Demand-Deficient (Cyclical) Unemployment

Idea

Demand-deficient unemployment occurs when aggregate demand is too low to employ the whole labour force. Because it rises and falls with the business cycle, it is also called cyclical unemployment.

Mechanism

When aggregate demand (AD) is insufficient, the economy produces below its full-employment level of output, leaving excess capacity. Firms facing weak demand reduce output and so employ fewer factors of production, including labour. The gap between current output and full-employment output is the measure of the deficiency, and the labour left idle in that gap is demand-deficient unemployment.

Diagram

Demand-deficient unemployment: aggregate demand AD₀ intersects aggregate supply on its horizontal range at output Y₀, below the full-employment output Y_f. The Y₀–Y_f gap is the excess capacity; the labour idle within it is demand-deficient unemployment.

Considerations

Two routes drive the demand shortfall:

A fall in external demand. When trading partners enter recession, their consumers cut spending on imports, reducing the domestic economy’s export revenue and so its AD. Highly export-dependent economies are exposed — Singapore’s unemployment rose sharply in the 2008 global financial crisis as export revenue fell.
A fall in domestic demand. In the downswing of the business cycle, weak consumer and investor confidence and low profits lead firms to cut output and employment.

Because the cause is a shortfall of total spending, the standard remedies work on demand — expansionary fiscal and monetary policy, currency depreciation, and protection — though the detail of those policies belongs to the macroeconomic-policy topic and is not pursued here.