Question

QUESTION THREE [25]

3.1 Fully discuss the type of unemployment that is linked to the business cycle of an economy. (10)

3.2 Explain how monetary policy can be implemented to meet the key macroeconomic objective of stable prices.

Answer 1

1. Unemployment refers to when a person is considered under the workforce, and willing, able, and eligible for work but does not get any job for various reasons. Four types of unemployment are linked to the business cycle, such that:

· Frictional unemployment: It refers to the time period when a person searches for a job after studying or after leaving his previous job. When an individual is trying to change his/her job and resigned from his job to find another job, that time, an individual faces frictional unemployment as he does not get any money during this period.

· Seasonal unemployment: It refers to unemployment when people who have specific skills and only able to work for a particular period of time due to some reasons such as a change in weather, change is the taste and preferences of the people. For example, people who sell woolen clothes will face seasonal unemployment as woolen clothes are not demanded in the summer due to which seller of woolen clothes does not get income in summer.

· Structural unemployment: It refers to unemployment when there is a difference between the skills of the people and the requirements of the employer. An individual faces structural unemployment when their skills are no more demanded by the employer due to which an individual will face difficulty in finding a job and does not get income.

· Cyclical unemployment: it refers to the type of unemployment that occurs due to the fluctuations in the business cycle such as peak, boom, recession, and so on. Such type of unemployment can be seen when an economy faces recession due to which employers need a lesser number of workers, as a result, start firing extra workers.

2. Monetary policy refers to the government action that is controlled and implemented by the central bank of any country. It is the most effective policy that is used to stabilize the price level as it directly affects the aggregate demand in the economy. The central bank generally uses open market operations as a monetary policy under which it buys or sells government securities to different sectors of the economy, such as households, financial institutions, and others.

When there is an increase in aggregate demand due to which price level increases, the central bank sells government securities in the market due to which people pay for such securities, which, in turn, decreases the money held by the people. As a result, aggregate demand decreases, and the price level came down to the initial level.

In contrast, when there is a decrease in aggregate demand due to which price level decreases, the central bank buys government securities from the people due to which people get money by selling such securities, and that, in turn, increases the money holding by the people. As a result, aggregate demand increases, and price level came up to the initial level.