Costs and benefits of Unemployment

Question 1

What is the main macroeconomic objective related to unemployment?

Answer 1

To achieve low unemployment, ideally close to the Natural Rate of Unemployment (NRU).

Question 2

How does unemployment affect output?

Answer 2

The economy operates inside its PPF, meaning lost output and lower living standards due to underused labor resources.

Question 3

How does unemployment affect government finances?

Answer 3

Lower income tax and VAT revenues (due to less income and spending).

Lower corporation tax (due to lower business profits).

Higher government spending on benefits and public services.

Question 4

What extra public spending might be required during high unemployment?

Answer 4

Police and security (to deal with increased crime, riots).

Healthcare (for physical and mental health issues).

Judicial services (due to rising crime, family breakdowns, etc.).

Question 5

What are the social costs of unemployment?

Answer 5

Mental and physical health decline

Increased crime rates

Marital and family breakdowns

Loss of skills and motivation (hysteresis)

Question 6

Can any unemployment be beneficial?

Answer 6

Yes, a small amount of frictional unemployment allows job matching to improve labor market efficiency.

Question 7

What is “creative destruction” and how is it linked to unemployment?

Answer 7

Unemployment can result from technological change or restructuring, but this can lead to more productive industries over time.

Question 8

How can unemployment help control inflation?

Answer 8

Lower demand for goods and higher labor supply reduces demand-pull and wage-push inflationary pressures.

Question 9

How does unemployment affect the government budget (fiscal deficit)?

Answer 9

Unemployment reduces tax revenue and increases government spending (especially on benefits), leading to a larger budget deficit.

Question 10

What are the consequences of a rising budget deficit?

Answer 10

Need to raise taxes or cut spending elsewhere

Potential increase in government borrowing

Higher opportunity cost from debt interest payments

Question 11

What are some social costs of unemployment?

Answer 11

Greater homelessness

Increased poverty and deprivation

Rising mental health issues (e.g. anxiety, depression)

Moral panic and societal unrest

Question 12

How does unemployment impact individuals’ living standards?

Answer 12

They lose their main source of income, risking relative or absolute poverty, with follow-on effects like worse health, stress, and relationship breakdowns.

Question 13

Can unemployment in one country affect others? How?

Answer 13

Yes—unemployment reduces demand for imports, harming trading partners’ export revenues and slowing their economic growth.

Question 14

What is hysteresis in unemployment?

Answer 14

It’s when short-term unemployment becomes long-term, making it harder for individuals to re-enter the workforce due to skill loss and lower confidence.

Question 15

Why does hysteresis reduce long-term growth?

Answer 15

Deskilling reduces worker productivity

Some unemployed drop out of the labor force, shrinking the workforce and reducing LRAS

Question 16

How does long-term unemployment affect aggregate demand (AD)?

Answer 16

Workers reliant on benefits have less income and lower consumption, which constrains AD and short-term economic growth.

Question 17

How can unemployment benefit employers?

Answer 17

Creates a larger pool of labor, allowing firms to select the most productive workers

Keeps wage demands low, which controls costs and protects profit margins

Question 18

Why can low unemployment reduce inflationary pressures?

Answer 18

With more job seekers than vacancies, workers have less bargaining power, reducing wage-push inflation.

Question 19

How can high unemployment improve the current account balance?

Answer 19

With lower incomes, people spend less on imports, which can help reduce a current account deficit.

Question 20

Why might some unemployment lead to better job matching?

Answer 20

Unemployed workers have more time to search for suitable jobs, improving labor market efficiency.

Question 21

When is unemployment acceptable?

Answer 21

When it’s at the Natural Rate of Unemployment (NRU)—includes frictional, structural, and seasonal unemployment without causing excess economic damage.

Question 22

What if unemployment is above the NRU?

Answer 22

Then the costs outweigh the benefits, unless the NRU itself is too high due to structural issues.

Question 23

Why does the duration of unemployment matter?

Answer 23

Short-term unemployment can be manageable

Long-term unemployment (12+ months) increases risk of hysteresis and intensifies social and economic costs

Question 24

How does the type of unemployment affect its impact?

Answer 24

Structural unemployment is the worst (due to skill and mobility mismatches)

Cyclical unemployment is damaging but often temporary

Frictional unemployment is least harmful and part of a healthy, dynamic labor market

Question 25

When can unemployment be considered healthy?

Answer 25

If people are voluntarily searching for better jobs, it can lead to more productive job matches, which improves labor efficiency.

Question 26

Why is youth unemployment particularly concerning?

Answer 26

Young workers often lack experience and skills They're more likely to face long-term unemployment Higher risk of deskilling and becoming economically inactive, leading to hysteresis

Question 27

What’s the economic impact of high youth unemployment?

Answer 27

Can reduce future productivity Weakens human capital development Becomes a long-term drag on growth and public finances