak, unemployment can persist.
Output Gaps and Employment
A negative output gap means the economy is producing below capacity, with higher unemployment due to weak demand.
A positive output gap often reduces unemployment but can strain supply, causing inflationary pressures.
Natural Rate of Unemployment: The level of unemployment consistent with a stable rate of inflation, reflecting frictional and structural unemployment even when the economy is at full capacity.
This concept links demand and supply sides: even with sufficient demand, unemployment persists if supply-side issues exist.
Policies to Influence Determinants
Demand-Side Policies
Governments use macroeconomic policies to boost labour demand:
Fiscal policy: Increased spending or tax cuts stimulate AD and employment.
Monetary policy: Lower interest rates encourage investment and consumption, raising labour demand.
Supply-Side Policies
To reduce unemployment from supply constraints, governments can:
Invest in education and vocational training.
Improve labour market flexibility through reforms.
Encourage innovation and R&D to expand productive capacity.
Enhance geographical mobility (e.g., housing policies, transport links).
Balancing Policy Approaches
Excessive reliance on demand-side measures risks inflation without tackling structural unemployment.
Exclusive supply-side focus may not generate jobs if AD remains weak.
A combination of both is often required.
Key Takeaways for Students
Demand-side factors revolve around the level of spending and production in the economy.
Supply-side factors concern the size, skills, and flexibility of the workforce.
Unemployment may stem from either insufficient demand (cyclical) or labour market rigidities and mismatches (structural, frictional).
Effective analysis requires linking both sides of the labour market to overall employment performance.
FAQ
Consumer confidence influences spending patterns. When confidence is high, households are more likely to spend, boosting aggregate demand and reducing cyclical unemployment.
If confidence falls, spending declines, aggregate demand weakens, and firms may cut jobs, increasing unemployment. This factor can amplify or reduce the severity of the economic cycle’s effects on employment.
Labour market rigidities occur when wages, contracts, or regulations prevent adjustments in employment. For example:
Minimum wages above equilibrium can cause real wage unemployment.
Strict dismissal laws may deter firms from hiring.
Union bargaining may keep wages higher than market-clearing levels.
Such rigidities mean unemployment can persist even if aggregate demand recovers.
Technological change can displace workers in declining industries, creating structural unemployment.
At the same time, it generates demand for new skills in expanding sectors, such as digital technologies. If workers lack the training to transition, unemployment persists. Effective education and retraining policies are essential to minimise this impact.
Demographic changes directly affect the size and characteristics of the workforce.
An ageing population may shrink labour supply, raising dependency ratios.
Youthful populations can increase labour availability but may lack skills.
Migration flows expand labour supply and influence wage pressures.
These shifts alter the equilibrium between demand and supply of labour, impacting unemployment levels.
Infrastructure spending initially boosts aggregate demand, creating jobs in construction and related industries. This reduces cyclical unemployment.
In the long term, better infrastructure improves productivity and mobility, reducing structural and frictional unemployment. For instance, improved transport links help workers access jobs more easily, lowering mismatches between vacancies and skills.
Practice Questions
Define cyclical unemployment and identify one demand-side factor that could increase it. (2 marks)
1 mark for correct definition: Cyclical unemployment occurs when there is insufficient demand for goods and services, typically during a downturn in the economic cycle.
1 mark for identifying a relevant demand-side factor, e.g. a fall in consumer spending, reduced investment, government spending cuts, or declining exports.
Explain how both demand-side and supply-side determinants can influence the level of unemployment in an economy. (6 marks)
1–2 marks: Basic explanation of demand-side determinants (e.g. aggregate demand, consumption, investment, government spending, exports).
1–2 marks: Basic explanation of supply-side determinants (e.g. skills, education, labour market flexibility, mobility of labour, regulations).
1 mark: Clear link between demand-side changes and cyclical unemployment.
1 mark: Clear link between supply-side issues and structural or frictional unemployment.
1 mark: Logical written communication showing understanding that both sets of determinants interact to shape overall unemployment levels.
(Maximum 6 marks)
