General Equilibrium with Unemployment: Theory and Application

Abstract

A general equilibrium model with unemployment is developed to evaluate the cost of equilibrium unemployment in an economy by comparing responses to policy changes in equilibrium unemployment economy to the full employment equilibrium economy. Model can assess the cost and benefits of unemployment and transfer programmes. Analysis of impacts of uniform capital and labour income taxes in the multi-household multi-sectoral general equilibrium model with unemployment shows that such unemployment is not necessarily growth retarding in the long run when economy runs through the dynamic adjustment process. Lower labour supply raises wage rates and labour income, consumption and saving by households and production and accumulation of capital by firms. In base as usual scenario the inequality of income and consumption persists if no measures are taken to reduce such inequality.