Question

b) Explain and show in a diagram the main differences between equilibrium unemployment and disequilibrium unemployment.
(a) Describe the main standard short-term monetary policy measures.

(b) Using the relevant graphical illustration, show and explain why a tariff on international trade is inefficient.

Answer 1

1.) Disequillibrium unempolyment- this is the unemployment due to the fact that the current real wage rate is above its equilibrium. The equilibrium wage rate in diagram 1 below is we where the quantity of total demand from all industries for labour (DL) equals the quantity of supply of labour (SL). The SL shows the number of people in the labour force who is willing and able to able to take up jobs at each wage rate. The SL slopes upward as higher real wage rate induces people who did not wish to work before like housemakers back to the market and the unemployed who are in between jobs to accept job offers. The DL, on the other hand, shows the number of workers firms are willing and able to hire at each wage rate. This demand curve is downward sloping as real wage rate rises, firms will have incentives to substitute labours with other factors of production like machineries. If wage rate is raised to w1 for some reasons like the imposition of a minimum-wage regulation or from the successful demand of trade union then QB (number of workers associated with point B) people are now willing and able to take up jobs but firms are only willing to hire up to QA people (number of workers associated with point A). Thus, QB - QA number of people will be unemployed. This sort of unemployment is called real-wage unemployment.

equilibrium unemployment - is the difference between those who would like to work and those who are willing and able to take up a job offer at current wage rate. If the current wage rate is we as in the diagram 1 above then those who like to work are represented by point F and those are willing and able to take up job offers are represented by point E. The difference Qf - Qe is the equilibrium unemployment. At a minimum wage rate of w1 as in diagram 1, the equilibrium unemployment is represented by Qc-Qb and disequilibrium unemployment is represented by Qb - Qa.

2.)

Monetary policy refers to the efforts by governments or central banks to influence economic activity through the money supply. There are different definitions of the money supply, but it generally incorporates any cash, checks, credit accounts and other liquid, exchangeable instruments. Most of the economic tools used in monetary policy center around the creation of new money units or the control of credit accounts through interest rate changes. The efficacy of monetary policy is a controversial topic among economists and policy makers, and the exact means of implementing monetary controls varies among governments and across time.

Many modern governments separate those who enact fiscal policy, taxing and government spending, from those who control monetary policy, often delegating the latter to central banks further removed from the political process. The most basic monetary function of central banks is to increase or decrease the total money supply. According to the quantity theory of money, an increase in the money supply tends to cause inflation, while a shrinking money supply tends to cause deflation.

In practice, however, controlling the money supply can be difficult. Private lenders can actually change the amount of money in circulation through the fractional reserve banking system, and technological innovations have introduced new means of exchange and stores of value. It can be very difficult for central banks to even measure the current money supply, let alone calculate its velocity or estimate the impact of future monetary injections.

Rather than simply printing or gathering units of currency, it is easier for central banks to use measurable metrics such as interest rates and consumer prices to set policy. This is why the Federal Reserve targets the discount rate and the federal funds rate; interest rates influence the cost of credit. Borrowing becomes cheaper when rates are lowered, and this tends to increase the amount of money in the economy through the multiplier effect. The opposite is true when rates are increased and credit is more expensive.

The Fed also sets the reserve ratio requirements for private lenders, which is the total percentage of a bank's lending assets that must be kept on deposit, not lent out, to meet demand account obligations. Banks often borrow money from each other overnight to meet these requirements, so the Fed controls how much interest can be charged on these short-term loans.

Central banks can actually enter the securities markets to influence prices and either inject or absorb money from the economy. If the Fed purchases U.S. Treasurys, for example, it increases the demand for that asset and simultaneously injects money into the market. Conversely, selling U.S. Treasurys increases supply for the asset and pulls money out of the market. This type of monetary activity is known as open market operations.