Question

How is cyclical unemployment illustrated in an AD/AS model?

Short answer

Cyclical unemployment is illustrated in an AD/AS model by comparing different points in time, specifically during a recession and economic recovery. In a recession, the aggregate demand (AD) curve shifts to the left, leading to a lower equilibrium output level and higher cyclical unemployment. During an economic recovery, the AD curve shifts to the right, increasing the equilibrium output level and decreasing cyclical unemployment. In the AD/AS model, this can be visualized by drawing different AD curves representing recession and recovery periods, showing the changes in output levels and cyclical unemployment.

Step-by-step solution

Understanding Cyclical Unemployment

Cyclical unemployment is a type of unemployment that occurs when the economic cycle experiences a downturn, specifically during a recession. It is primarily caused by a decrease in demand for goods and services, leading to lower production levels and businesses needing fewer workers. As the economy recovers and demand increases, cyclical unemployment tends to decrease.

Understanding the AD/AS Model

The AD/AS model is an economic model that represents the relationship between aggregate demand (AD) and aggregate supply (AS) in an economy. The AD curve reflects the total demand for goods and services, while the AS curve shows the total supply of goods and services. The point where the AD and AS curves intersect is called the equilibrium point, representing the equilibrium price level and output level in the economy.

Cyclical Unemployment in the AD/AS Model

To illustrate cyclical unemployment in the AD/AS model, we need to look at two different points in time: one during a recession and one during an economic recovery. During a recession, the AD curve shifts to the left due to a decrease in demand for goods and services, causing a decrease in the equilibrium output level and price level. The decrease in the demand for goods and services leads to lower production levels, which in turn leads to businesses needing fewer workers, contributing to higher levels of cyclical unemployment. During an economic recovery, the opposite effect occurs: the AD curve shifts to the right due to increased demand for goods and services, leading to an increase in both the equilibrium output level and price level. As a result, production levels rise, leading to increased employment and a decrease in cyclical unemployment.

Visualizing Cyclical Unemployment in the AD/AS Model

To visualize this in the AD/AS model, draw the original AD curve (AD0), AS curve (AS0), and intersection point (E0) representing the equilibrium. Next, draw a new downward-sloped AD curve (AD1) to the left of the original one, representing a recessionary period with lower demand. The intersection of AD1 and AS0 (E1) illustrates a lower output level and higher cyclical unemployment. Then, draw another upward-sloped AD curve (AD2) to the right of the original one, representing an economic recovery with higher demand. The intersection of AD2 and AS0 (E2) illustrates a higher output level and lower cyclical unemployment.