Macroeconomics Essay Example


  1. (a) Frictional Unemployment

This type occurs when potential workers are able and willing to work at the prevailing wage rates, but cannot secure employment, or the employers cannot find these workers.

Frictional unemployment is caused by the disparity of information available and accessible between the potential workers and employers. A classic example of this is illustrated when college graduates actively engage themselves in scanning through the internet, newspapers and sending un-solicited job applications to potential employers in search of employment opportunities. Another case would be when workers are in between jobs. The time and effort spent when a worker leaves employment with a certain firm and is actively searching for an opportunity in other companies, considering such aspects as work hours, personal preferences like career development mobility and others.

  1. Structural Unemployment

It is caused by a mismatch between the specific skills required for a particular job and the skills that the labor market has to offer.

It occurs due to changes in the structure of the particular job which renders would have been skills available redundant. This is common with technological advancement for instance, where, automation of automobile production led to the unemployment of several blue collar workers. College students cannot predict with certainity, which job skills will be relevant by the time they graduate from college.

(c )Cyclical Unemployment

This type of unemployment occurs when there are shifts in the aggregate demand of labor in the market. In this case, the demand for employment by the workers is greater than the industries or labor market can offer.The boom economic times denote increased production rates which imply increased labor demand. When the economy is at recess, production levels go down, causing the loss of employment.

(d ) Seasonal Unemployment

This is caused by variations in demand levels throughout the business period.

Workers are employed when there is demand for their skills throughout that season, then have to wait again until the next season for them to get employment. For instance, ice cream vendors are fully employed during summer and remain unemployed during winter. This is caused by the changes in the weather throughout the year.

The aggregate demand curve slopes downwards due to inverse relationship between price levels and three distinct factors that are components of the aggregate demand. One is the wealth effect brought about by the relationship between real wealth and consumption. When price levels decrease, the value of real wealth increases. The increased purchasing power for a given level of real wealth induces more consumption which in turn increases the aggregate demand. For instance, if price levels reduce by 10%, $ 1000 wealth is worth more or can purchase more that it could at the initial price level.

The Interest Rate effect. This is caused by the relationship between interest rates and the level of investments. Interest rate is the price of money, and it determines the quantities of money demanded for investment. When interest rates increase, consumers demand high amounts of money for investments. Consequently, when interest rates rise, the demand level of money falls as well. Low levels of interest rates imply reduced mortgage payments, therefore low demand for money. For instance, if a firm requires $1 million for investment, a 10% interest rates, means that it would need to borrow $1.1 million, but at 6% interest rate, it will need to borrow a relatively lower amount, only $ 1.06 million.

The Exchange Rate Effect. This is caused by the effect of interest rates on foreign investments. When domestic interest rates decrease relative to interest rates offered in foreign markets, investors tend to invest abroad where they expect more favorable returns. The outflow of money to international markets depreciates the real exchange rate for domestic currency due to the influx of international currency. This in effect increases the level of domestic export to foreign markets, since they become relatively cheaper. This acts as an incentive for further production which then increases the aggregate demand.

The demand and supply of the Australian Dollar will decrease. This is because; it becomes expensive for commercial banks to borrow from the Reserve bank, thereby decreasing their demand and hence hold less money. Commercial banks in turn, due to the low supply of money on their end, increase their lending rates to consumers. This increases the interest rates for loans on consumable like cars, mortgages, investments etc. The population generally borrows less, therefore hold less amounts of money. Higher interest rates by the reserve bank also encourage the public to invest with the government, with the expectation of higher returns in the future. This in effect reduces the supply of the Australian dollar among the population by reducing the amount of currency available for disposal or consumption.

Due to its low supply in the economy, the Australian dollar will appreciate in value. Increased interest rates by the Australian Reserve bank and the consequent increased rates in the market attracts foreign investors, and the increased demand in turn leads to an increased ‘price’ of the Australian dollar, manifested in the exchange rate. Rising nominal rates by the Australian Reserve Bank do not in isolation cause an appreciation of the country’s currency but it is a positively determining factor. Other factors are at play in the valuing of the currency including economic and political stability, the country’s aggregate demand in terms of the balance of trade and increases gross domestic product. It is therefore important, for Australia in this case to maintain a healthy state of the increasing interest rates without the accompanying inflation, so that the Australian dollar can maintain an appreciated value in the long run.






Australian Reserve Bank Interest Rate

Australian Dollar value/USD


macroeconomics 1

Prepared from original data retrieved from the URL , retrieved on 01-June-2017.

As shown in the above diagram, the exchange rate of the Australian dollar decreases with corresponding decrease in Australian Reserve Bank Interest Rates between the years 2014 and 2017. The reverse relationship between these two variables is true.

(a) (1) Advantages of Fixed Exchange Rate Regime

(a) Caution against adverse currency fluctuations

Foreign exchange is influenced by changes in the aggregate demand of a country. When there is low demand for domestic exports in foreign markets, there exists a negative balance of trade, which negatively affects the country’s domestic currency. In a fixed exchange rate regime, this downward movement is not felt since the exchange rate of the currency is fixed, regardless of the performance of the economy or the level of the aggregate demand.

(b) Incentive for Investments

Fixing the exchange rate encourages foreign investors since their expected returns are not subject to any currency exchange rate risks. This improves investments by firms and individuals in the country.

(c ) Inflation Control

A fixed exchange rate protects a country against inflation that can be caused by independent monetary policy actions. The economy is able to control investments through varying interest rates.

(2) Disadvantages of Fixed Exchange Rate Regime

  1. Conflict with other monetary policy motives.

There is need for some degree of flexibility in exchange rates to ensure that the economy remains stable and that the country can fairly compete in international markets. A country employing fixed exchange system in the face of inflation and high levels of unemployment may find it difficult to reap from the benefits accruing from increasing its interest rates so as reduce the money supply.

  1. Wrong choice of an exchange rate

The rate chosen by an economy for fixed exchange rate may deny it economic development. If it is too low, it will eventually lead to inflation, and if too high it will cause a negative balance of trade. Both instances unfavorable to the economy.

  1. Advantages of Flexible Exchange Rate Regimes

  1. Stabilizing the Economy

When other economic variables like the level of unemployment, demand for domestic produce abroad, consumption levels and interest rates, the exchange rates acts to even out the effects caused by these. It is therefore an automatic measure that acts to stabilize the economy.

  1. Low reserve requirements

Flexible exchange rate is left to be influenced by the variations in underlying factors, which implies that the central bank has little or no control over the value of the country’s currency. It also does not need to hold huge amounts of foreign currency reserves to ensure or maintain it’s a fixed exchange rate.

Disadvantages of Flexible Exchange Rate Regimes

  1. Uncertainty

Flexible exchange rates are dependent on the underlying factors performance. It normally rises and falls in a minute. Investors may have difficulties engaging in foreign investments of a flexible exchange regime since they are not certain the level of return for their investments.

  1. Lack of Optimal Resource Allocation

As exchange rates change, so does the returns from employment of resources. If exchange rates keep fluctuating, an economy cannot settle on one specific strategy in the long term.


Economics Online, Types of Unemployment , viewed on 01.June.2017,

Economics Help, Aggregate Demand, viewed on 01.June.2017,

Management Study Guide, Advantages and disadvantages of freely floating exchange rates, viewed on 01.June.2017,