OxfordAQA International AS and A-level Economics: Employment, unemployment, inflation and deflation (9640)

This guide follows the OxfordAQA International AS and A-level Economics (9640) specification, version 1.2. It covers section 3.2.3.2 (employment and unemployment) and section 3.2.3.3 (inflation and deflation). Section 3.2 is International AS content; the same ideas support the extra International A2 content. All countries, firms and figures below are invented and illustrative.

Use it with the revision notes and the practice set. The course page is OxfordAQA A-level Economics, the checklist tracks progress and the free diagnostics find weak spots. For index numbers and real values see measurement of macroeconomic performance.

What you must be able to do

Section	Outcome
3.2.3.2	Measure unemployment, including the ILO measure
3.2.3.2	Explain cyclical, structural, frictional and seasonal unemployment
3.2.3.2	Distinguish unemployment from underemployment
3.2.3.2	Explain demand-side and supply-side influences on employment
3.2.3.2	Explain global influences on employment
3.2.3.3	Define inflation, deflation and disinflation
3.2.3.3	Analyse demand-pull and cost-push inflation
3.2.3.3	Explain the effects of world commodity prices, money supply and the exchange rate on inflation

Measuring unemployment

The International Labour Organisation (ILO) measure counts a person as unemployed if they have no job, are available to start work soon and have actively looked for work recently. Anyone in work is employed. Everyone else of working age is economically inactive (students, carers, people who have stopped looking).

• Labour force: the employed plus the unemployed
• Unemployment rate: (unemployed ÷ labour force) × 100
• Participation rate: (labour force ÷ population of working age) × 100

Worked example (Country Alpha, illustrative). Working-age population 6,500,000. Employed 4,180,000. ILO unemployed 220,000. Inactive 2,100,000.

• Check: 4,180,000 + 220,000 + 2,100,000 = 6,500,000.
• Labour force = 4,180,000 + 220,000 = 4,400,000.
• Unemployment rate = 220,000 ÷ 4,400,000 × 100 = 5.0%.
• Participation rate = 4,400,000 ÷ 6,500,000 × 100 = 67.7%.

Now suppose 44,000 unemployed people give up looking and become inactive. Unemployed = 176,000. Labour force = 4,356,000. Rate = 176,000 ÷ 4,356,000 × 100 = 4.04%. The rate fell although nobody found a job, and participation fell to 67.0%. So a falling rate can hide discouraged workers. Because the ILO measure relies on survey answers about searching, it also excludes people who want work but are not searching.

Types of unemployment

Type	Cause	Example	Suited policy
Cyclical	Weak aggregate demand	Factory lays off staff in a downturn	Raise aggregate demand
Structural	Mismatch of skills or location	Mill closes, workers lack skills for new jobs	Retraining, mobility support
Frictional	Time spent between jobs	Graduate searching for a first post	Better job information
Seasonal	Predictable yearly demand	Resort staff laid off in winter	Little; often accepted

Cyclical and the output gap. A negative output gap means real GDP is below the productive potential of the economy. Firms need fewer workers, so cyclical unemployment rises. Illustration: potential output 500, real GDP 485. Gap = (485 − 500) ÷ 500 × 100 = −3.0%. Raising aggregate demand can close the gap and cut cyclical unemployment.

Supply-side causes and LRAS. Structural and frictional unemployment are supply-side. They reduce the normal capacity level of output, so the vertical long-run aggregate supply (LRAS) curve sits further left than it would with better matching. Raising aggregate demand alone then risks inflation instead of jobs. The policy must match the cause: retraining and mobility help structural unemployment, and extra demand does not.

Unemployment and underemployment

Unemployed people have no work. Underemployed people have work but not enough of it or not the right kind: part-timers who want full-time hours, or graduates in jobs that use few of their skills.

Worked example. In Country Alpha, 410,000 of the 4,180,000 employed want more hours. Underemployment = 410,000 ÷ 4,180,000 × 100 = 9.8%. A worker on 16 hours who wants 40 has 24 unused hours, or 60% of capacity. These people are counted as employed, so the 5.0% unemployment rate understates spare capacity in the labour market. Underemployment signals wasted resources, lower incomes and lower output, and it can mean a negative output gap even when headline unemployment looks low.

Demand-side and supply-side influences on employment

Labour demand is derived demand: firms hire workers to produce goods that people buy.

• Demand side: higher consumption, investment, government spending or net exports raise aggregate demand, output and employment. A fall does the reverse.
• Supply side: wages relative to productivity, skills, education, labour mobility, benefits that weaken the search for work, and regulation that raises the cost of hiring.

Underemployment has both sides too: weak demand leads firms to cut hours instead of jobs, while skill mismatch, a shortage of full-time vacancies and the spread of short-hours contracts keep workers in too little or unsuitable work.

Chain: higher business confidence → more investment → higher aggregate demand → firms expand → more vacancies → employment rises, unemployment falls. This lasts only if capacity grows. If the economy is near capacity, wages and prices rise instead.

Global influences

• Falling demand abroad cuts exports and shifts aggregate demand left, causing cyclical unemployment in export industries.
• Cheaper imports or lower-cost producers abroad can close domestic industries, causing structural unemployment.
• Firms may move production abroad; foreign firms may invest at home, creating jobs.
• Migration changes labour supply and can fill shortages.
• A higher exchange rate makes exports dearer and imports cheaper, which can reduce jobs in trade-exposed sectors.
• Higher world commodity prices raise costs and may reduce output and hiring.

Evaluation: the size depends on how open the economy is, how flexible and skilled its workers are, and how fast it can switch into new industries.

Inflation, deflation and disinflation

• Inflation: a sustained rise in the general price level.
• Deflation: the price level is falling.
• Disinflation: the inflation rate is falling, but prices still rise.

Worked example (Country Beta, illustrative; index 2020 = 100). Year 1 = 124.6, year 2 = 129.1. Inflation = (129.1 − 124.6) ÷ 124.6 × 100 = 3.6%.

Basket check: weights food 30%, housing 40%, transport 30%, with item indices 108, 104 and 120. Index = 0.30 × 108 + 0.40 × 104 + 0.30 × 120 = 32.4 + 41.6 + 36.0 = 110.0.

Real wage: if nominal pay rises 3.1% and prices rise 4.5%, real pay changes by 1.031 ÷ 1.045 − 1 = −1.3%.

Disinflation versus deflation. Inflation of 7%, then 5%, then 2% takes a price index from 100 to 107.0, then 112.35, then 114.6. Disinflation: the rate fell each year but the price level rose each year. Now suppose prices fall 1.5% a year for three years. The index goes 98.5, 97.02, 95.57. That is deflation, a cumulative fall of 4.4%.

Deflationary policy. Policies that cut aggregate demand (higher taxes, higher interest rates) are called deflationary. They usually produce disinflation: a tax rise might cut inflation from 5% to 3%, so prices still rise. Deflation needs a fall in the price level itself.

Demand-pull inflation

Demand-pull inflation comes from a rightward shift of aggregate demand (AD) along short-run aggregate supply (SRAS), especially near full capacity. Causes: faster consumer spending, investment, government spending, export demand, or excessive growth in the money supply.

	Price level	Real GDP
AD shifts right from AD to AD2	100 → 108	500 → 520 (+4.0%)

Money supply chain: if the money supply grows 9% a year while capacity grows 2%, and people’s spending per unit of money is steady, spending outruns output. Excess ≈ 1.09 ÷ 1.02 − 1 = 6.9%, which bids up prices. Faster money growth raises AD only if money is spent.

Cost-push inflation

Cost-push inflation comes from a leftward shift of SRAS caused by higher unit costs: wages above productivity, dearer raw materials, energy, or higher indirect taxes.

	Price level	Real GDP
SRAS shifts left	100 → 108	500 → 480 (−4.0%)

Output falls while prices rise, so unemployment may rise too.

Worked example (bakery, illustrative). Cost per loaf 2.00: ingredients 40%, energy 15%, labour 45%. Ingredients +10%, energy +20%, labour +2%. Cost rise = 0.40 × 10 + 0.15 × 20 + 0.45 × 2 = 4.0 + 3.0 + 0.9 = 7.9%. New cost = 2.00 × 1.079 = 2.158.

External events and the exchange rate

World commodity prices. If a key fuel or metal becomes dearer on world markets, firms that use it face higher costs (cost-push). Households buy it directly. How far inflation rises depends on how much the economy imports and whether the country can switch to substitutes.

Exchange rate. Country Delta’s currency is the zed. An imported good costs 50 foreign units. At 1 zed = 2.0 foreign units, it costs 25 zeds. After the zed depreciates to 1.6, it costs 50 ÷ 1.6 = 31.25 zeds, +25%. If imports are 20% of the basket and pass-through is 60%, imported inflation adds 0.6 × 0.20 × 25 = 3.0 percentage points. Depreciation also lifts exports and AD (demand-pull). Appreciation works in reverse and can reduce inflation.

Common errors

• Treating a falling inflation rate as falling prices.
• Calling any unemployment “cyclical” without linking it to weak demand.
• Writing “AD shifts right” for a cost-push cause.
• Ignoring inactive people when explaining a falling unemployment rate.
• Dividing unemployed by the working-age population instead of the labour force.
• Recommending extra demand for structural unemployment without evaluating the risk.

Official syllabus

OxfordAQA International AS and A-level Economics (9640), specification version 1.2, first teaching September 2020, published by Oxford International AQA Examinations. Sections 3.2.3.2 and 3.2.3.3.