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Essay Samples > Economics > Macroeconomic Stabilization Theory
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Macroeconomic Stabilization Theory

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It is the expectation of all macroeconomists that all markets operate according to the functions of demand and supply curves. This is because; the demand and supply determine the direction of these markets in terms of the quantity of goods and services supplied and the prices at which these products are sold or purchased. A perfect market will always have its demand and supply curves meeting at a certain point commonly referred to as the equilibrium point. At this point, the total quantity of the goods and services demanded equals the total quantity of the goods and services supplied at a given price. Thus a market that meets this requirement is referred to as a clearing-market since there are no deficits or surpluses incurred. Taking a closer look at the labor market, this work will determine if it is appropriate for it to be considered as a clearing market or not.   

According to macroeconomics definitions, a labor market can be described as the exchange of labor services for wages and/ or salaries where as labor is the number of available human resources that a given company is willing and ready to hire at a given period of time and at a given wage. Like every other market, the labor market is affected by the aggregate demand for labor and the aggregate supply as well. According to Arnold (2007, p.153) aggregate demand is described as the total amount of finished goods and/ or services that can be purchased in a given economy and any given time and price. It is the quantity of products and services that can be bought at all possible prices. The aggregate demand curve is usually represented by a downward inclined curve which implies that when the prices of the goods are low or decrease, their demand is usually high. Figure 1 illustrates the inverse proportional relationship between the product prices and the product quantity that can be purchased at that price. As the prices increase from INFL1 to INFL2, the purchasing power decreases hence the demand reduces from y1 to y2.

http://webpages.shepherd.edu/lkinney/ECON%20123/ADAS123.doc

Aggregate supply on the other hand is described as the total amount of goods and services that a given economy can supply at a given period of time (Grant & Vidler 2003). The production of goods and services varies depending on the demand for those products. If the demand is high, the goods supplied may become insufficient in meeting the needs of the consumers, therefore companies make efforts to produce more so as to satisfy the consumers. The aggregate supply curve, as shown in figure 2, is usually upward-inclined following the fact that when the products prices increase, their supply increases as well.

http://webpages.shepherd.edu/lkinney/ECON%20123/ADAS123.doc

This is because, as illustrated in figure 2 above, a higher selling price motivates the producers and suppliers to produce and sell more products respectively. Therefore as product prices increase from INFL1 to INFL2, most producers are motivated to produce and as a result, total product supply increases from y1 to y2.

At any given time and economy however, these two functions work simultaneously. One function decreases with an increase of the other function. For instance, the supply increases with a decrease in demand due to the fluctuation in prices. As stated by Nattrass (2002, p. 130). The meeting point of these two curves is known as the point of equilibrium where when all other factors are held constant, the amount produced equals the amount consumed or demanded. As illustrated in figure 3, the point EMR is the point of equilibrium whereby the suppliers are willing to sell their products at price INFL1 and the consumers are willing to purchase quantity Yf of the products at the same price, INFL1.  At this point, there is maximum exploitation of resources and no product surpluses are found in the market.

http://webpages.shepherd.edu/lkinney/ECON%20123/ADAS123.doc 

Using the above illustrations, it has never been possible for a labor market to reach to equilibrium.  This is as a result of factors which change the labor force and the unemployment levels. The labor force here is described as the number of people that are sixteen years and above, or determined by the constitution of the country, who are in employment or they are looking for employment (Mazumdar & Sarkar 2008). This number however excludes those people serving in the army, those who are hospitalized and the detainees since they do not contribute to the economy. Factors that bring changes in to the labor force include the natural population increase. Since people are born year in year out, and the birth rate increases every year, the number of people is always higher than the number of job opportunities that a given economy can offer at a given time. Thus the labor force varies depending on the number of people that are born every year.

Another factor that affects the labor force is immigration. Even though some countries have low birth rates, their population keeps on increasing due to the number of people that enter into the country. Some enter legally in search for greener pastures, education, advanced technology or as registered refugees where as other enter into the country illegally for more of less the same reasons (Mazumdar & Sarkar 2008). A country can only control the entrance of the lawful immigrants but may not be in a position to control the entrance of the non-registered immigrants. There entrance into this country therefore means that the level of the labor force has increased. A country that can control the number of people migrating into it will definitely have a relatively lower labor force than a country that can not control the movement of foreigner into it. Migration rate is however a two way equation. People who leave their country for another reduce the level of labor for in this country.  Retirement is also another factor that affects the labor force. Different countries, depending on their constitutional demands, have imposed different ages after which an individual is expected to retire from work. Thus people who retire when their time comes reduce the level of labor force therefore causing some variations. 

Unemployment on the other hand comprises of all the people who are past the age of sixteen years old and are neither employed nor looking for any form of employment. This group includes prisoners, hospitalized, and housewives etc. Mazumdar & Sarkar (2008, p.149) Factors that are presumed to bring variations in the level of unemployment include inflows from people who were once not looking for employment and start to look for employment. For instance, house wives who begin to look for employment to supplement their spouses’ earnings or those grown ups that have just turned sixteen and are now looking for employment.

Another factor is that of people who were once employed but have lost their jobs and are now looking for new jobs. Others just leave their current jobs because either the working conditions are not conducive or they are not well paying. Such people start looking for new well paying jobs or look for favorable working environments thus affecting the unemployment levels. There are also those people who decide to drop or lose their jobs but are not interested in looking for other jobs (Ghatak 1994). These similarly contribute to the unemployment level.

These factors, coupled with the fact that the economic growth is not always constant have rendered the labor market different from all other markets. While like the other markets, its wages and salaries are determined by the forces of demand and supply, it differs from them in a number of ways. The most conspicuous different is that of the demand and supply in setting the wages and the quantity. While in other markets the insufficient supply leads to the production of more goods until the demand of the people is satisfied; this is not the case with labor market. Sufficient supply can not be produced because people can not be manufactured and at the same time they work within a restricted amount of time. Therefore having them meeting the functions of demand and supply may not be possible. While it is expected that an increase in wages and salaries leads to an increase in the labor supply, the income effect contradicts this. Mazumdar & Sarkar (2008, p. 110) suggests that an overall rise in the wages and salaries may result into a low labor supply. This is due to the reason that laborers may take a good amount of time off their duties to go and spend this increased income. Thus instead of having a high supply, there is a low supply of labor. The substitution effect on the other hand demands that an increase in wages may result into an increase supply of workers due to opportunity cost. It is however believed that these two effects; the income effect and the substitution effect may cancel out to bring about no impact on the labor supply i.e. no significant increase may be detected on the labor supply (Mazumdar & Sarkar 2008).

It can therefore be deduced from this reasoning that labor market is not a clearing-market. It is thus inappropriate to consider the labor market as a clearing market because, Ghatak (1994, p. 78) asserts that it does not meet the requirements and qualifications of a clearing market; it does not have a real equilibrium point. In market clearing, the amount demanded should equal the amount supplied i.e. the amount of goods and/or services supplied by the producers should be equal to the amount of goods and services purchased by the consumers at any given time regardless of their prices. This is therefore regarded clearing because there will be no deficit or surplus (Baldwin et al 2005). The goods and services supplied will exactly meet the needs of the customers and they will be supplied at a price that will be affordable to the consumers. Similarly, the consumers will be comfortable with the prices therefore they can free buy the goods and there will be no surplus. Thus the quantity supplied by the producers equals the quantity demanded by the consumers. While all other markets can absorb their surpluses given time, the labor market can not. There has always been a constant unemployment since the demand and the supply curves of labor do not reach to equilibrium (Nattrass 2002).

It can therefore be concluded that a labor market involves the exchange of labor for wages and salaries and like any other market, the supply of man power and the wages are determined by the forces of the supply and demand curves. An aggregate demand is the total amount of products and services that consumers are ready and willing to buy at a given price in a given economy. An aggregate supply on the other hand is the total amount of goods and services that suppliers are willing and ready to supply at a given period of time for a given amount of money. When all other factors are held constant, the aggregate supply curve and the aggregate demand curve meet at the point of equilibrium where the amount demanded equals the amount supplied. A market is qualified to be called a clearing-market at any given time if its aggregate demand and aggregate supply curves meet at a central point, the equilibrium point. At this point, there are neither deficits in production or surpluses on consumption. A labor market can not therefore be considered a clearing-market because its aggregate demand and aggregate supply curves never meet at an equilibrium point. That is why at any given time there is a surplus of people looking for employment. Even though the number of people actively looking for employment may vary from one country to another, the fact remains that the labor market has never and will never lack surplus, thus it is a non-clearing market. This is so because of the natural populace growth rate, immigrations and job preferences among others.

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