Aggregate demand for labor and Aggregate

supply of labor
Aggregate demand for labor and Aggregate supply of labor

AD and AS is the total demand and supply of labor in the whole economy. The real average
wage rate is plotted on the vertical axis. This is the average wage rate expressed in terms of
its purchasing power: in other words, after taking prices into account.
The aggregate supply of labor curve (ASL) shows the
number of workers willing to accept jobs at each wage rate.
This curve is relatively inelastic, since the size of the labor force at any one time cannot
change significantly. Nevertheless it is not totally inelastic because (a) a higher wage rate will
encourage some people to enter the labor market (e.g. parents raising children), and (b) the
unemployed will be more willing to accept job offers rather than continuing to search for a
better-paid job. The aggregate demand for labor curve (ADL) slopes
downwards. The higher the wage rate, the more will firms
attempt to economies on labor and to substitute other
factors of production for labor.
The labor market is in equilibrium at a wage of We –
where the demand for labor equals the supply.
If the wage rate were above We, the labor market would
be in a state of disequilibrium. At a wage rate of W1, there is
an excess supply of labor of A – B. This is called disequilibrium unemployment.
For disequilibrium unemployment to occur, two conditions must hold:
• The aggregate supply of labor must exceed the aggregate demand.
• There must be a ‘stickiness’ in wages. In other words, the
wage rate must not immediately fall to We.
Equilibrium level of unemployment

The curve N shows the total number in the labor force.

The horizontal difference between it and the aggregate supply
of labor curve (ASL) represents the excess of people looking for
work over those actually willing to accept jobs.
Q e represents the equilibrium level of employment and
the distance D – E represents the equilibrium level of
unemployment. This is sometimes known as the natural
level of unemployment.
Note that the ASL curve gets closer to the N curve at higher
wages. The reason for this is that the unemployed will be more
willing to accept jobs, the higher the wages they are offered
equilibrium and disequilibrium unemployment

Figure 14.5 shows both equilibrium and

disequilibrium unemployment.
At a wage of W1, disequilibrium
unemployment is A – B; equilibrium unemployment
is
C – A; thus total unemployment is C – B.
 Assignment
But what are the causes of disequilibrium unemployment? What are
the causes of equilibrium unemployment?
(page no 401)
Aggregate demand and Aggregate supply

As Aggregate demand consist of four elements :

consumer spending (C), private investment (I), government
expenditure on goods and
services (G) and expenditure on exports (X) less expenditure
on imports (M).
AD = C + I + G + X - M
AD Curve is downward slop because of income effects and
substitution effects.
The aggregate supply (AS) curve shows the amount of
goods and services that firms are willing to supply at each
level of prices. To keep things simple, let us focus on the
short-run AS curve. When constructing this curve, we
assume that various other things remain constant. These
include: wage rates and other input prices, technology and
the total supply of factors of production (labor, land and
capital)
Equilibrium in the macroeconomic occurs when aggregate
demand and aggregate supply are equal. To demonstrate
this, consider what would happen if aggregate demand
exceeded aggregate supply: for example, at P2
Rate of inflation
 Rate of inflation
The rate of inflation measures the annual percentage
increase in prices.
Demand-pull Inflation

Demand-pull inflation is caused by

continuing rises in
aggregate demand. In Figure 14.10, the AD
curve shifts to the right (and continues doing
so).
Cost-push inflation

Cost-push inflation
Inflation caused by persistent rises
in costs of production (independently of
demand).
Cost-push inflation is associated with
continuing rises in costs and hence continuing
leftward (upward) shifts in the
AS curve. Such shifts occur when costs of
production rise
independently of aggregate demand
Additional causes of cost-push inflation include the
following:
• Tax-push inflation.
• The exhaustion of natural resources.
 Policies to control inflation
Demand-side policies
Policies designed to affect aggregate demand: fiscal policy and monetary policy.
Supply-side policies
Policies designed to affect aggregate supply: policies to affect costs or productivity.
Fiscal policy
Policy to affect aggregate demand by altering the balance between government expenditure
and taxation.
Contractionary (or deflationary) policy
Fiscal or monetary policy designed to reduce the rate of growth of aggregate demand.
Expansionary (or reflationary) policy
Fiscal or monetary policy designed to increase the rate of growth of aggregate demand.
Monetary policy
Policy to affect aggregate demand by altering the supply or cost of money (rate of interest).
Balance of payment and exchange rate
 Balance of payment and exchange rate

Open economy
One that trades with and has financial dealings with other countries.
Current account of the balance of payments
The record of a country’s imports and exports of goods and services, plus incomes
and transfers of money to and from abroad.
Balance on trade in goods or balance of visible trade or merchandise balance
Exports of goods minus imports of goods.
Balance on trade in goods and services or balance of trade
Exports of goods and services minus imports of goods and services.
Balance of payments on current account
The balance on trade in goods and services plus net investment incomes
and current transfers.
Capital account of the balance of payments
The record of the transfers of capital to and from abroad.
Financial account of the balance of payments
The record of the flows of money into and out of the country for the
purposes of investment or as deposits in banks and other financial
institutions.
Exchange rate
 Exchange rate
• An exchange rate is the rate at which one currency trades
for another on the foreign exchange market.
Arbitrage
Buying an asset in a market where it has a lower price and selling it again
in another market where it has a higher price and thereby making a profit.
Floating exchange rate
When the government does not intervene in the foreign exchange
markets, but simply allows the exchange rate to be freely determined
by demand and supply.
 Depreciation VS Appreciation

Depreciation
A fall in the free-market exchange rate of the domestic currency with
foreign currencies.
Appreciation
A rise in the free-market exchange rate of the domestic currency with
foreign currencies.