Definitions of employment, unemployment and full employment

Government and the Macro‑economy

1. Government macro‑economic aims

• Economic growth – a sustained increase in real national income (real GDP).
• Full employment – the economy operates at its natural rate of unemployment (only frictional + structural unemployment).
• Low inflation – price rises are kept moderate and stable.
• Balance of payments equilibrium – the current‑account deficit (or surplus) is at a level that can be financed without excessive borrowing or loss of reserves.
• Equitable distribution of income – reducing poverty and narrowing the gap between rich and poor.
• Sustainable development – meeting present needs without compromising the ability of future generations to meet theirs.

Note: These aims can conflict (e.g., rapid growth may raise inflation or widen the current‑account deficit). Government policy must therefore balance them.

2. Fiscal policy

Fiscal policy uses the government’s budget to influence aggregate demand (AD) and achieve the macro‑economic aims.

2.1 Budget basics

• Budget balance = Total tax revenue – Total government spending

• Surplus → revenue > spending.
• Deficit → spending > revenue.

2.2 Main areas of government spending

• Health, education, defence, social security, infrastructure, law & order.

2.3 Types of taxation

2.4 How fiscal policy works

• Expansionary fiscal policy – deficit spending and/or tax cuts → ↑ AD → higher output & employment, but may raise inflation and public debt.
• Contractionary fiscal policy – surplus or tax increases → ↓ AD → lower inflation, but risk ↑ unemployment.

3. Monetary policy

Conducted by the central bank (e.g., the Bank of England) to control the money supply and interest rates.

3.1 Key tools

• Open‑market operations – buying (expands) or selling (contracts) government securities.
• Policy interest rate (base rate) – influences borrowing costs for banks, firms and households.
• Reserve requirements – proportion of deposits banks must hold as reserves.

3.2 Policy effects

• Expansionary monetary policy – lower interest rates or increase money supply → ↑ investment & consumption → ↑ AD, lower unemployment, possible ↑ inflation.
• Contractionary monetary policy – raise interest rates or reduce money supply → ↓ AD → lower inflation, possible ↑ unemployment.

4. Supply‑side policies

Supply‑side measures aim to increase the productive capacity of the economy, shifting the long‑run aggregate‑supply (LRAS) curve rightward.

• Improving education and training – raises skill levels → higher productivity.
• Infrastructure investment – reduces transport costs, improves efficiency.
• Labour‑market reforms – e.g., reducing statutory redundancy payments, encouraging part‑time work, flexible hiring/firing.
• Deregulation & privatisation – lowers business costs, stimulates competition.
• Research & development incentives – promotes innovation and technological progress.

5. Economic growth

• Definition: A sustained increase in real GDP (output adjusted for inflation).
• Measurement:

  • Real GDP = Nominal GDP ÷ (Price Index / 100)
  • Growth rate = ((Real GDP_t – Real GDP_t‑1) ÷ Real GDP_t‑1) × 100 %

• Sources of growth

  • Increase in capital stock (investment).
  • Improved technology (innovation).
  • Higher labour input (population growth, higher participation).
  • Better human capital (education, health).

• Consequences

  • Higher living standards, larger tax base.
  • Potential environmental pressure and rising income inequality.

• Recession – two consecutive quarters of negative real‑GDP growth; policy response usually involves expansionary fiscal and/or monetary measures.

6. Employment, unemployment and full employment

6.1 Key definitions (Cambridge syllabus)

6.2 Labour‑force concepts

1. Labour force = Employed + Unemployed (people aged 16 + who are either working or actively seeking work).
2. Labour‑force participation rate = (Labour force ÷ Working‑age population) × 100 %.
3. Employment‑rate = (Employed ÷ Working‑age population) × 100 %.

6.3 Types of unemployment

6.4 Measuring unemployment – issues to consider

• Reference period – usually the four weeks before the survey; shorter periods may miss seasonal or part‑time workers.
• Discouraged workers – people who have stopped looking for work; they are classed as “not in the labour force” and therefore lower the headline unemployment rate.
• Under‑employment – workers who are part‑time but would like full‑time work; not captured by the headline rate.
• Hidden unemployment – informal or illegal work not recorded in official statistics.
• Part‑time vs full‑time – some surveys distinguish “part‑time workers who want more hours” as a separate category.

6.5 Full‑employment diagram (description)

7. Balance of payments (BOP)

• Current account – trade in goods and services, net income from abroad, and net current transfers.
• Capital account – net inflows/outflows of capital (foreign direct investment, portfolio investment, loans).
• Financial account – changes in ownership of assets.
• Overall BOP balance = Current account + Capital account + Financial account + Errors & omissions.
• Equilibrium is achieved when the overall balance is close to zero; persistent deficits must be financed by borrowing, drawing down reserves, or attracting foreign investment.

8. Evaluation of government policies on employment

8.1 Fiscal policy

• Expansionary spending (e.g., infrastructure projects) can quickly lower demand‑deficient unemployment, but may:

  • Increase inflation if the economy is near full capacity.
  • Widen the budget deficit, raising future tax burdens.

• Tax cuts raise disposable income and can boost consumption, yet:

  • May be less effective if households choose to save rather than spend.
  • Reduce government revenue, potentially limiting public‑service provision.

8.2 Monetary policy

• Lowering the policy rate reduces borrowing costs, encouraging investment and job creation; however:

  • If rates are already low, further cuts may have little impact (liquidity trap).
  • Excessive money creation can fuel asset‑price bubbles.

• Raising rates curbs inflation but can increase cyclical unemployment, especially in interest‑sensitive sectors such as construction and housing.

8.3 Supply‑side measures

• Education and training address structural unemployment in the medium‑to‑long term, but:

  • Benefits are delayed – it takes years for a trained worker to enter the labour market.
  • Requires substantial public investment.

• Labour‑market flexibility (e.g., reducing redundancy payments) can lower frictional unemployment and make firms more willing to hire, yet:

  • May reduce job security and increase income insecurity.
  • Can raise concerns about social welfare and inequality.

8.4 Trade‑offs and the Phillips curve

• In the short run, lower unemployment often comes with higher inflation (upward‑sloping Phillips curve). Policymakers must decide which is the more pressing problem.
• Achieving a lower natural rate of unemployment usually demands long‑run investment in human capital and technology, which may temporarily divert resources from immediate growth objectives.

9. Summary checklist for exam preparation

• Know the six government macro‑economic aims and be able to discuss conflicts between them.
• Be able to define and calculate:

  • Budget balance, fiscal multiplier (basic idea), real GDP, growth rate, unemployment‑rate, participation‑rate.

• Identify the three main tools of monetary policy and explain how they affect AD.
• Distinguish between demand‑deficient, frictional and structural unemployment and match each to appropriate policy responses.
• Explain the concept of full employment, the natural rate of unemployment, and how it is illustrated in a labour‑market diagram.
• Understand the components of the balance of payments and why a persistent current‑account deficit matters.
• Evaluate policies using criteria: impact on output, employment, inflation, public debt, income distribution and long‑run sustainability.