ECO202 –Macroeconomics Essay Example

  1. Explain four types of unemployment

The following are the four types of unemployment:

Structural unemployment – this type of unemployment occurs when there is a mismatch between workers and jobs as a result of lack of requisite skills among workers for certain jobs or simply lack of jobs that are desired by the workforce. The key determinants of structural unemployment are the dynamic changes in the economy and the social needs within the economy (Luke 2011). For example, if new technology is introduced, previous workforce may be rendered irrelevant as they may not have the required skills for the new technology. In addition, the technology may automate the processes that the workers used to work on.

Frictional unemployment – this type of unemployment is always in the economy. It occurs as a result of employers and workers making temporary transitions. This type of unemployment also occurs in instances where workers and employers have incomplete information. This unemployment type also depends on the dynamics of the economy and therefore it is related to structural unemployment. Some of the causes of frictional unemployment include lack of necessary skills, failing firms, obsolete skills or poor job performance (Luke 2011).

Cyclical unemployment – this type of unemployment occurs when there is a contraction on the economy. Economic growth normally leads to creation of jobs, which in turn results in low unemployment levels. On the other hand, when a recession occurs, it causes high levels of unemployment. Thus cyclical unemployment occurs as a result diminishing job openings that are as a result of economic contraction (Luke 2011).

Seasonal unemployment –this type of unemployment occurs in industries whose services or products are demanded only specific times during the year. Seasonal unemployment is common in construction work, farming and tourism (Luke 2011).

  1. Explain why the aggregate demand curve slopes downwards

The AD (Average Demand) curve indicates that when the price level decreases, purchases of output (real domestic) increase. The AD curve is downward sloping for the following three reasons:

The interest-rate effect – with the assumption that money supply remains unchanged in the economy, an increase in the price level implies that more money is required for inputs and for making purchases. Since the money supply remains unchanged, the increased demand for money will lead to higher rates of interest thus discouraging the purchase of goods, which in turn leads to decreasing quantities of demanded output.

The wealth/real balances effect –with an increase in the price level, the purchasing power of accumulated financial asset, including money, decreases. This therefore implies that people will be poorer in real terms leading to a decrease in the demanded quantity of real output.

Foreign purchases effect –as a given country’s price level increases in comparison with other countries, that specific country will experience low demand for its products from its populace, who will prefer to buy goods abroad. At the same time foreigners will decrease their demand for that country’s products, leading to decreased quantity of demanded real output in that country.

  1. Suppose the Reserve Bank Australia increases the interest rate. What happens to the supply and demand for Australian dollars? Does the dollar appreciate or depreciate? Explain with words and a diagram.

IECO202 –Macroeconomics f the Reserve Bank Australia decides to increase the interest rate, Australian investments become attractive. Investors will be able to get better rates of return after investing/saving with Australian banks. This therefore implies that the demand for Australian dollars will increase and consequently its supply will decrease. The Australian dollar will therefore appreciate in the short run before other factors that determine foreign exchange rates come into play.

AECO202 –Macroeconomics  1 US $ to US $ S1

ECO202 –Macroeconomics  2

Q1 Q2 Q of AUS $

From the above diagram, an increase in the demand for the Australian dollar leads to an increase in its value relative to the US $ (Factors which influence the exchange rate 2015).

  1. Explain the advantages and disadvantages of:

A flexible exchange rate regime

A flexible exchange rate has a number of advantages. The main advantage is that it protects the economy from the undesired effects of external shocks by adjusting appropriately. For instance, if oil prices rise, then the exchange rate will change accordingly and reduce the impact of the rise in oil prices. Additionally, the government is free to pursue the policies that it feels are good for the domestic economy without fear of having a conflict between such policies and the external policy. Lastly, a flexible exchange rate allows for restoration of competitiveness of exports in a case where there are balance of payments deficits by depreciating currency (Evrensel n.d.).

On the flip side, a flexible exchange rate regime leads to instability in the economy. That is, the value of currency is prone to large fluctuations leading to uncertainty for investors. Additionally, flexible exchange rate system, there is speculation, which causes exchange rate changes unrelated to the patterns of trade in the economy. Lastly, a flexible exchange rate system gives room for pursuance of inappropriate policies by the government domestically (Evrensel n.d.).

A fixed exchange rate regime

A fixed exchange rate regime is advantageous in that it offers certainty to investors. Investors are able to make investment decisions with a known exchange rate and thus their investments are less risky. In addition, there is no speculation in a fixed exchange rate system because people believe that there are no chances for devaluation or revaluation. Lastly, a fixed exchange rate system constrains government policy in a positive way. That is, the government may find itself unable to pursue irresponsible or extreme macro-economic policies because these would lead to a strain on foreign exchange reserves, which would prove to be unsustainable in the medium-term (Advantages and disadvantages of exchange rate systems n.d.).

A fixed exchange rate system is limiting in a number of ways. Firstly, the economy may not be able to adjust to shocks. A fixed exchange rate system implies that there may be no means for the government to take remedial measures when it faces balance of payment crises. In addition, fixed exchange rate systems need large reserves for foreign exchange, which can lead to international liquidity problems. If foreign exchange markets believe there may be a devaluation or revaluation, speculation may occur, which may have significant cost implications to the government in terms of foreign exchange reserves. A fixed exchange rate system has a deflationary bias in which countries deflate their economies in a bid to correct balance of payments deficits. Lastly, a fixed exchange rate may prove to be incompatible with other economic growth targets like unemployment and inflation, which may lead to conflict of policies (Advantages and disadvantages of exchange rate systems n.d.).


Advantages and disadvantages of exchange rate systems n.d. Available from [26 January 2016].

Evrensel, A n.d., The Advantages and Disadvantages of Flexible Exchange Rates. Available from [26 January 2016].

Factors which influence the exchange rate, 2015. Available from [26 January 2016].

Kontoleon, A. n.d., Answers to homework questions for chapter 11. Available from: [26 January 2016].

Luke, J 2011, Types (Causes) of Unemployment. Available from: [26 January 2016].