Disequilibrium is a type of unemployment that prevents the labor market from "clearing." This means that something is keeping the labor market from reaching equilibrium.
Example 1: Real Wage Unemployment/ Classical Unemployment
Example 1: Real Wage Unemployment/ Classical Unemployment
- This is when wages are above equilibrium, causing the supply of labor to be greater than the demand.
- Economists argue that this is caused by trade unions and government minimum wages interfering with the labor market. Trade unions negotiate wages that are set higher than equilibrium and a minimum wage is also set higher than equilibrium.
- Occupations affected: any jobs with trade unions are affected by this type of unemployment, because if the wage set by the union is too high, the demand for labor will decrease, and not as many workers will be hired. If the unemployment is caused because of a government-set minimum wage, then lower-paying jobs (such as cashiers) are affected, as they pay most, if not all their workers minimum wage.
- Some possible solutions are: If the trade unions are preventing the labor market from clearing, then the government should reduce the ability of unions to negotiate higher wages. If the minimum wage prevents the market from clearing, then the minimum wage should be reduced or abolished.
- Some problems with these solutions are: It may be difficult to reduce union power, and the effects of such policies will harm poorest workers the most. High-income workers do not receive minimum wage and thus will not be affected. The reduction in minimum wage will reduce the income and living standards of those workers who are already earning low wages. Such a policy can lead to a worsening distribution of income without an economy.
- The graph below shows how real wage unemployment works. The higher enforced wage (4.86) is above the equilibrium point (c). Because of this, the supply of labor is greater than the supply of demand, and unemployment is created (a-b).
Example 2: Cyclical Unemployment/Demand-deficit Unemployment
Graph 1 Graph 2
- This results when the overall demand for the goods and services of an economy cannot support full employment. It occurs during periods of slow economic growth or during periods of economic contraction.
- During these periods of slower growth, demand tends to fall as consumers spend less on goods and services. This then leads to a fall in demand for labor, as firms cut back on production.
- Some possible solutions are: The government can intervene to bring about an increase in demand through the use of fiscal policies; increased demand through increased government spending, or it could lower direct and indirect taxes to indirectly increase consumption by households and investments by firms. They could also use monetary policies; the central bank could decrease interest rates or increase the money supply.
- Occupations affected: jobs that depend on luxury goods, such as travel agents or luxury car salespeople, will face this unemployment. People will not be spending as much on goods and services, especially not luxury goods. Thus these firms do not make as much money, and therefore decrease demand, cutting down the demand for labor.
- The graph below shows cyclical unemployment. Consumers are spending less on goods and services, shown in the shift in AD to AD1. It shifts to the left, showing a decrease. This is then likely to lead to a fall in the demand for labor as firms cut back on production. This shift can be seen in the second graph. The demand for workers (ADL) shifts to the left, showing a decrease. If labor markets functioned perfectly, the average real wage would fall to W1 in Graph 2. However, this is not the case, and the wages are "sticky downwards."
- This means that workers wages can easily increase, but it is less likely they will fall. Some reasons for this are: firms realize that paying lower wages are likely to lead to discontent and reduced motivation in workers. It also may result in lower worker productivity. Also, firms may not be able to reduce wages due to labor contracts and trade union power. Wages are likely to remain "stuck" at We in Graph 2, so the supply of labor will be greater than the demand for labor, and unemployment of a-b will be created.
Graph 1 Graph 2