Policies to Reduce Unemployment (Cambridge (CIE) A Level Economics): Revision Note

How to reduce unemployment

• The appropriate policy depends on the type of unemployment

  • Cyclical unemployment (demand-deficient) → primarily addressed with demand-side policies

  • Structural, frictional and voluntary unemployment → primarily addressed with supply-side policies

• Most real-world economies require a policy mix, with the balance depending on the state of the labour market

Demand-side policies

1. Expansionary fiscal policy

• Increases in government spending (G) or cuts in taxation raise disposable income and AD

• Multiplier effect amplifies the initial impulse — firms hire more workers as output rises

• Most effective when economy has a negative output gap (spare capacity)

2. Expansionary monetary policy

• Cut in interest rates reduces the cost of borrowing, raising consumption (C) and investment (I)

• Currency may depreciate, raising net exports (X−M)

• Quantitative easing increases money supply when interest rates approach zero

Diagram analysis

• The economy is initially in macroeconomic equilibrium at AP₁Y₁

  • This is a position below full employment (Y_FE) with spare capacity on the highly elastic section of the Keynesian LRAS

• The central bank wants to boost economic growth and lowers interest rates

• Lower interest rates cause investment and consumption to increase, which are components of AD

  • Aggregate demand increases from AD₁ → AD₂

  • The economy reaches a new equilibrium at AP₂Y₂

  • This is a higher average price level and a greater level of national output, as the economy moves up the upward-sloping section of the LRAS

• Employment rises as firms hire more workers to meet the higher level of output

  • Unemployment falls as the economy moves closer to Y_FE

Evaluating each policy

Supply-side policies

1. Market-based supply-side policies

• Cuts in income tax and benefits — raise incentive to work; reduce voluntary unemployment

• Trade union reform — increases labour market flexibility; reduces disequilibrium unemployment

• Deregulation of labour markets — easier hiring and firing encourages job creation

• Cuts in corporation tax — encourages firms to invest and expand employment

2. Interventionist supply-side policies

• Education and training — reduces structural unemployment by improving skills match

• Retraining programmes — help displaced workers move into new occupations (links to 9.3.6)

• Improved labour market information — job centres and digital platforms reduce frictional unemployment

• Subsidies to employers for hiring — e.g. wage subsidies for young or long-term unemployed workers

• Regional policy — infrastructure investment in high-unemployment areas to reduce geographical immobility

Evaluating each policy