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CHAPTER 29
Business Cycles, Unemployment, and Inflation
A. Short-Answer, Essays, and Problems
1. What is meant by the term business cycle as described by economists?
3. “In the last four months, GDP has been declining and many sectors have shown a contraction in business
activity. Still, employment has remained constant. We are currently in a recession.” Evaluate this
4. How is the severity of a recession measured? How severe was the recession of 2007–2009 compared with
other recessions since 1950?
5. How does the size of the 2007–2009 recession compare with the Great Depression of the 1930s?
7. What are five economic shocks that may cause business cycles?
9. What appears to be the immediate cause of most changes in the business cycle from the perspective of most
economists?
10. “The increasing importance of durable goods has made our economy more vulnerable to cyclical
11. Which types of industries are hit hardest by a recession? Explain.
12. In the table below are statistics showing the labor force and total employment in month 1 and month 2 of
the same year. Make the computations necessary to complete the table. (Number of persons is in
thousands.)
Month 1
Month 2
Labor force
136,297
137,065
Employed
129,558
129,526
Unemployed
_____
_____
Unemployment rate (%)
_____
_____
13. In the table below are statistics showing the labor force and total employment during year 1 and year 5.
Make the computations necessary to complete the table. (Number of persons is in thousands.)
Year 1
Year 5
Labor force
95,450
108,250
Employed
90,325
100,830
Unemployed
_____
_____
Unemployment rate (%)
_____
_____
14. In the table below are statistics showing the civilian non-institutional population, the civilian labor force
and total employment in year 1 and year 2. Make the computations necessary to complete the table.
(Number of persons is in thousands.)
Year 1
Civilian non-institutional population
209,699
Civilian labor force
140,862
Employed
135,208
Unemployed
_____
Unemployment rate
(to one decimal place)
_____
15. If the population is 267 million, the labor force is 136 million, and the number measured as unemployed is
6.8 million, what is the rate of unemployment?
17. What are two criticisms of the unemployment rate? How do these criticisms relate to the overstating or
18. Explain the differences among the frictional, structural, and cyclical forms of unemployment.
19. Name the type of unemployment occurring in each of the causes below and explain your answer.
20. (Consider This) Are wages more flexible upward or downward? Explain what effect this has during a time
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21. Define the “full–employment” or “natural” rate of unemployment and give its approximate percentage rate
22. “The economic cost of unemployment is measured by the GDP gap.” Explain this statement.
26. What is the consumer price index? How is it different from the GDP price index?
27. Answer the next four questions based on the following data using year 1 as the base year. All dollars are in
billions. Calculate to one decimal place.
Year
CPI
1
160
2
165
3
170
4
177
28. Calculate the rate of inflation between Year 1 and Year 2. The price index in Year 1 was 124.0. It was
130.7 in Year 2.
29. The table below shows the price index in the economy at the end of four different years. (a) What is the
rate of inflation in years 2, 3, and 4? (b) Using the “rule of 70,” how many years would it take for the
prices to double at each of these three inflation rates?
Year
Price index
Rate of
inflation
Years to double
1
100
2
108
_____
_____
3
120
_____
_____
4
132
_____
_____
30. Inflation is frequently described as “too much money chasing too few goods.” Is this an acceptable
definition?
31. What is “demand–pull” inflation?
33. (Consider This) How was the practice of clipping coins during feudalism contributing to inflation? Who
benefited from this inflation?
34. What is core inflation? Why is it used?
35. Answer the next four questions based on the following data using year 1 as the base year. All dollars are in
billions.
Year
Nominal income
CPI
1
$3166
100
2
3402
114
3
3774
108
4
3989
112
36. Answer the next four questions based on the following data using year 1 as the base year. All dollars are in
billions.
Year
Nominal income
CPI
1
$50,000
100
2
60,000
110
3
70,000
115
4
80,000
120
37. Assume that nominal income is $35,000 and the price index is 1.20 in year 1. In year 2, nominal income
rises to $38,000 and the price index rises to 1.25. What was the percentage change in real income from
year 1 to year 2? What was the absolute amount of increase in real income? Make your calculations of the
38. Explain the difference between real and nominal income. How can you get an approximation of the
42. “Unexpected inflation is more beneficial to those who save than those who borrow.” Evaluate this
statement. How does your answer change if the inflation is expected?
43. “Inflation is a harsh and arbitrary form of taxation.” Do you agree? If so, who pays this tax?
44. Someone says to you: “Inflation benefits the rich and hurts the poor” and asks for your assessment as an
economist. What would be your response?
46. How does unanticipated deflation affect incomes, debts, and savings?
47. Why are there mixed effects from unexpected inflation for most individuals?
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48. What are the effects of cost-push inflation on real output?
50. What is hyperinflation and what are its effects?
51. (Last Word) Discuss the difference in job creation during the recovery from the Great Recession by age
groups. Why is it expected this occurred?
B. Answers to Short-Answer, Essays, and Problems
1. What is meant by the term business cycle as described by economists?
2. Describe the four phases of the business cycle.
3. “In the last four months, GDP has been declining and many sectors have shown a contraction in business
activity. Still, employment has remained constant. We are currently in a recession.” Evaluate this
statement.
4. How is the severity of a recession measured? How severe was the recession of 2007–2009 compared with
other recessions since 1950?
5. How does the size of the 2007–2009 recession compare with the Great Depression of the 1930s?
6. What phase of the business cycle is our economy experiencing at the present time? Justify your answer.
7. What are five economic shocks that may cause business cycles?
8. Briefly describe the economic conditions that contributed to the severe recession of 2007–2009.
9. What appears to be the immediate cause of most changes in the business cycle from the perspective of most
economists?
10. “The increasing importance of durable goods has made our economy more vulnerable to cyclical
fluctuations.” Explain and evaluate.
There is evidence that durable goods purchases are much more volatile than nondurable purchases.
Therefore, to the extent that durable goods production becomes more important relative to nondurables, this
11. Which types of industries are hit hardest by a recession? Explain.
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12. In the table below are statistics showing the labor force and total employment in month 1 and month 2 of
the same year. Make the computations necessary to complete the table. (Number of persons is in
thousands.)
Month 1
Month 2
Labor force
136,297
137,065
Employed
129,558
129,526
Unemployed
_____
_____
Unemployment rate (%)
_____
_____
Month 1
Month 2
Labor force
136,297
137,065
Employed
129,558
129,526
Unemployed
6,739
7,539
Unemployment rate (%)
4.9%
5.5%
13. In the table below are statistics showing the labor force and total employment during year 1 and year 5.
Make the computations necessary to complete the table. (Number of persons is in thousands.)
Year 1
Year 5
Labor force
95,450
108,250
Employed
90,325
100,830
Unemployed
_____
_____
Unemployment rate (%)
_____
_____
(a) How is it possible that both employment and unemployment increased?
(b) Would you say that year 5 was a year of full employment?
(c) Why is the task of maintaining full employment over the years more than just a problem of finding
jobs for those who happen to be unemployed at any given time?
Year 1
Year 5
Labor force
95,450
108,250
Employed
90,325
100,830
Unemployed
5,125
7,420
Unemployment rate (%)
5.4%
6.8%
(a) The labor force increased more than employment increased.
(b) No, the unemployment rate of 6.8% is greater than the full employment rate of 5–5.5 percent.
(c) The number of people looking for work expands.
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14. In the table below are statistics showing the civilian non-institutional population, the civilian labor force
and total employment in year 1 and year 2. Make the computations necessary to complete the table.
(Number of persons is in thousands.)
Year 1
Year 5
Civilian non-institutional population
209,699
211,864
Civilian labor force
140,862
141,815
Employed
135,208
135,973
Unemployed
_____
_____
Unemployment rate
(to one decimal place)
_____
_____
Year 1
Year 5
Civilian non-institutional population
209,699
211,864
Civilian labor force
140,862
141,815
Employed
135,208
135,973
Unemployed
5,654
6,742
Unemployment rate
(to one decimal place)
4.0%
4.8%
15. If the population is 267 million, the labor force is 136 million, and the number measured as unemployed is
6.8 million, what is the rate of unemployment?
17. What are two criticisms of the unemployment rate? How do these criticisms relate to the overstating or
understating of the unemployment rate?
18. Explain the differences among the frictional, structural, and cyclical forms of unemployment.
Frictional unemployment is the unavoidable and even positive type of unemployment characterized by
people who are searching for new jobs or waiting to take jobs in the near future. Structural unemployment
is unemployment due to changes occurring over time in the structure of consumer demand or in technology
which result in some skills being in less demand or even becoming obsolete. It may also be due to a
change in the geographic distribution of job opportunities. Cyclical unemployment is the unemployment
caused by the recession phase of the business cycle. Economists place special emphasis on this type of
unemployment because they believe that economic policy can reduce cyclical fluctuations in the economy
and therefore can reduce cyclical unemployment.
19. Name the type of unemployment occurring in each of the causes below and explain your answer.
(a) Frank recently lost his job as the computer manufacturing company he works for recently downsized
after poor sales and poor performance of the economy during the last year.
(b) Julie just recently graduated from college and is spending the summer traveling before she begins a job
with a consulting firm in the fall.
(c) Tom recently lost his job as the steel manufacturing firm he worked for moved their plant overseas.
The other steel plants in the nation have been also been following this trend.
(d) Susan recently left her marketing job at a local bank because she found that finance interests her more.
She is currently looking for a job as a financial consultant.
20. (Consider This) Are wages more flexible upward or downward? Explain what effect this has during a time
of expansion and a time of recession.
Wages are flexible upward, workers are happy to accept an increase in their wage rate. However, workers
21. Define the “full–employment” or “natural” rate of unemployment and give its approximate percentage rate
as economists currently define it.
22. “The economic cost of unemployment is measured by the GDP gap.” Explain this statement.
23. What is Okun’s law? Give an example of how it works.
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24. Discuss the unequal burden of unemployment for different demographic groups in the United States.
25. Describe the personal and social costs of unemployment.
26. What is the consumer price index? How is it different from the GDP price index?
27. Answer the next four questions based on the following data using year 1 as the base year. All dollars are in
billions. Calculate to one decimal place.
Year
CPI
1
160
2
165
3
170
4
177
(a) What was the percentage rise in prices between years 1 and 2?
(b) What was the percentage rise in prices between years 2 and 3?
(c) What was the percentage rise in prices between years 3 and 4?
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28. Calculate the rate of inflation between Year 1 and Year 2. The price index in Year 1 was 124.0. It was
130.7 in Year 2.
29. The table below shows the price index in the economy at the end of four different years. (a) What is the
rate of inflation in years 2, 3, and 4? (b) Using the “rule of 70,” how many years would it take for the
prices to double at each of these three inflation rates?
Year
Price index
Rate of
inflation
Years to double
1
100
2
108
_____
_____
3
120
_____
_____
4
132
_____
_____
Year
Price index
Rate of
inflation
Years to double
1
100
2
108
8.0%
Approx. 8.8
3
120
11.1
Approx. 6.3
4
132
10.0
Approx. 7
(a) To get the rate of inflation, subtract last year’s index from this year’s index (108 − 100 for year 2);
divide this result (8) by last year’s index (100) to get 0.08; multiply by 100 to change to percent (8%).
(b) The rule of 70 says divide the rate of increase, 8, into 70 and this gives the approximate time for prices
to double (approx. 8.8 years). Note that in years 3 and 4, the index changes by 12 points each year, but
the inflation rate will differ because the reference index base has changed from 108 to 120.
30. Inflation is frequently described as “too much money chasing too few goods.” Is this an acceptable
definition?
31. What is “demand–pull” inflation?
32. Describe cost-push inflation and its major source.
Cost-push or supply-side inflation is caused by the per-unit cost of production rising so that costs push up
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33. (Consider This) How was the practice of clipping coins during feudalism contributing to inflation? Who
benefited from this inflation?
34. What is core inflation? Why is it used?
35. Answer the next four questions based on the following data using year 1 as the base year. All dollars are in
billions.
Year
Nominal income
CPI
1
$3166
100
2
3402
114
3
3774
108
4
3989
112
(a) Find real income in year 4.
(b) What was the percentage rise in prices between years 1 and 3?
(c) What was the percentage rise in prices between years 2 and 4?
(d) What was the increase in real income from year 3 to year 4 in percentage?
36. Answer the next four questions based on the following data using year 1 as the base year. All dollars are in
billions.
Year
Nominal income
CPI
1
$50,000
100
2
60,000
110
3
70,000
115
4
80,000
120
(a) Find real income in year 2.
(b) What was the percentage rise in prices between years 2 and 3?
(c) What was the percentage rise in prices between years 3 and 4?
(d) What was the increase in real income from year 3 to year 4 in percentage?
37. Assume that nominal income is $35,000 and the price index is 1.20 in year 1. In year 2, nominal income
rises to $38,000 and the price index rises to 1.25. What was the percentage change in real income from
year 1 to year 2? What was the absolute amount of increase in real income? Make your calculations of the
percentage change in real income and the absolute change in real income using the approximation formula
and using the more precise method with index numbers.
38. Explain the difference between real and nominal income. How can you get an approximation of the
percentage change in real income from one time period to another?
40. Examine the possible responses savers can have to a negative real interest rate
.
41. (Consider This) Explain the “deflationary spiral.”
42. “Unexpected inflation is more beneficial to those who save than those who borrow.” Evaluate this
statement. How does your answer change if the inflation is expected?
43. “Inflation is a harsh and arbitrary form of taxation.” Do you agree? If so, who pays this tax?
44. Someone says to you: “Inflation benefits the rich and hurts the poor” and asks for your assessment as an
economist. What would be your response?
45. Explain the difference between nominal and real interest rates.
46. How does unanticipated deflation affect incomes, debts, and savings?
47. Why are there mixed effects from unexpected inflation for most individuals?
48. What are the effects of cost-push inflation on real output?
49. Some economists believe that creeping inflation cannot be accepted because a gradual increase in prices
leads to an ever-rising rate of inflation. Other economists argue that in order to achieve economic growth,
some moderate price increases are necessary. Contrast and evaluate these two points of view.
The argument in the first case is that even low levels of inflation impose a cost on the economy that reduces
50. What is hyperinflation and what are its effects?
51. (Last Word) Discuss the difference in job creation during the recovery from the Great Recession by age
groups. Why is it expected this occurred?