Unit 3.3, Chapter 11, the Last Word

1) Weigh the two arguments regarding unemployment in Europe. Is unemployment high because of high because of high natural rates of unemployment or because of deficient aggregate demand?
**Argument 1::High natural rates of unemployment. It has been claimed by many economists that the high unemployment rates in Europe are considerably normal, and are simply due to the high natural rates of unemployment in these countries. They believe that the full-employment level of real output has been reached, and there are simply high levels of frictional and structural unemployment. Therefore, for these countries to increase aggregate demand (for it has also been claimed that the high unemployment rate is due to deficient aggregate demand) would cause the countries to produce at a level higher than full-employment and would thus lead to demand-pull inflation. There is one main reason for the high natural rates of unemployment in these countries: the cost of hiring workers is relatively high while the cost of being unemployed is low. Because of this, firms do not hire low-skilled workers due to the high minimum wages, and the large amount of welfare benefits far from encourage people to look for jobs.
**Argument 2::Deficient Aggregate Demand. Other economists claim that the high rates of unemployment in Europe result from "insufficient aggregate demand". The believe that, for fear of causing inflation, European governments have not established policies in order to increase aggregate demand, and countries are therefore producing a real output lower than it should. According to these economists, an outward shift in the aggregate demand curve would simply expand output and employment without causing inflation.

Perhaps the reason for high unemployment rates in Europe lies between these two arguments; natural rates of unemployment may be relatively high in comparison to the united states due to the high minimum wages and generous welfare benefits offered by European governments; however, aggregate demand might also be slightly lower than it perhaps should be. Therefore, a combination of lower minimum wages, a slight reduction of welfare benefits, and expansionary government policies such as reduced interest rates would perfectly solve the problem of the high unemployment rates in Europe.



2) Explain the experience of the US between 1996 and 2000 when the economy was at greater than full employment with high GDP growth while maintaining low levels of inflation. What allowed this so-called "New Economy" to occur, and what brought it to an end in 2001?

Between 1996 and 2000, the US economy was about to operate at greater than full employment with high GDP growth while maintaining low levels of inflation, for both AD and AS shifted out. Therefore, GDP increased while the Price Level remained fairly constant.