Question

5) Show and explain using a numerical example and a demand and supply of labor GRAPH how an increase in employment does not always lead to an equivalent decrease in the unemployment rate. (Hint; You must change a Demand and/or a Supply curve for employment/ labor.)

W

Quantity of Labor, L

Explain;

Answer 1

An increase in employment will not always lead to a decline in the unemployment rate if there is an increase in the labor force (supply of labor) that is greater than the increase in the demand for labor.

For instance, consider an economy where initially, the total labor force is 1000. The total employed is 600 so the unemployment rate is ((1000-6000)/1000)*100 = 40%

Now suppose the number of employed increase to 800 but the total labor force increase to 2000. Now the new unemployment rate = ((2000-800/2000)*100 = 60%

Thus, despite an increase in the total employed, the unemployment rate has increased.

In terms of a graph, this means that both the labor demand and labor supply curve are shifted to the right (showing an increase), but the shift in the supply is larger than the shift in demand (supply increases more). As a result, at the new equilibrium, the quantitiy of labor (L) will be higher but wages will be lower. These lower wages are reflective of the fact that the unemployment rate has increased and the bargaining power of workers has decreased as there is excess supply fo labor.