fa_p24-31 vol4-4 essays

24 THE UNEMPLOYMENT ISSUE THE UNEMPLOYMENT ISSUE 25

SKILLS CONTENTBUSTER ESSAYS ARTICLES

FEATURE

(a) Explain the effects of a minimum wage on a producer. [10]

(b) Examine the effects of a minimum wage on the macroeconomic goals of

a country. (15)Q1

A minimum wage is set by the government above the market equilibrium wage to protect the wage of the low income

workers. Governments enforce a minimum wage as a tool to alleviate income inequality that results from low-skilled workers having wages that are too low. By legislating a minimum wage, governments can ensure that low income earners earn at least a wage sufficient for subsistence and for affording basic necessities. Though such a policy of enforcing a minimum wage helps meet the objective of equity, it oftentimes leads to a trade-off in the other microeconomic goal of efficiency. This trade-off of efficiency can be seen from the effects of the minimum wage on producers in a country.

Labour is a key factor of production in most countries, especially for countries that have a small population. The factor payment in return for the services of labour is known as wages.

A minimum wage is a stipulated reward to labour, such as $6 per hour, and for it to be effective, it needs to be set above the market clearing wage rate (determined by the intersection of demand for labour and supply of labour in the market).

In Figure 1, the market equilibrium wage is determined by demand and

supply of labour and is at W1. A minimum wage is set at Wmin, which is higher than W1. Any firm found to pay a wage below Wmin will face legislative penalties.

In the short run, firms hiring Q2 workers will have to pay a higher wage at Wmin to all their workers. This translates into higher labour costs and thus total cost of production. To a firm seeking to maximize profits, in the short run it faces higher total cost of production as the size of its labour force remains unchanged and it has to pay each worker a higher wage. With total revenue unchanged, this translates into lower total profits for a firm.

The impact on cost of production depends on the labour intensity of the

firm. A producer whose firm is high in labour intensity, such as a construction firm, will be unable to reduce the number of workers in the short run, thus suffering a high cost of production and significantly reduced profits.

The effect of the higher costs of production can be seen from Figure 2 where a rise in wages causes the average cost curve

to rise in the short run. As workers are employed on a long-term contract basis, the cost of hiring workers is a fixed cost to the firm. As seen from the figure, the AC shifts up, reflecting a higher per unit cost, and this translates into reduced profits for the firm. (Profits fall from PcaC1 to AC2baAC1).

In the longer run, employers facing the higher wage per hour and in turn reduced profits

may want to cut the number of

workers in order

PART A FIGURE 1

As the focus of this question is on the effects of firms, there is a need to explicitly examine the effect on profits.


MICROECONOMICS

to reduce the total cost of labour. Since each worker costs more now, to increase profits means having to reduce the total cost of production, which is done by reducing the number of workers. (Q2–Q3).

As the number of workers entering the workforce increases, since the higher minimum wage is making more people willing and able to rejoin the labour force (including those who were previously actively searching for work but had stopped) due to the higher remuneration. This means firms have a greater pool of workers to hire from (Q1–Q3). The persistent excess supply of labour allows firms to pick better employees.

Both the trimming of workers and the

possibility of firms ending up with better quality workers may then reduce the total cost of production, allowing firms to enjoy higher profits in the long run.

Faced with higher wages, producers may consider passing on the higher

cost of production to consumers. They may choose to raise the price of their output, thus increasing total revenue and offsetting the rise production cost and maintaining current profits. Raising prices to cover the higher costs can be done only when a firm’s product has a price inelastic demand.

Since the demand of the good is price inelastic, a rise in price will cause a less than proportionate fall in demand, so total revenue increases and profits are unchanged. This happens when the producer is one selling basic necessities, such as sugar, rice, or petrol. Generally, a firm facing a minimum wage can raise prices when it has a significant share of the market with few or no rivals. Examples include utilities providers or sellers.

On the contrary, a firm with a price elastic demand for its products, where there are many rivals and thus many substitutes for its products, will find it difficult to raise the price of its goods.

As any attempt to raise price will cause quantity demanded to fall by a more than proportionate amount and total revenue to fall. Profits will worsen further as both total costs have risen with a fall in total revenue.

If the producer is one that sells in the overseas market, that firm will also suffer, as the large number of substitutes available in foreign markets cause demand for the firm’s product to be highly price elastic.

A firm operating in a country with an imposed minimum wage will see a loss of export competitiveness and a corresponding fall in total revenue.

A longer term effect of a higher minimum wage may also be the reduced inflow of foreign direct investment into a country. This means reduced technological transfer and firms may suffer from inefficiency due to the lack of adoption of the latest and most cost efficient ways of production. Lack of FDI may also cause firms to suffer higher costs due to lack of investment coming into the country in areas such as telecommunications and banking

services. Firms, regardless of industry, will see higher costs of conducting businesses due to the higher cost of telecommunication and banking.

The earlier instance of reduced profits for firms translates into a reduced ability to undertake research and development. Firms face a harder time keeping up with other firms as they are unable to plough in huge sums of capital towards developing new products to shift demand for their products to the right. In the long run, firms may face falling demand for their products due to lack of innovation.

Having a minimum wage is not all bad. A higher minimum wage means a higher income level for employees, and thus households will have a higher purchasing power. This means demand for goods that are highly income elastic will rise. Producers may see a rise in revenue for such goods, and thus a rise in profits.

The other possible benefit is that paying higher wages encourages firms to take action to raise worker productivity. Since each unit of labour now costs more, employers will spend more on training workers to get more returns from each unit of labour. This raised productivity from training will then reduce costs and keep firms competitive.

The imposition of a minimum wage will have mixed effects on firms, depending on the labour intensity of the firm and also whether the firm undertakes ways to increase efficiency. The negative impacts of a minimum wage are felt hardest by firms competing in international markets.

T he macroeconomic goals of a country include high economic growth, low inflation, low unemployment, and a strong

balance of payments. As discussed earlier, a minimum

wage results in higher labour costs. The quantity of labour is now higher than

PART B

FIGURE 2

Note that the extent of rise in unemployment as a result of the minimum wage is not of interest to part (a), but only to part (b) of the question, as it looks at what happens to the economy.

Besides having a larger pool of workers to choose from, since hourly wages have risen, employees are now more motivated to work. Efficiency may increase and quality of work will improve. These will cause the average costs of production to fall, thereby turning into higher profits.

Given that a minimum wage increases the income of the lowest paid in an economy, their MPC is extremely high. That is, for every dollar increase in salary, a huge portion of it is spent and this in turn causes demand for goods to increase—especially for basic necessities.


the quantity demand for labour, thus

retrenchment of workers results.

This leads to demand deficient unemployment as the aggregate demand of a country falls due to reduced levels of exports sold in international markets when producers raise prices as a result of

a minimum wage. This leads to reduced levels of injection. For small and open economies such as Singapore that are highly dependant on trade, the fall in exports leads to a significant fall in aggregate demand. When firms raise prices due to higher wages, assuming income remains unchanged, households will see a fall in purchasing power (except for those who benefit from the higher minimum wage). They may then end up cutting back on purchasing goods and services.

Thus consumption of aggregate demand falls from higher cost of goods and services for those without a rise in income (higher income earners) and at

the same time a rise in the minimum wage encourages more spending and consumption. If consumption falls as a result of the former effect being greater, aggregate demand falls further.

Aggregate demand is also likely to fall due to a decrease in the inflow of foreign direct investment as well as outflow of domestic investment. Higher wages make the country unattractive as a location for FDI, especially those that require a large amount of labour.

Together, the fall in export revenue, consumption, and investment causes aggregate demand to fall and a multiplied decrease in national income. This leads to reduced economic growth and potential growth falls as well, due to reduced investment. This generates demand deficient unemployment.

In Figure 3, when exports and investments fall, aggregate demand falls from AD2 to AD. This causes national income to fall from Y1 to Y2 via the reverse multiplier effect. As national income decreases further from the full employment level of national income, fewer resources will be hired for production of output and demand deficient unemployment results.

In the long run, this may also lead to structural unemployment because workers who are protected by a minimum wage are usually less skilled and are unable to move into industries that require higher-skilled workers.

Unemployment means that scarce resources such as human labour are not utilized fully. The opportunity cost is the potential output that could have been produced should these resources

be maximally utilized. There is a loss of production, and thus a fall in national income. Actual economic growth falls and the standard of living falls correspondingly.

Should the fall in production levels occur in companies that export their goods, there would be a fall in the total exports of the country. This worsens the account of balance of payments and the exchange rate will

depreciate. Furthermore, higher labour costs due

to a minimum wage may deter foreign investors, since higher costs translate to lower profits. Total investment in the country falls, worsening the financial account of the balance of payment and the exchange rate depreciates.

A rise in labour costs translates into higher overall cost of production. As discussed earlier, producers may choose to raise prices to maintain profits, depending on the price elasticity of demand. This may lead to inflation, especially since the price of basic necessities counts into the calculation of the consumer price index. If the higher minimum wage causes prices to rise and in turn triggers further wage increases to help maintain real wages, it will trigger a wage-price spiral and set the stage for

Similarly, when supply of labour is highly responsive to the wage increase, the QUANTITY SUPPLIED of labour increases dramatically, worsening the unemployment caused by the minimum wage.

Again, how much export revenue falls depends on the labour intensity of the production of that particular export as well as the price elasticity of demand for the country’s exports. If the exports face few substitutes, the higher price of exports may lead to a less than proportionate fall in quantity demanded and export revenue increases. This can be the case of pharmaceutical medicines with few alternatives. The negative effects of a higher minimum wage can also be negated by a weaker exchange rate that lowers the foreign currency price of the export.

FIGURE 3

The danger is that demand deficient

unemploy-ment in the long run will lead to structural

unemployment, and inflation will result as labour costs and cost of production remain high.”


FEATURE

The extent of unemployment that results in the economy depends on the price elasticity of demand for workers by employers. If employers are very sensitive to wage increases – making dd for workers highly wage elastic, we are likely to see a greater fall in the QUANTITY DEMANDED of workers (movement along dd for labour curve).


FIGURE 4

cost push inflation. This means that the goal of price stability will not be met. If cost push inflation is set off, national income will fall from Y1 to Y2, causing economic growth and unemployment to worsen. All three internal goals will then not be attained.

In the long run, firms may be forced to raise productivity in order to offset the rise in production cost as a result of rise in labour costs. This is especially important for firms with high labour intensity that cannot retrench workers to reduce costs. Should firms be successful in raising productivity (for example, through the use of technology), there may be a rise in demand for labour to operate the machinery. Employment may not necessarily worsen in the long run. Furthermore, this raises the country’s export competitiveness and attractiveness

to investors. Should the external sector, namely exports and investments, be a huge proportion of AD, the AD rise will lead to actual growth. Potential growth may also result if productivity increases, as there is a greater capacity for firms to

increase output. This leads to a higher material standard of living.

Workers who are protected by higher wages are usually earning low income. Should they receive higher payouts from employers, there is less need for the government to aid the poor through assistance programs. Thus there is less government spending and in turn taxes may be reduced. This helps to keep the country competitive through reduced tax rates. For example, lower tax rates help retain firms’ final profits and thus the country will be seen as more attractive to investors, as well as retaining foreign expatriates as the country becomes more attractive to foreign talent.

In conclusion, the main aim of imposing a minimum wage is to achieve a

microeconomic goal—equality. However, the immediate trade-off is that of inefficiency. When examining the effect on the macroeconomic goals of the country, in the short run, it will worsen all four goals of the economy. This is due to a rise in cost of production and a fall in production level. The danger is that demand deficient unemployment in the long run will lead to structural unemployment, and inflation will result as labour costs and cost of production remain high. In the long run, firms may be forced to raise productivity so as to offset the rise in labour costs. This may bring positive benefits to the

country, such as more competitiveness in terms of exports and investments, thereby

improving the macroeconomic

goals.

Most of the time, students answer a minimum wage question without bringing in the goal of reducing income inequality in a country. It is important to do so, as this can surface as a trade-off in goals. Helping the microgoal of equity is usually at the expense of the macrogoals.

The danger is that demand deficient

unemploy-ment in the long run will lead to structural

unemployment, and inflation will result as labour costs and cost of production remain high.”

MICROECONOMICS


PART A

Q2

Unemployment refers to the situation whereby people of legal working age, willing and able to work for the current

wages, and actively seeking work are unable to find employment.

Unemployment represents inefficiency due to wastage of scarce resources. The opportunity cost of unemployment is the output that could have been produced should those resources be fully utilized. Limited resources are hence left idle and not put to use. This is seen from the economy being on a point within the Production Possibility Curve rather than on it.

As a result, there is a loss of production and national income falls as short-term aggregate supply falls. Also, due to falling income of households, their purchasing power is reduced and domestic consumption falls. Households fear further job losses or wage cuts and cut back on nondiscretionary spending on non-necessities. Households save more as thrift increases due to pessimistic outlook and uncertainty regarding the outlook of the economy.

This causes consumption to fall and increased withdrawals through savings. Thus aggregate demand falls, causing national income to fall further to a multiplied extent. This results in lower actual growth and a lower material standard of living.

In the long run, should unemployment persist, the unemployed may lose touch of their skills, causing the economy’s potential output to fall. This is indicated by a leftward shift of PPC. As skills erode, firms will find workers unattractive and as a result will not want to carry out investment in a country.

Firms not finding workers with relevant skills find the quality of workers lacking, impeding their process of setting up a new plant or office. Costs of carrying out investment in such countries will be higher, as there is a need to train workers. This causes FDI to fall and aggregate demand to fall further.

A loss of human capital also results in structural unemployment in the long run. Such unemployment occurs as existing workers are stuck with an old set of skills and become irrelevant as the economy changes its structure. These workers do not possess the skills to move into

(a) Explain the costs of unemployment to an economy. [10]

(b) Examine the effects of increased globalisation on the nature of unemployment in countries today. [15]

FIGURE 1

This is an important microeconomics link to the macro problem of unemployment.


FEATURE


sunrise industries that will require skilled talent. This reduces the long run potential growth of the economy.

In the situation of unemployment, there is thus a need for government to spend on retraining the unemployed in order to improve the competitiveness of the economy. This government

expenditure is on top of greater welfare payouts to the unemployed and less tax revenue collected due to a smaller workforce. The tax base of the country shrinks with increased unemployment. Unemployment thus causes a drain on government finances and the government will have fewer financial resources to allocate to other sectors of the economy to boost growth.

Globalisation refers to the integration of national economies through the trade of goods and services, foreign direct

investment, capital flow, spread of technology, and labour migration.

The sources of unemployment may arise from supply side reasons or demand side reasons. On the supply side, unemployment can be classified as frictional, structural, or seasonal. Frictional unemployment comes about due to labour movement from one job to another. Lack of information and the time taken to search for a new job causes transitional unemployment, called frictional unemployment. Structural unemployment tends to be longer term in nature and is caused by a mismatch between worker skills and what is in demand in the economy. Seasonal unemployment comes from changes in weather patterns, creating employment related to ski resorts, etc. Demand deficient unemployment is caused by a fall in demand related to booms and busts of the economy experienced through the phases of a business cycle.

INCREASED GLOBALISATION CAUSES MORE FREQUENT AND SEVERE CYCLICAL UNEMPLOYMENT IN OPEN ECONOMIES

THAT HAVE A LARGE EXTERNAL SECTOR.With increased globalisation,

economies may embrace trade as a major engine of growth. This means that exports and foreign direct investment increases at a faster rate and takes up a more significant proportion of aggregate demand, leading to a large external sector of the economy. Globalisation has thus changed the source of economic growth from internal engines of consumption to external engines of trade. This makes each country more vulnerable to trade shocks when there are sudden collapses in export revenues.

Such an economy is highly susceptible to external contagion and recessions no longer occur simply due to domestic changes in demand, but also to global changes in demand. For example, when other countries experience recession, they will see a fall in national income and purchasing power. This reduces the demand for exports from open economies and correspondingly export-producing economies will face a fall in AD and a

multiplied fall in national income through the reverse multiplier process.

Global changes in demand are more

severe and volatile, so economies

will face more frequent recessions and cyclical unemployment. The severity of unemployment will depend on the openness of the economy. Should external sectors make up a large proportion of the economy’s aggregate demand (such as in Singapore), the country will face more severe cyclical unemployment.

Thus globalisation causes demand deficient unemployment to occur more frequently and the extent of demand deficient unemployment tends to be

bad—higher levels of unemployment rates during each round of recession—such as double digit unemployment rates that are higher than the natural rate of 3%.

In Figure 2, when exports fall, aggregate demand falls from AD2 to AD. This causes national income to fall from Y1 to Y2 via the reverse multiplier effect. As national income decreases further from the full employment level of national income, fewer resources will be hired for production of output and demand deficient unemployment results.

INCREASED GLOBALISATION CAUSES A HIGHER PROPORTION OF STRUCTURAL

FIGURE 2

As the word used in the question is ‘costs’, the points in this paragraph can be seen as the explicit costs of higher levels of unemployment.

PART B

This is so even for economies with fairly large domestic consumption to spur growth.

It is better if the student explains in detail why recessions tend to be more severe and frequent. Recessions tend to be more frequent as each country is now exposed to the economic conditions of more countries through trade. At one point it is Japan’s economy that brings risk, while at another, it may be the Euro region. Recessions tend to be more pronounced or severe due to the contagion effect of multiple countries contracting at the same time. Synchronized contraction is the economic contraction of one country that will cause more than one country to feel the effects, thereby compounding the contraction.

Another feature of globalisation is increased imports. This may mean higher levels of MPM for each country and makes any expansionary fiscal policy ineffective. By increasing G, governments hope to increase AD and reduce demand deficient unemployment, but due to the high leakages through imports, the size of the multiplier is reduced, making any expansionary FP ineffective and causing prolonged demand deficient unemployment.

MICROECONOMICS


UNEMPLOYMENT, ESPECIALLY IN ADVANCED ECONOMIES.

Globalised countries trade and specialize according to the law of comparative advantage. This means that trade occurs from a country that produces a good at a comparative advantage due to lower opportunity cost to a country that produces the same good at a comparative disadvantage due to higher opportunity cost. Export-producing countries change their allocation of resources by shifting to the production of goods that are of comparative advantage so as to benefit from trade. Advanced countries that possess the necessary skills and technology move into knowledge-based economies and higher value-added production. This results in structural changes in the economy. Workers in sunset industries, such as those in lower value-added manufacturing, are retrenched but are unable to move into sunrise industries due to a lack of skills.

With increased globalisation, there is also an increased flow of technology to recipient countries when foreign firms relocate to other countries. This represents a gain in resources that are suited to the production of higher value-added manufacture goods, causing a shift to production of such goods. Workers who are not technologically savvy are displaced. Also, automation may replace lower-skilled labour. Initially, when workers are displaced due to being replaced by highly-skilled labour, it

creates demand deficient unemployment. Subsequently, due to labour immobility as labour is unable to take up new skills in technologically intensive manufacturing industries that came about due to the technological transfers, structural unemployment results.

Countries that open up to trade face greater flow of cheaper imports into their markets to compete with domestic producers. There is a decline in demand for domestic goods, leading to the shutdown of domestic firms. Large-scale retrenchment of lower-skilled workers in such companies results and often those workers don’t possess the necessary skills to move into higher-skilled industries.

The earlier three reasons usually occur in advanced economies that are open and shifting to higher value-added production. An example is Singapore, which has moved into electronics and biomedical industries due to our resource endowment of advanced technology and a highly educated workforce. As such, primary industries such as agriculture and low-end manufacturing (such as textiles) are being forced to shutdown. Lower-skilled workers who are unemployed are unable to move into Singapore’s growing industries. As such, the government has implemented retraining programmes and incentives to improve the skills of the workforce.

HOWEVER, INCREASED GLOBALISATION CAUSES A LOWER PROPORTION OF STRUCTURAL UNEMPLOYMENT IN THE GLOBAL ECONOMY.

From a global perspective, with increased globalisation comes increased labour flow across countries. Such labour flow is in response to the demands of the global economy. For example, low-cost labour moves from poorer countries where demand for such labour is lower (due to abundance of such labour) to advanced nations where demand for such labour is higher. Such low-cost workers are able to seek higher wages in advanced nations, as locals shun low-skill jobs (as the wages are perceived to be too low) and firms are able to offer a higher wage to attract workers. For example, Singapore’s local construction firms employ both Chinese and Indian workers.

Some firms even outsource services to low-cost nations (such as call services) which allows labour resources

to be tapped across borders. Labour movements are no longer restricted to within the domestic economy but move in response to changes in demand within the larger global economy, thereby reducing structural unemployment in the global economy.

In conclusion, there is a higher proportion of structural unemployment in many countries, especially advanced nations, due to structural reforms according to the need to develop new comparative advantages for their economies. Open economies shift to knowledge-based and technologically-driven economies due to the increased

flow of technology and the emergence of low-cost countries that compete in the global economy. Workers who are less skilled in such open economies are unable to find employment in growing sectors and remain structurally unemployed due to labour immobility.

Global recessions occur more frequently in this globalised world due to the threat of external contagion. This leads to large-scale cyclical unemployment. After every recession, the economy restructures to eliminate inefficiencies and low-skilled workers who are more likely to be cyclically unemployed after a recession find themselves unable to find jobs in the newly restructured economy. In the long run, human capital is lost and structural unemployment worsens.

However, increased globalisation also means improved flow of knowledge and skills from other countries. This occurs when foreign firms locate in the country and pass on their expertise. To remain globally competitive, governments in advanced nations also recognise the need to implement retraining programmes and offer incentives to increase the skills and employability of the workforce. Thus, in the long run, structural unemployment may be reduced.

It is good that the student makes clear qualified statements before backing up with relevant explanations. In this case, the statement that there is greater segment of unemployment caused by structural reasons is qualified as being true for advanced countries.

Besides the existence of structural unemployment, it is important to explain how structural unemployment is made worse as the skills gap that is to be narrowed is becoming wider and wider. Due to the wide difference in the skills required, it takes a much longer time to train workers and the increased learning curve makes it difficult for some low-skilled workers to move into the higher-skilled class.

Given that technological transfer occurs more rapidly these days, countries constantly need to alter their comparative advantages through acquiring of factor endowments over time. This means structural changes will occur more frequently, causing more frequent instances of structural unemployment.


FEATURE


IN CONCLUSION, THERE IS A HIGHER

PROPORTION OF STRUCTURAL UNEMPLOYMENT IN MANY COUNTRIES, ESPECIALLY

ADVANCED NATIONS, DUE TO STRUCTURAL REFORMS ACCORDING TO THE NEED TO DEVELOP NEW COMPARATIVE ADVANTAGES FOR THEIR ECONOMIES.

MICROECONOMICS

An important step taken by the student was to discuss the effects of globalisation on unemployment in BOTH developed and developing economies.

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