The price of labour could have been raised by the imposition of a minimum wage (minimum price for labour), above the equilibrium level or by successful collective bargaining by labour unions.  Alternatively the rise in average wage levels could be the result of generous unemployment benefits, which prevents some workers from accepting a job at a wage below this level. 

The solutions to this type of unemployment include abandoning the minimum wage, reducing the power of the trade unions and the scrapping of out of work benefits. 

In economic terms the costs of such a policy are probably minimal.  Families receiving out of work benefits will probably have a high MPC and so the transfer payments made will circulate around the economy.  However, given that such payments are not new money but instead simply diverted from tax payers this benefit is likely to be small. 

A bigger cost to the society of cutting out of work benefits would the social costs for families who may be forced to live without an income for a period of time.  Such a policy is likely to provide a strain on the families involved as well as very likely lead to a rise in crime and other anti social behaviours.

Unemployment caused by a fall in AD within the economy.

When AD is low, profits are lower and both capital and labour are idle, meaning that the economy is operating below its maximum.

This is because of sticky wages.  Normally when demand falls in any market the price would reduce, allowing the market to clear at a new equilibrium.  However, the labour market does not operate so efficiently, with workers reluctant to accept lower wages, especially when there are sufficient out of work benefits available and / or trade unions are successful in bargaining up wages, even in recession.  Employers for their part are very reluctant to reduce nominal wage levels and will generally only allow them to fall in real terms.  This all prevents the market from clearing when AD falls.

This means that following a fall in the AD for labour, the market does not clear at point B, as would be the case in the market for other products.  Instead wages remain stuck at We causing A to C unemployment. 

Your graph should indicate an inverse relationship between the two variables and this is little surprise.  As economic activity is reduced firm's profits fall and many will respond by cutting back on recruitment and possibly wages.  Similarly as unemployment rises workers purchasing power is reduced and this forces down the level of gross domestic product.  However, there is a clear time lag between GDP changing and the impact on unemployment - the rate of job creation particularly rises very slowly, even when the economy recovers.

Guidance in answering this question

Command term: Illustrate

The command term illustrate requires responses to use appropriate diagrams to demonstrate the difference between the two types of unemployment.

Responses should include the following in any response:

A definition of both structural and demand-deficient unemployment.  Responses should note that cyclical / demand deficit unemployment is caused by a lack of aggregate demand in the economy, where as structural unemployment can be caused by a lack of geographical and / or occupational mobility in the labour market.

A diagram(s) illustrating both types of unemployment. The cyclical unemployment diagram (to the left), should show a deflationary / recessionary gap resulting from a fall in demand in the economy.  Alternatively responses could include a PPF diagram with a point clearly marked inside the PPF curve, indicating that the economy is producing below its full employment level. 

A  structural unemployment diagram should include a fall in demand for certain kinds of labour, illustrated on diagram 2 by a fall in the number of workers in that industry from Q1 to Q2. 

Examples of some of the causes of structural unemployment e.g. the decline of some industries due to competition from low wage economies, greater automation or a change in consumption patterns e.t.c.

Responses should also include a recognition that cyclical unemployment is likely to be temporary while structural unemployment may end up permanent without appropriate government action.

An explanation that cyclical unemployment occurs in a recession where as structural unemployment will occur even when the economy is in equilibrium.  

Command term: Evaluate

Key term: Unemployment, supply side policies, demand side policies

The command term evaluate requires a response which compares the effectiveness of supply side policies, in comparison with alternative policies (demand side policies) in reducing unemployment.

Real world examples should note that the effectiveness of demand and supply side policies depends on the type of unemployment that a government wishes to address.

Responses should include the following:

Examples of supply-side policies that may be used to reduce long term unemployment include measures to improve the nation's infrastructure, investments in human capital as well as increased spending on research and development. 

A recognition that supply side measures, unlike demand side policies, are effective in reducing structural unemployment rates, by providing new jobs for workers whose previous skills have become redundant or providing those workers with new skills so that they can compete in the modern jobs market.

Responses should also include an AD/AS diagram illustrating a right shift in the AS curve or an outward shift in the PPF curve, following an increase in aggregate supply in the economy.  This is illustrated In diagram one by a growth in productive capacity and real GDP rising from Y1 to Y2, creating more job opportunities as a result of supply side policies.

A recognition that another advantage of supply side policies is that are more likely than other job creation policies at reducing unemployment in the long run, but do not provide a short term fix, sometimes making them less popular with governments.

A recognition that supply side measures, like all economic policies also have some disadvantage e.g. time-lags and the costs associated with large scale investment and government training projects.  Another disadvantage is that supply-side policies aimed at increased labour market flexibility or a reduction in access to unemployment benefits may also come at a social cost in terms of a reduction in labour protection or employment security.  

In the interests of balance responses should then consider alternative job creation policies, e.g. demand side policies.

An explanation that expansionary demand-side policies can be effective in raising the level of national income / economic growth by increasing one or more of either C, G, I or X.  This in turn reduces cyclical unemployment by increasing the demand for labour.  Illustrated by diagram two showing a rise in real GDP from Y1 − Y2.

Examples of different monetary and fiscal demand-side policies that may increase either consumption, government spending, investment or net exports. 

A discussion of the weaknesses of demand-side policies in reducing unemployment.  For example, time-lags, inflationary pressure, higher levels of government debt, increased import levels or crowding out. 

A recognition that another significant weakness of demand side policies is that they are only effective in reducing cyclical unemployment levels.  Demand side measures are not effective, for example, in reducing levels of equilibrium unemployment.

Relevant real world examples might include fast growing economies such as China, South Korea and Singapore e.t.c. that have successfully employed supply side measures to reduce unemployment levels.  Similarly, nations such as UK, USA and Germany have maintained very low levels of unemployment in part a result of labour market de-regulation and cuts to out of work benefits.