Deck 9: Business Cycles, Unemployment, and Inflation

Question 1

Suppose that a country's annual growth rates were 5, 3, 4, -1, -2, 2, 3, 4, 6, and 3 in yearly sequence over a 10-year period. What was the country's trend rate of growth over this period? Which set of years most clearly demonstrates an expansionary phase of the business cycle? Which set of years best illustrates a recessionary phase of the business cycle?

Answer 1

The country's trend rate of growth over thiS₁0-year period is the average of the growth rates:
An expansionary phase of the business cycle is demonstrated by year 6 to year 9, when the growth rate increased.
A recession phase of the business cycle is illustrated by year 1 to year 5, and year 10, when growth rates decreased.

Question 2

What are the four phases of the business cycle? How long do business cycles last? Why does the business cycle affect output and employment in capital goods industries and consumer durable goods industries more severely than in industries producing consumer nondurables?

Answer 2

The four phases of business cycles are: peak, recession, trough and expansion.
Business cycles usually vary a lot. The table below shows the duration of several recessions in the U.S. history. From the last column of the table it is noted that the duration of business cycles are between 8 and 18 months.
Business cycles affect capital goods industries and durable goods industries more severe than nondurable goods industries because within limits, firms can postpone the purchase of capital goods. Investment in capital goods declines sharply in recession. The pattern is much the same for consumer durables such as automobiles and major appliances. Firms producing these products suffer.
In contrast, nondurable consumer goods industries are somewhat insulated from the most severe effects of recession. People find it difficult to cut back on needed medical and legal services; nor are the purchases of food and clothing easy to postpone.

Question 3

Assume the following data for a country: total population, 500; population under 16 years of age or institutionalized, 120; not in labor force, 150; unemployed, 23; part-time workers looking for full-time jobs, 10. What is the size of the labor force? What is the official unemployment rate?

Answer 3

The size of the labor force is the number of people who are employed and those who are unemployed but actively seeking work. Part-time workers looking for full-time jobs are counted as employed. Thus the work force is the addition of unemployed and employed. First we look at the formula for total population:
Next we calculate the size of labor force:
The official unemployment rate is the percentage of unemployed in labor force:

Question 4

How, in general, can a financial crisis lead to a recession? How, in general, can a major new invention lead to an expansion?

Question 5

Suppose that the natural rate of unemployment in a particular year is 5 percent and the actual rate of unemployment is 9 percent. Use Okun's law to determine the size of the GDP gap in percentage-point terms. If the potential GDP is $500 billion in that year, how much output is being forgone because of cyclical unemployment?

Question 6

How is the labor force defined and who measures it? How is the unemployment rate calculated? Does an increase in the unemployment rate necessarily mean a decline in the size of the labor force? Why is a positive unemployment rate-one more than zero percent-fully compatible with full employment?

Question 7

If the CPI waS₁10 last year and iS₁21 this year, what is this year's rate of inflation? In contrast, suppose that the CPI waS₁10 last year and iS₁08 this year. What is this year's rate of inflation? What term do economists use to describe this second outcome?

Question 8

How, in general, do unemployment rates vary by race and ethnicity, gender, occupation, and education? Why does the average length of time people are unemployed rise during a recession?

Question 9

How long would it take for the price level to double if inflation persisted at (a) 2, (b) 5, and (c) 10 percent per year?

Question 10

Why is it difficult to distinguish between frictional, structural, and cyclical unemployment? Why is unemployment an economic problem? What are the consequences of a negative GDP gap? What are the noneconomic effects of unemployment?

Question 11

If your nominal income rose by 5.3 percent and the price level rose by 3.8 percent in some year, by what percentage would your real income (approximately) increase? If your nominal income rose by 2.8 percent and your real income rose by 1.1 percent in some year, what must have been the (approximate) rate of inflation?

Question 12

Because the United States has an unemployment compensation program that provides income for those out of work, why should we worry about unemployment?

Question 13

Suppose that the nominal rate of inflation is 4 percent and the inflation premium iS₂ percent. What is the real interest rate? Alternatively, assume that the real interest rate iS₁ percent and the nominal interest rate is 6 percent. What is the inflation premium?

Question 14

What is the Consumer Price Index (CPI) and how is it determined each month? How does the Bureau of Labor Statistics calculate the rate of inflation from one year to the next? What effect does inflation have on the purchasing power of a dollar? How does it explain differences between nominal and real interest rates? How does deflation differ from inflation?

Question 15

Distinguish between demand-pull inflation and cost-push inflation. Which of the two types is most likely to be associated with a negative GDP gap? Which with a positive GDP gap, in which actual GDP exceeds potential GDP?

Question 16

Explain how an increase in your nominal income and a decrease in your real income might occur simultaneously. Who loses from inflation? Who gains?

Question 17

Explain how hyperinflation might lead to a severe decline in total output.

Question 18

LAST WORD Suppose that stock prices were to fall by 10 percent in the stock market. All else equal, would the lower stock prices be likely to cause a recession? How might lower stock prices help predict a recession?