ChainWhat it assumes · how to break it
Start
The world economy falls into recession, as in 2008-09, and demand for UK exports such as cars, machinery and financial services falls.
1
As a result, households and firms abroad cut spending, so demand for UK exports falls.
exports · income elasticity of demand (YED)
exports · income elasticity of demand (YED)
Assumes: UK exports are income elastic.
But: Exports of necessities and essential services fall less than exports of luxury goods, cars or financial services.
2
This means net exports fall, so aggregate demand shifts to the left.
net exports · aggregate demand
net exports · aggregate demand
Assumes: Imports do not fall by as much as exports.
But: If UK incomes fall too, spending on imports also falls, partly offsetting the fall in exports in net trade.
3
Consequently, exporting firms cut output, so their derived demand for labour falls and they cut hours and jobs.
derived demand for labour
derived demand for labour
Best link to attack
Assumes: Firms cut jobs rather than hoard labour.
Assumes: Firms cut jobs rather than hoard labour.
But: In the UK in 2008-09 many firms kept workers on reduced hours or with pay freezes, so employment fell less than output.
4
Therefore, workers who lose jobs or hours spend less, and through the multiplier demand falls in domestic sectors such as retail and hospitality.
multiplier
multiplier
Assumes: Households cut spending when incomes fall.
But: Unemployment benefits and other automatic stabilisers support incomes, so spending falls less.
5
As a result, cyclical unemployment rises across the economy, not only in exporting industries.
cyclical (demand-deficient) unemployment
cyclical (demand-deficient) unemployment
Assumes: Wages do not fall enough to price workers back into jobs.
But: If wages are flexible, firms may cut pay rather than jobs, so unemployment rises less but real incomes fall.
End
Employment falls and cyclical unemployment rises, starting in exporting industries and spreading through the multiplier.
Evaluation chain
- E1However, the size of the rise in unemployment depends on whether firms cut jobs or hoard labour.
- E2When workers accept pay freezes or shorter hours and firms expect demand to recover, then firms keep their skilled workers rather than pay to rehire and retrain them later.
- E3As a result, employment falls less than output, although productivity and real wages fall instead.
- E4So unemployment may rise by much less than the fall in GDP suggests, as happened in the UK after 2008 compared with earlier recessions.
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Questions this answers
- Assess the impact of a global recession on unemployment in the UK.
- Explain how a fall in demand for exports can lead to cyclical unemployment.
- Discuss whether a global recession would affect employment equally in all regions of a country.
Diagram
AD/AS diagram with AD shifting left and real output falling, linked to the fall in derived demand for labour; a labour market diagram with labour demand shifting left can support it.
Reverse and related
Global boom → export demand rises, firms take on workers and cyclical unemployment falls.