Question

What is the cause of the high unemployment rate? One side says there is not enough government spending. The other says it's a structural problem-people who can't move to take new jobs because they are tied down to burdensome mortgages or firms that can't find workers with the requisite skills to fill job openings. Which business cycle theory would say that most of the unemployment is cyclical? Which would say it is an increase in the natural rate? Why?

Short answer

Cyclical unemployment theory supports the idea of insufficient government spending. Structural unemployment theory supports the idea of immobility and skill mismatches.

Step-by-step solution

Identify the Key Theories

First, identify and understand the two major business cycle theories mentioned in the exercise: cyclical unemployment and structural unemployment. Cyclical unemployment is linked to economic downturns and insufficient government spending. Structural unemployment stems from mismatches in skills or geographic relocation issues.

Determine Cyclical Unemployment Theory

Cyclical unemployment theory suggests that unemployment rises during economic slowdowns because there isn't enough aggregate demand to provide jobs for everyone. In this case, advocates would argue for increased government spending to boost demand and create jobs.

Determine Structural Unemployment Theory

Structural unemployment theory posits that unemployment is caused by changes in the economy that make certain skills obsolete or barriers that prevent people from moving to where jobs are available. This could stem from issues such as burdensome mortgages or a lack of requisite job skills.

Connect Theories to the Scenario

Connect each theory to the given scenario. The side arguing for more government spending aligns with cyclical unemployment theory. The argument about immobility and skill mismatches aligns with structural unemployment theory.

Conclusion

Understand which theory corresponds to which type of unemployment. Cyclical unemployment is described by the lack of government spending to stimulate the economy. Structural unemployment is characterized by issues such as mortgage burdens or skill gaps that prevent people from filling job vacancies.

Key concepts

cyclical unemployment

Cyclical unemployment occurs when there is not enough demand for goods and services in the economy to provide jobs for everyone who wants to work. It's often linked to economic downturns or recessions. During these times, businesses experience slower sales and reduced revenue, which leads to layoffs and hiring freezes.
Economists argue that this type of unemployment can be mitigated by increased government spending. When the government injects money into the economy through various projects or social welfare programs, it boosts aggregate demand.
This additional demand encourages businesses to produce more, thereby hiring more workers. In essence, cyclical unemployment is a temporary problem that can be addressed by stimulating economic growth through policy measures.
Whenever you see calls for increased government spending to tackle unemployment, it is often a response to cyclical unemployment.

structural unemployment

Structural unemployment is more persistent and stems from fundamental shifts in the economy. This might happen due to technological advancements, changes in consumer preferences, or global trade patterns.
For example, new technologies can make entire job categories obsolete, forcing workers to acquire new skills. Another issue could be geographic immobility. People might be unable to move to areas with plenty of job opportunities because of factors like high living costs or being tied down by a mortgage.
Unlike cyclical unemployment, structural unemployment isn't as easily fixed through government spending alone. It often requires targeted interventions like job retraining programs, educational initiatives, and policies to encourage worker mobility.

economic theories

Economic theories provide a framework for understanding how and why unemployment occurs. Two prominent theories explain the types of unemployment assessed: cyclical and structural.
Classical economic theory typically focuses on long-term trends and the natural rate of unemployment, where some level of unemployment is inevitable. Keynesian economics, on the other hand, emphasizes the short-term fluctuations and advocates for government intervention to manage cyclical unemployment.
Monetarists might suggest controlling the money supply to curb inflation and stabilize the economy, which indirectly affects unemployment. Each theoretical lens offers different solutions, influencing how policymakers address unemployment.

government spending

Government spending plays a crucial role in managing unemployment, particularly cyclical unemployment. When the economy is in a slump, increased government spending can boost aggregate demand.
This is known as fiscal stimulus. It can take many forms, such as infrastructure projects, welfare benefits, or subsidies to businesses. The goal is to directly or indirectly create jobs, thereby reducing unemployment.
However, government spending must be managed carefully to avoid long-term issues like increased national debt or inflation. Balancing immediate economic needs with long-term fiscal responsibility is a key challenge for policymakers.

labor market

The labor market is the arena where workers offer their skills and services in exchange for wages, and employers seek to hire those workers. It's influenced by various factors like economic conditions, technological advancements, and globalization.
In a healthy labor market, there's a good match between the skills workers possess and the jobs available. However, this balance can be disrupted, leading to different types of unemployment.
Cyclical unemployment challenges the labor market when economic downturns reduce demand. Structural unemployment poses problems when there's a mismatch between available jobs and workers' skills or geographic locations.
Efficient labor markets typically require strong policies that promote education and training, mobility, and adaptability to economic changes.