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Chapter 7: Economic Growth, Business Cycles, and Unemployment

Chapter 7: Economic Growth, Business Cycles, and Unemployment

Questions and Exercises

1. Economic growth is measured by increases in total output and increases in output

per person.

2. The U.S. per capita growth rate of 2.1 percent per year is lower than those of
Japan (4.2 percent per year) and China (4.9 percent per year), close to those of
Western Europe (2.2 percent per year) and Latin America (2.0 percent per year),
and higher than those of Eastern Europe (1.7 percent per year) and Africa (0.4
percent per year).

3. Real output is a measure of the total goods and services an economy actually
produces stated in constant prices (using the price level from a chosen base year).
Potential output is a measure of the total goods and services an economy is
capable of producing given its resources and institutions. Specifically, potential
output depends on capital utilization and the rate of unemployment.

4. a. The labor force participation rate is the total number of people employed and/or
looking for work (or the labor force) as a fraction of the population over 16 years
old. In this instance it is (152,762,000/231,480,000) X 100 = 66%”.
b. The unemployment rate is the total number of unemployed as a fraction of the
labor force. In this instance it is (13,724,000)/154,731,000) X 100 = 8.9%.
c. The employment-population ratio is the total number of employed as a fraction of
the population. This is (141,007,000/235,272,000) X 100, or 60.0%.

5. A representative business cycle is

shown in the accompanying graph.
Each of the four phases—peak,
downturn, trough, and upturn—is
clearly labeled.

6. Besides predicting the recessions that did occur, the index has also predicted
many recessions that did not occur. So the predictions have not been especially
accurate. Predicting recessions is difficult because business cycles have varying
durations and intensities. The leading indicators are called indicators and not
predictors because they're only rough approximations of what's likely to happen in
the future.

Colander’s Economics, 8e. McGraw Hill © 2010 1

Chapter 7: Economic Growth, Business Cycles, and Unemployment

7. Structural unemployment results from the institutional structure of the economy

or changes in the economy itself, while cyclical unemployment results from
fluctuations in economic activity (business cycles.)

8. Structural unemployment, because it results from changes in the structure of the

economy, is best studied in the long-run framework.

9. Cyclical unemployment, which results from fluctuations in economic activity, is

best studied in the short-run framework.

10. Some economists (Keynsians) argue that the unemployment rate underestimates
unemployment because people who have gotten frustrated and stopped trying to
find jobs are considered voluntarily idle and are not counted as unemployed. Also,
the unemployment rate doesn’t include people who are underemployed. Others
(Classical economists) point out that, because of unemployment insurance, people
often say they are looking for work when they really aren't, and therefore
unemployment is overstated. Furthermore, these economists believe that people
could find a job if they really wanted to, but often turn down jobs they find
unappealing. So there are tendencies both to overestimate and underestimate the

11. Okun’s rule of thumb states that a 1 percentage point change in the
unemployment rate will cause income to change in the opposite direction by 2
percentage points. Thus, a 2 percentage point rise in unemployment will likely
cause income to decrease by 4 percent.

12. Real output is $166.67 (250/150 X100 = $166.67).

13. Real output rose 13 percent (15 – 2).

14. a. The index in 2009 is 68/64 X 100 = 106.25.

b. Real output is Nominal output/Price index X 100 = $300 billion/115 X 100 =
$260.9 billion.
c. Percent change in nominal output = Percent change in real output + Percent
change in the price level. Thus, rise in nominal output = 5 percent + 2 percent = 7
d. Percent change in price level= Percent change in nominal output – percent change
in real output. Thus inflation= 7 percent – 3 percent = 4 percent.

15. a. Nominal output rose 3.7% ($0.5billion/$13.5billion X100 = 3.7%)

b. The price index rose by 5.0% (5/100 X100 = 5%)
c. Real output fell by $167 million, or 1.2% (real output = $14billion/105 =
d. The price index would have had to rise 3.7% because that is how much nominal
output increased.

Colander’s Economics, 8e. McGraw Hill © 2010 2

Chapter 7: Economic Growth, Business Cycles, and Unemployment

16. Expectations are central to understanding inflation because the ultimate change in
prices is due both to the prices that producers would like and the inflation that
they expect. Because expectations of inflation can be self-fulfilling in this way,
they play an important role in any ongoing inflation and can “snowball” a small
inflationary pressure into accelerating inflation over a long period of time.

17. False. While inflation doesn’t make the nation any poorer on average, it does have
costs. Its costs include increased transactions costs, painful distributional effects,
the destruction of the informational value of prices, and the breaking down of the
institutional structure within which markets work.

18. Inflation is generally associated with low unemployment because both tend to
accompany economic upturns; low unemployment rates give workers greater
leverage in demanding wage increases and since labor is a large portion of the
production of many goods, these wage increases get passed on as price increases
in most industries. However, once expectations of inflation are built in, there can
be high inflation with high unemployment.

Issues to Ponder

1. Deciding the purpose of life and therefore what constitutes a desired lifestyle is a
complicated issue. To the extent that work provides a sense of self-worth and
identity, complete idleness is not desirable. This, however, is a normative
question. Unemployment within our culture and set of institutions is a measure of
aggregate well-being to the extent that employment provides a sense of well-
being and sufficient income to support a desired lifestyle. This example shows
that unemployment must be understood within this broader framework--its
meaning is specific to a set of institutions and a culture.

2. Reducing unemployment to 1.2 percent today is not likely for several reasons.
One is that a low inflation rate seems to be incompatible with low unemployment.
Another is that today’s economy differs from that of the World War II period,
when there was an enormous ideological commitment to the war effort and
acceptance of strong wage and price controls.

3. a. Possible explanations include Japanese cultural emphases on tradition, honor, and

loyalty. In Japan, firms are less willing to lay off workers in times of excess
supply and workers are less likely to change employers in search of higher
compensation. Another explanation is the nature of Japanese production. One
could suggest that Japanese production does not rely on a changing base of skills
so that the skills of workers always match the skills demanded by a particular
b. It is impossible to say which is better. Each needs to be judged within the broader
context of the economy.

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Chapter 7: Economic Growth, Business Cycles, and Unemployment

c. The answer to this question depends on the distribution of layoffs and hires in
each of the economies. If layoffs in Japan were unavoidable and occurred among
mid to-low ranking employees, the average tenure of Japanese employees would
decline. If instead the elderly were asked to retire earlier, the average tenure
would decline much less. In the United States firms would have to lay off fewer
workers than usual due to the booming economy, and average tenure would rise.

Colander’s Economics, 8e. McGraw Hill © 2010 4