THEORY OF CYCLICAL UNEMPLOYMENT

The COVID-19 pandemic that is plaguing the world had created detrimental effects on both
public health and the economy in Malaysia. This crisis has hit economic development
leading to an economic recession. Resulting of that, many workers have lost their jobs as a
result of being laid off by the firms. This situation can lead to an increase in cyclical
unemployment which is known as demand deficient unemployment. This unemployment is a
component of unemployment that results directly from the cycle of economic growth and
recession that occurs.

First, when the economy enters a recession phase, there is a decline or decrease in
demand. If firms consider the economy to be at slow growth, no growth, or a period of
economic contraction and a recession, they will take the action to hire a lower quantity of
labor or they had to off their employees to make up for losses incurred in their sales to
further reduce the cost of operating expenses. It is due to demand for goods or services
decreasing, the goods or services produced or offered by the firms are cannot be sold and
end up bringing losses that have to be borne by the firms. At this time, the labor demand
curve will shift to the left. Firms will continue this process until they successfully manage to
recover the losses. But, if the firms are unable to recover the losses or even the situation
become worsens making them unable to survive in the market then, they will cease
operation

Furthermore, if firms consider the economy to be at development or expanding, they will hire
more quantity or greater quantity of labor. Due to the high demand for goods or services and
firms need efficient labor for the production of products or services. At this time, the labor
demand curve will shift to the right.

S
Wage Rate

W1 
W0 

D1
D0
Q0 Q1 Quantity of Labor

Figure 1: Rising demand for labor, wages rise

Figure 1 above shows when there is growth in the economy, an increase in demand leads to
a rise in demand for labor. Figure 1 above also illustrates the situation where labor demand
shifts to the right from D0 to D1. In this situation, the equilibrium wage increases from W0 to
W1, and the equilibrium quantity of labor hired increases from Q0 to Q1.

Wage Rate S

W0  
W1 

D0
D1
Q2 Q1 Q0 Quantity of Labor

Unemployment

Figure 2: Falling demand for labor, and unemployment

Figure 2 shows the situation it would tend to do in recession in which the demand for labor
shifts to the left, from D0 to D1. In a situation where wages do not decrease or decline, a fall
in the demand for labor from D0 to D1 leads to a decline in the quantity of labor at the wages
(W0) from Q0 to Q2. Some of the reasons that will cause the firms not to be able to reduce
wages, such as economic laws and institutions. For low-skilled workers, they receiving
minimum wages. So, it is illegal to reduce or cut their wages. In addition, workers who
operate under contract with the firms, reduce or cut their wages might violate the contract
and create a labor strike. Therefore, the wages instead of decreasing to W1 will remain at
W0. So, this will create a surplus situation where the aggregate demand for labor will be at
‘a’ in the curve and the aggregate supply of labor will be at ‘b’ in the curve.