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1. The business cycle is a term that encompasses the recurrent ups, or (decreases, increases)
_____________, and downs, or ______________, in the level of business activity in the economy.
The order of the four phases of a typical business cycle are peak, (expansion, trough, recession)
______________, ______________, and ______________.
2. Business cycle fluctuations arise because of economic (shocks, deflation) ______________ that the
economy has difficulty adjusting to quickly or easily because in the short run, prices are (flexible,
sticky) ______________. Such economic shocks cause unexpected changes in the level of total
(money, spending) ______________.
3. Expansion and contraction of the economy affect to a greater extent the production and
employment in the consumer (durables, nondurables) ______________ and (capital, consumer)
______________ goods industries than they do (durable, nondurable) ______________ goods and
service industries.
4. The unemployment rate is found by dividing the number of (employed, unemployed)
______________ persons by the (population, labor force) ______________ and (multiplying,
dividing) ______________ by 100.
5. In calculating the unemployment rate, the U.S. Bureau of Labor Statistics treats part-time workers as
(unemployed, employed, not in the labor force) ______________ and discouraged workers who are
not actively seeking work as ______________. Critics of the official BLS calculation contend that
such designations mean that unemployment is (overstated, understated) ______________.
6. When workers are searching for new jobs or waiting to start new jobs, this type of unemployment is
called (structural, frictional, cyclical) ______________, but when workers are laid off because of
changes in the consumer demand and technology in industries or regions, this unemployment is
called ______________; when workers are unemployed because of insufficient total spending in the
economy, this type of unemployment is called ______________.
7. The full-employment unemployment rate is called the (Okun, natural) ______________ rate of
unemployment. It is equal to the total of (frictional and structural, cyclical and frictional)
______________ unemployment in the economy. It is realized when the (frictional,
cyclical)______________ unemployment in the economy is equal to zero and when the actual
output of the economy is (less than, equal to) ______________ its potential output.
8. The GDP gap is equal to the actual GDP (minus, plus) ______________ the potential GDP. For every
percentage point the unemployment rate rises above the natural rate, there will be a GDP gap of (2,
5) ______________ percent.
9. The burdens of unemployment are borne more heavily by (black, white) ______________, (adult,
teenage) ______________, and (white-collar, blue-collar) workers, and the percentage of the labor
force unemployed for 15 or more weeks is much (higher, lower) ______________ than the overall
unemployment rate.
10. Inflation means (an increase, a decrease) ___________ in the general level of (unemployment,
prices) ___________ in the economy.
11. To calculate the rate of inflation from year 1 to year 2, subtract the price index for year 1 from year
2, then (multiply, divide) ______________ the result by the price index for year 1, and
______________ by 100.
12. To find the approximate number of years it takes the price level to double, (multiply, divide)
______________ 70 by the percentage annual increase in the rate of inflation. This approximation is
called (Okun’s law, rule of 70) _______.
13. The basic cause of demand-pull inflation is (an increase, a decrease) ______________ in total
spending beyond the economy’s capacity to produce. This type of inflation is characterized as “too
(little, much) _____________ spending chasing too (few, many) ______________ goods.”
14. Cost-push inflation is explained in terms of factors that raise per-unit (inflation, production)
______________ costs. When these costs rise, they (increase, decrease) _____________ profits and
_____________ the amount of output firms are willing to supply, which causes the price level for
the economy as a whole to ______________.
15. The amount of goods and services one’s nominal income can buy is called (variable, real)
______________ income. If one’s nominal income rises by 10 percent and the price level by 7
percent, the percentage of increase in (variable, real) ______________ income would be (1, 2, 3)
______________. If nominal income was $60,000 and the price index, expressed in hundredths, was
1.06, then (variable, real) ______________ income would be ($56,604, 63,600) ______________.
16. Unanticipated inflation hurts those whose nominal incomes are relatively (fixed, flexible)
______________, penalizes (savers, borrowers) ______________, and hurts (creditors, debtors)
______________.
17. The redistributive effects of inflation are less severe when it is (anticipated, unanticipated)
______________. Clauses in labor contracts that call for automatic adjustments of workers’ incomes
from the effects of inflation are called (unemployment benefits, cost-of-living) ______________
adjustments.
18. The percentage increase in purchasing power that the lender receives from the borrower is the
(real, nominal) ______________ rate of interest; the percentage increase in money that the lender
receives is the ______________ rate of interest. If the nominal rate of interest is 8 percent and the
real interest rate is 5 percent, then the inflation premium is (8, 5, 3) ______________ percent.
19. Cost-push inflation (increases, decreases) __________ real output. The output effects of demandpull inflation are (more, less) ______________ certain. Some economists argue that mild demandpull inflation (increases, decreases)______________ real output while others argue that it
______________ real output.
20. An extraordinary rapid rise in the general price level is (deflation, hyperinflation) ______________.
Economists generally agree that there may be an economic collapse, and often political chaos, from
______________.
1. The business cycle is best defined as alternating periods of increases and decreases in the rate of
inflation in the economy. T F
2. Business cycles tend to be of roughly equal duration and intensity. T F
3. Fluctuations in real output in the economy are caused by economic shocks, and because prices are
sticky, it is difficult for the economy to quickly adjust to such shocks. T F
4. During a recession, industries that produce capital goods and consumer durables typically suffer
smaller output and employment declines than do industries providing service and nondurable
consumer goods. T F
5. The unemployment rate is equal to the number of people in the labor force divided by the number
of people who are unemployed. T F
6. Discouraged workers, those people who are able to work but quit looking for work because they
cannot find a job, are counted as unemployed by the U.S. Bureau of Labor Statistics. T F
7. Frictional unemployment is not only inevitable but also partly desirable so that people can
voluntarily move to better jobs. T F
8. The essential difference between frictionally and structurally unemployed workers is that the
former do not have and the latter do have marketable skills. T F
9. Most frictionally unemployed workers stay in the unemployment pool for a long time. T F
10. Cyclical unemployment is caused by a decline in total spending T F
11. If unemployment in the economy is at its natural rate, the actual and potential outputs of the
economy are equal.TF
12. An economy cannot produce an actual real GDP that exceeds its potential real GDP. T F
13. The economy’s GDP gap is measured by subtracting its potential GDP from its actual GDP. T F
14. The economic cost of cyclical unemployment is the goods and services that are not produced. T F
15. Unemployment imposes equal burdens on different groups in the economy. T F
16. Inflation is defined as an increase in the total output of an economy. T F
17. From one year to the next, the Consumer Price Index rose from 154.5 to 160.5. The rate of inflation
was therefore 6.6 percent. T F
18. If the price level increases by 10 percent each year, the price level will double every 10 years. T F
19. The essence of demand-pull inflation is “too much spending chasing too few goods.” T F
20. Cost-push inflation explains rising prices in terms of factors that increase per-unit production cost.
T F
21. A person’s real income is the amount of goods and services that the person’s nominal (or money)
income will enable him or her to purchase. T F
22. Whether inflation is anticipated or unanticipated, the effects of inflation on the distribution of
income are the same. T F
23. Borrowers are hurt by unanticipated inflation. T F
24. Cost-push inflation reduces real output. T F
25. Hyperinflation is caused by reckless expansion of the money supply and causes severe declines in
real output T F
PROBLEMS
1. The following table gives statistics on the labor force and total employment during year 1 and year
5. Make the computations necessary to complete the table. (Numbers of persons are in thousands.)
a. How is it possible that both employment and unemployment increased?
________________________________________________________________________
b. In relative terms, if unemployment increases, employment will decrease. Why?
________________________________________________________________
c. Would you say that year 5 was a year of full employment?
______________________________________________________________________________
______
d. 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?
______________________________________________________________________________
_______
2. Suppose that in year 1 an economy is at full employment, has a potential and actual real GDP of
$3000 billion, and has an unemployment rate of 5.5%.
a. Compute the GDP gap in year 1 and enter it in the table below.
b. The actual and potential real GDPs in years 2 and 3 are also shown in the table. Compute and
enter into the table the GDP gaps in these 2 years.
c. In year 2, the actual real GDP is ________% of the potential real GDP. (Hint: Divide the actual
real GDP by the potential real GDP and multiply by 100.)
1. The actual real GDP is ________% less than the potential real GDP.
2. Using Okun’s law, the unemployment rate will rise from 5.5% in year 1 and be ________%
in year 2.
d. In year 3 the actual real GDP is ________% of the potential real GDP.
1. The actual real GDP is ________% less than the potential real GDP.
2. The unemployment rate, according to Okun’s law, will be ________%.
3. The following table shows the price index in the economy at the end of four different years.
a. Compute and enter in the table the rates of inflation in years 2, 3, and 4.
b. Employing the rule of 70, how many years would it take for the price level to double at each of
these three inflation rates? ________
c. If nominal income increased by 15% from year 1 to year 2, what was the approximate
percentage change in real income? ________
d. If nominal income increased by 7% from year 2 to year 3, what was the approximate percentage
change in real income? ________
e. If nominal income was $25,000 in year 2, what was real income that year? ________
f. If nominal income was $25,000 in year 3, what was real income that year? ________
g. If the nominal interest rate was 14% to borrow money from year 1 to year 2, what was the
approximate real rate of interest over that period? ________
h. If the nominal interest rate was 8% to borrow money from year 3 to year 4, what was the
approximate real rate of interest over that period? ________
4. Indicate the most likely effect—beneficial (B), detrimental (D), or indeterminate (I) —of
unanticipated inflation on each of these persons:
a. A retired business executive who now lives each month by spending a part of the amount that
was saved and deposited in a fixed-rate savings account for a long term. ________
b. A retired private-school teacher who lives on the dividends received from shares of stock
owned. ________
c. A farmer who borrowed $500,000 from a bank at a fixed rate; the loan must be repaid in the
next 10 years. ________
d. A retired couple whose sole source of income is the pension they receive from a former
employer. ________
e. A widow whose income consists entirely of interest received from the corporate bonds she
owns. ________
f. A public school teacher. ________
g. A member of a union who works for a firm that produces computers. ________
SHORT ANSWER AND ESSAY QUESTIONS
1. Define the business cycle. Describe the four phases of a business cycle.
2. In the opinion of most economists, what is the cause of the fluctuations in the levels of output in
the economy?
3. Compare the manner in which the business cycle affects output and employment in the industries
producing capital and durable goods with the way it affects industries producing nondurable goods
and services. What causes these differences?
4. How is the unemployment rate measured in the United States?
5. What two criticisms have been made of the method the Bureau of Labor Statistics uses to
determine the unemployment rate?
6. Distinguish among frictional, structural, and cyclical unemployment.
7. Do frictionally unemployed workers remain unemployed for a long period of time? Explain your
answer.
8. When is there full employment in the U.S. economy? (Answer in terms of the unemployment rate,
the actual and potential output of the economy, and the markets for labor.)
9. What is the natural rate of unemployment? Will the economy always operate at the natural rate?
10. What is the economic cost of unemployment, and how is this cost measured? What is the
quantitative relationship called Okun’s law) between the unemployment rate and the cost of
unemployment?
11. What groups in the economy tend to bear the burdens of unemployment?
12. How does the unemployment rate in the United States compare with the rates for other
industrialized nations in recent years?
13. What is inflation, and how is the rate of inflation measured?
14. What has been the experience of the United States with inflation since the 1960s? How does the
inflation rate in the United States compare with those of other industrialized nations in recent
years?
15. Compare and contrast demand-pull and cost-push types of inflation.
16. Why do economists and policy-makers use core inflation for evaluating inflation?
17. What is the difference between the effects of unanticipated inflation and the effects of anticipated
inflation on the redistribution of real incomes in the economy?
18. What are the effects of cost-push inflation on real output?
19. What are the effects of demand-pull inflation on real output? Are economists in agreement about
these effects? Discuss.
20. Why does hyperinflation have a devastating impact on real output and employment? Explain what
happens during hyperinflation.