Yr 12 Exam Preparation

– Extended Responses

3. Account for the trend in Australia’s unemployment rate in the last five years and
discuss the main economic problems associated with unemployment

Australia’s has experienced many different economic conditions in the past five years,
ranging from a peak in the business cycle in 2007-08 to a trough in 2008-09 to a rapid
recovery in 2010-11. As the negative correlation between economic growth and
unemployment is very strong, Australia’s unemployment rate troughed in 2007-08 but rose in
2008-09 due to the global financial crisis (GFC). The government has nevertheless used
many different macro- and micro-economic policies in the last five years to reduce
unemployment in Australia, since unemployment is capable of causing many subsequent
problems including opportunity costs, budget deficits and inequitable distribution of income.
Australia’s sustained economic growth that has been uninterrupted since 1991 reached a
peak in 2007-08 as a result of increasing asset prices caused by the housing boom. As
households received more income from their appreciating assets, Australian businesses
produced more goods and services to meet the economy’s growing aggregate demand.
Consequently, cyclical unemployment fell as more labour is hired to allow firms to increase
their output. Structural factors in addition contributed to Australia’s low unemployment in
2006-08. Due to microeconomic reforms introduced in the 1990’s e.g. decentralised
productivity-based wage negotiations, labour productivity improved and encouraged
employers to use labour rather than capital. A combination of these factors made Australia to
approach and pass its NAIRU—estimated to be around 5% unemployment—in 2006-07. In
February 2008, Australia’s unemployment rate further troughed at 4% of labour force. This
was its lowest level in more than 4 decades.
In late 2008, however, unemployment began rising after the onset of the Global Financial
Crisis arrived in Australia. Unemployment peaked at 5.8% in May 2009, which was 1.7%
higher than its level of 4.1% in August 2008 at the peak of the economic cycle. The GFC was
capable of raising the unemployment rate because in downturns, Wage Level
businesses become uncertain about future demand and profit S
D
levels and hence reduce output and their demand for labour. As a a b
result, there is a surplus of supply ab in the labour market. W Min

However, since prices in the labour market are regulated by the W E

Minimum Wage Panel of Fair Work Australia, wages cannot fall

to the new equilibrium wage level of OW E to allow the labour S D
market to clear the surplus of workers. The supply of labour O
(OQS) therefore exceeds the demand for labour of (OQ D), Q D
Q E
Q S
Qty of
Labour
causing an increase in unemployment.
 Nevertheless, Australia’s increase in unemployment Expenditure
AS
during the GFC was significantly lower than that in the Unemployment/
US (5.25%) and in Europe (2.75%). This could largely be Deflationary Gap

attributed to the government’s timely and targeted Eq

ADF
F
economic stimulus packages that helped sustain jobs. As E ADE
F

the Keynesian unemployment gap diagram shows on the G Eq E

right, lowered aggregate demand level during the GFC E E

could only sustain an equilibrium level of employment at

O
YE. To make the economy return to full employment at Y F, Y Y Income
E F
the government has to increase its discretionary spending
from OEE to OEF to fill the unemployment gap.
As a result, in October 2008, the Rudd government announced its first economic
stimulus package of $10.4b. The package included initiatives such as the $900 cash bonus
targeted at low income earners who have a high marginal propensity to consume (MPC). This
was effective at stimulating economic activity because according to the simple multiplier
formula k = 1 / (1 – MPC), the multiplier effect increases as MPC increases. This ensured that
the initial injection of $10.4b into the Australian economy caused a larger-than-proportional
increase in Australia’s national income, which maintained a sound level of aggregate demand
in the economy. This meant that firms retained staff to produce outputs to meet the demand,
which lowered the unemployment rate. The government’s second economic stimulus package
of $42b further introduced programs that directly generated jobs, including the $17.4
Building the Education Revolution program and the $3.9 Home Insulation Program. Since
these programs targeted the heavily labour-intensive construction industry, the government’s
stimulus has helped support more than 210,000 jobs during the GFC. Government fiscal
policy therefore explained why Australia’s unemployment rate has begun to trend down in
much of 2010.
Australia’s unemployment rate has nevertheless not had a sharp decrease after the GFC.
This was because as Australian employers have experienced a severe labour shortage in the
2000’s, they were wary of cutting jobs during the GFC, since they know when the economy
eventually recovers, finding suitable workers would be difficult. To save business running
costs, they reduced worker’s hours instead. When the downturn ended, employers were
therefore able to respond to the growing demand by simply re-increasing their workers’ hours
rather than hiring new staff. Fewer jobs were hence created after the GFC, which explains
why unemployment only returned to 5.2% by November 2010.
Maintaining full employment is an important goal of economic Good A
policy makers because unemployment has a wide range of negative
effects on the economy, the most important of which is the opportunity
cost of low economic growth. As the production possibility frontier on
the right shows, unemployment causes an economy to operate at U
U
where the production level of neither good A nor good B is maximised.
Since output is lower than what the economy is capable of achieving, the Good B
level of economic growth is not as high as it would have been had there
been full employment. In addition, since resources are being allocated towards assisting the
unemployed during period of high unemployment, not as much resources could be allocated
towards producing capital goods. This therefore also reduces the economic growth rate in the
long-term, since low investment in capital goods usually means that less goods and services
can be produced in the future.
High unemployment also often contributes towards budget deficits, since the government
is obliged to increase its spending on social welfare payments as well as on providing better
training and job search facilities. In 2008-09 when unemployment rose to 5.8% due to the
GFC, the government’s social welfare expenditure rose from $97,842m in 2008-09 to
$124,581m in 2009-10, which is equivalent to an increase of 27.3% on the previous year.
This reflects the fact that as more people became unemployed during the GFC, they became
eligible for Centrelink’s NewStart Allowance. The government’s budget deficit is exacerbated
by the fact that since less people are working when unemployment rises, its personal income
taxation revenue would decrease. This would ultimately mean increased tax burden on future
Australian taxpayers, since deficits would eventually have to be returned to surpluses through
increased tax rates.
Unemployment in addition results in a redistribution of income away from low income
earners to high income earners. High income earners are unlikely to lose their jobs in
economic downturns because the very reason for their high income is their possession of
highly-demanded skills. This means that skills such as performing heart operations are always
demanded regardless of economic conditions. Low income earners, meanwhile, are so paid
because they do not possess skills for which employers have a high demand. Hence, in a
downturn, those unemployed are more likely to become reliant on social welfare, while most
high income earners stay in their jobs and keep receiving an income. Unemployment
therefore causes a more inequity income distribution. This could have many negative
economic effects, such as lowered aggregate demand (as high-income earners’ savings could
have been spent if redistributed to low-income earners) and increased burden on the
government (as low-income earners require greater social security payments).
Unemployment is thus an undesirable scenario that could be harmful to the economy, as
it presents it with opportunity costs, increases the government’s social welfare expenditure
and increases income inequality. As the business cycle troughed in 2008-09, unemployment
and its related problems have to a certain extent affected Australia’s economic performance.
However, the government has since taken actions that prevented unemployment from rising
too rapidly. These policies stabilised Australia’s economic cycle, and consequently it could be
argued that it was these actions ensured that the impact of unemployment on the Australian
economy was limited in the last five years.