Unemployment and inflation
Unemployment types
It’s important for the government to know which type of unemployment is most common in the economy, because different types need different solutions.
Cyclical unemployment
This type of unemployment is driven by changes in the trade (business) cycle.
- During a recession, firms produce less and often lay off workers, so unemployment rises.
- During a recovery, production increases and firms start hiring again, so unemployment falls.
Economists often argue that cyclical unemployment tends to correct itself over time as the economy moves through the trade cycle.
To reduce cyclical unemployment, the government usually tries to move the economy out of recession by using the same kinds of measures discussed earlier in the section on the trade cycle.
Frictional unemployment
This occurs when people are temporarily unemployed while moving between jobs.
Example:
If an accountant leaves a job for valid reasons, there may be a short period before they receive and accept another job offer. That gap is frictional unemployment.
This is usually not seen as a serious or long-term form of unemployment because it is temporary. The government can still help by:
- Sharing job information and vacancies
- Offering interview preparation
- Providing short training to help people match available jobs
Seasonal unemployment
This affects workers in industries where demand and production vary by season.
Example:
Farm workers are often affected because work may be available during the growing or harvesting season, but not during the off-season.
The government can help by providing benefits (such as social grants) during periods when workers cannot earn income. This supports households and helps stabilize spending in the economy.
Structural unemployment
This arises when the structure of the economy changes.
This can occur when:
- Firms or industries close
- Consumer tastes change
- New technology changes how goods and services are produced
Workers may be willing to work but find that their skills do not match the jobs available in growing industries.
A common government response is to provide training and re-skilling programs.
Example:
Some countries (including South Africa) have created training centers offering courses that can last from a week to six months or more.
These programs help retrenched workers gain relevant skills and qualifications that improve employability.
Real wage unemployment
This occurs when wages are kept above the level that would balance labour supply and labour demand.
One cause can be powerful trade unions that negotiate high wages. If wages are high, firms may:
- Hire fewer workers because labour is expensive
- Require existing workers to work longer hours instead of employing additional staff
The government may respond by reducing the power of trade unions and, where possible, lowering the minimum wage.
Inflation
Inflation refers to a sustained increase in the general price level in an economy. It can arise from different causes, which are typically grouped into two main types.
Demand pull-inflation
When total demand rises faster than supply, firms can raise prices even though the value of the product hasn’t increased.
To reduce demand-pull inflation, the government may try to reduce aggregate demand so that supply can keep up.
Cost-push inflation
Cost-push inflation happens when prices rise because production costs rise, especially the cost of raw materials.
Example:
You might visit a brand’s website and see a notice like: “From 1 October the price of … will be increased by $… due to an increase in the raw material price.”
That situation is cost-push inflation (not demand-pull inflation).
The government can respond with supply-side policies, such as subsidies and grants, that reduce firms’ production costs and help limit price increases.
Expectation effects inflation
Expectation effects inflation occurs when people expect incomes or wages to rise. This is common when an economy is coming out of a recession. When firms notice that households are earning more (or are expected to earn more), they may increase prices.
There is not much the government can do about this type of inflation, except possibly setting maximum prices on goods that are most affected to prevent prices from rising too quickly.
How the government can achieve growth in an economy
During a recession, an economy will:
- Reduce interest rates
- Run a budget deficit
- Reduce the level of taxation
- Set maximum prices
During periods where the supply side of the economy is struggling, the government may:
- Provide training centers and incentives (for example, during COVID-19 there was a growing need for nurses, and many governments increased training support)
- Fund university research to develop new technology that benefits the economy
- Deregulate markets to allow them to operate more freely and support growth
- Provide subsidies to firms
- Offer workshops to train business owners and improve their skills
- Invest in infrastructure such as road networks and railways (for example, China has expanded these significantly in recent years)