Chapter 9, Business Cycles, Unemployment, and Inflation

A college graduate using the summer following graduation to search for a job would best be classified as

a part of frictional unemployment

Rule of 70

is 70 divided by % change in annual rate of price increase = Number of years for price level to double

The natural rate of unemployment

is also the full-employment unemployment rate, It is the sum of frictional and structural unemployment.

Economists fear deflation

it can lead to a wave of bankruptcies among firms, which may cause the firms to lay off more workers, further reducing demand. This decrease in demand can result in even more deflation (more negative), resulting in a deflationary spiral.

What is the effect of mild demand-pull inflation on real output according to economists who see it as beneficial for the economy?

it increases real output, Economists who argue for a mild inflation rate see demand pull inflation as a benefit for society because it increase real output

Index of 256.8

means prices increased by 256.8%, Or that what used to cost $100 now costs $256.80

Index of 115

means that prices increased by 15%. what used to cost $100 now costs $115

Consumer Price Index (CPI)

measures price changes in goods and services monthly

Assume the CPI is currently 125. A year ago it was 115. The rate of inflation over the past year was

8.70%, (CPI this year minus CPI last year) / (CPI last year) times 100, (125 - 115) / (115) x 100

Real interest rate

% change in purchasing power that the borrower pays the lender = nominal interest rate - inflation rate

Nominal interest rate

% increase in the money that the borrower pays the lender = real interest rate + inflation rate

Approximation of the percentage changes (% ∆) in real income

% ∆ real income ~= % ∆ nominal income - % ∆ price (level) 3% ~= 6% - 3%

If the annual inflation rate is 5 percent a year, about how many years will it take for the price level to double?

14 years, 5/70 times 2

If actual GDP is $340 billion and there is a positive GDP gap of $20 billion, potential GDP is:

320 billion

If the natural rate of unemployment is 5% and the actual unemployment rate is 7%, then according to Okun's law, the GDP gap is

4.0%, The natural rate is 5% and the actual rate is 7%, so the GDP gap is 2 X 2

Assume that the economy has an annual inflation rate of 1.5%. Approximately how many years will it take for the price level to double?

47 Years, Use the rule of 70. 70/1.5 ≈

Suppose the total population is 350 million of whom 140 million are in the labor force. Of this labor force, 124 million people are employed full time and another 6 million are employed part time. There are 1 million people in the population who are classified "discouraged workers." The Unemployment rate is

7.1%, There are 124+6=130 million employed workers out of 140 million in the labor force, meaning 140-130=10 million are officially unemployed for an unemployment rate of (10/140)*100%

Suppose the total population is 300 million of whom 150 million are in the labor force. Of this labor force, 100 million people are employed full time and another 38 million are employed part time. There are 6 million people in the population who are classified "discouraged workers." The unemployment rate is

8%

1982-84

=100.0 [base period]

Which of the following businesses are typically most negatively affected by a downturn in the business cycle?

Car dealerships

Cyclical fluctuations

Durable goods output is more volatile than nondurables and services because spending on latter usually cannot be postponed.

In which phase of the business cycle will the economy most likely experience rising real output and falling unemployment rates?

Expansion

Core Inflation

Food and energy prices are very volatile due to changes in supply and demand, which are usually temporary changes. doesn't include food and energy goods. if its low and stable current policy may not need to be changed even if the CPI is rising

Okun's Law

For every 1% the unemployment rate differs from its natural rate, a 2% gap is generated between potential and actual GDP.

Unanticipated Inflation

Hurts—erodes purchasing power, has stronger impacts; those expecting inflation may be able to adjust their work or spending activities to avoid or lessen the effects. (borrowers) can be helped and lenders hurt by unanticipated inflation.Interest payments may be less than the inflation rate, so borrowers receive "dear" money and are paying back "cheap" dollars that have less purchasing power for the lender.

In which of the following cases would real income rise?

Nominal income rises by 2 percent, and the price level remains unchanged.

In the short-run, businesses handle shocks with

Price changes and Quantity changes

cost-push or supply-side inflation

Prices rise because of rise in per-unit production costs (Unit cost = total input cost/units of output).

Demand-pull inflation

Spending increases faster than production. It is often described as "too much spending chasing too few goods."

Kevin has lost his job in an automobile plant because of the use of robots for welding on the assembly line. Kevin plans to go to technical school to learn how to repair microcomputers. The type of unemployment Kevin is faced with is

Structural

Inflation

The increase in the general level of prices over some time period.

natural rate of unemployment

The rate of unemployment when the economy is at its potential output

Kevin has lost his job in an automobile plant due to the current recession. The type of unemployment Kevin is faced with is

cyclical, has become unemployed due to a downturn in the economy. This type of unemployment is cyclical unemployment

Peak

business activity reaches a temporary maximum with full employment and near-capacity output.

Short-run

can have fluctuations in economy, Increases and decreases in real GDP, positive and negative rate of economic growth

The industries or sectors of the economy in which business cycle fluctuations tend to affect output the most are

capital goods and non durable goods

Structural

change in composition of work force - in sectors, is due to changes in the structure of demand for lab or (e.g., when certain skills become obsolete or geographic distribution of jobs changes)

Frictional

consists of those searching for jobs or waiting to take jobs soon; it is regarded as somewhat desirable, because it indicates that there is mobility as people change or seek jobs.

Alpha Dog Foods is a business firm which produces 10,000 units of dog food a week, which is the optimal output for the size of the business. If prices for this product are flexible and Alpha Dog Foods experiences an unexpected decrease in demand, it is most likely to

decrease the product price

To get real income

divide nominal income by price index (in 100ths) for each year.

Cyclical

downturn in the business cycle, is caused by the recession phase of the business cycle. a. As firms respond to insufficient demand for their goods and services, output and employment are reduced. b.Extreme unemployment during the Great Depression (25 percent in 1933) was cyclical unemployment.

The full-employment unemployment rate

equal to the total frictional and structural unemployment

% change/ inflation rate

equals Index 2 minus Index 1 divided by Index 1 times 100

Unemployment rate

equals unemployed divided by labor force times 100

During which of the four phases of a generalized business cycle will inflation occur?

expansion

Last year, Bill's nominal income increased by 2% while the price level rose by 4%. Consequently, Bill's real income

fell by approximately 2%, Bill's real income increased by the difference between the increase in his nominal income and the increase in the price level

The situation where a government prints too much money for the resources it has and this action leads to extremely rapid inflation is best characterized as

hyperinflation, occurs when there is extradinarily rapid inflation that is caused by the government printing too much money. This event leads to a sharp increase in total spending that is far greater than what the economy can produce

Real income

income in base year $

Nominal income

income in current $

If total spending unexpected drops and firms cannot lower prices

output decreases and unemployment increases

Trough

output or production reaches its lowest point, bottom of the recession period

Who is hurt least by high rates of unanticipated inflation?

people receiving income based on a cost of living adjustment, Those who receive income based on a cost of living adjustment (COLAs) are hurt least and may be better off

Recession

period of decline in total output and employment which lasts six months or longer

If unemployment rate < natural rate

potential real GDP < actual real GDP

If unemployment rate = natural rate

potential real GDP = actual real GDP

If unemployment rate > natural rate

potential real GDP > actual real GDP

"Inflation premium"

the amount that the interest rate is raised to cover effects of anticipated inflation.

Long-run

there will be an upward trend in economic growth, increase in size of real GDP, positive rate of economic growth

During periods of full employment the

unemployment rate for African-Americans is about twice the rate for whites.

Recovery

when output and employment are expanding toward full-employment level

Cost-push inflation

where resource prices rise unexpectedly, could cause both output and employment to decline. Real income falls.