Download Answers to Text Questions and Problems in Chapter 7

Answers to Text Questions and Problems in Chapter 7
Answers to Review Questions
1. A recession is a period in which the economy is growing at a rate significantly below normal,
whereas an expansion is a period in which the economy is growing at a rate significantly above normal.
The beginning point of a recession is called the peak (the point at which economic activity reaches its
highest point and begins to decline), whereas the end point of a recession (and the beginning of the
expansion) is called a trough. In postwar Canada, expansions have been longer than recessions on
average.
2. The term “cycle” implies a predictably recurring event. In fact, recessions and expansions are of
irregular length and size. This irregularity makes forecasting peaks and troughs quite difficult.
3. Generally, producers of durable goods are affected most by recessions while producers of services
and nondurables (like food) are affected least. This suggests that the automobile producer would see its
profits reduced the most, the barbershop the least. Boots and shoes are semi-durable, since a pair of shoes
may last for several years (and people can put off purchases of these for a while if necessary). Thus the
boot manufacturer’s losses are likely to fall in between those of the other two firms.
4. The four broad types of unemployment are frictional unemployment, due to the process of matching
workers and jobs; structural unemployment, which occurs when workers are unable to fill available jobs;
seasonal unemployment, associated with the seasons; and cyclical unemployment, brought about by
recession. Frictional unemployment is the least costly.
5. The natural unemployment rate is the sum of structural and frictional unemployment and excludes
cyclical unemployment. Thus the natural unemployment rate by definition should not be affected by a
recession. Also by definition, the cyclical unemployment rate rises in recession. The inflation rate tends to
decline in the period following a recession.
6. Potential output, or potential GDP, is the amount of output the economy can produce when it is
using its inputs, such as capital and labour, at normal rates. Because inputs can be used at greater than
normal rates for a time (for example, workers can work overtime and machines can be used at night or on
weekends), it is possible for the economy to produce an amount exceeding potential output.
7. False. When output equals potential output, the unemployment rate equals the natural unemployment
rate. Cyclical unemployment is zero when output equals potential output, but frictional and structural
unemployment still exist.
8. By Okun’s law, output that is 2% below potential output is associated with cyclical unemployment
of 1%, so in that case the overall rate of unemployment (natural plus cyclical) would be 6%. If output is
2% above potential, cyclical unemployment is –1%, so overall unemployment equals 5% – 1% = 4%.
Answers to Problems
1.
Year
Output gap as a
percentage of
Copyright © 2009 McGraw-Hill Ryerson Limited
Recessionary or
expansionary gap
Growth rate of real
GDP
1
2001
2002
2003
2004
2005
2006
potential GDP
-51/981 = -5.20%
-42/1011 = -4.15%
54/1140 = 4.74%
0/1113 = 0%
-23/1132 = -2.03%
-24/1177 = -2.04%
expansionary
expansionary
recessionary
no gap
expansionary
expansionary
--2.03%
3.13%
2.49%
3.77%
3.98%
2. If actual unemployment in 2000 averaged 6.8% and the natural rate of unemployment was 5.3%,
then unemployment was 1.5% above the natural rate, so GDP was 3% below potential. Since GDP was
$1056 billion, then potential GDP would have to have been $1056/0.97 = $1089 billion. The recessionary
gap would thus have been $33 billion. If the natural rate was instead 7%, then unemployment was 0.2%
below the natural rate, so GDP was 0.4% above potential. Then potential GDP would have to have been
$1056/1.004 = $1052 billion. The expansionary gap would thus have been $4 billion.
3. (1) In 2006, real GDP is 2% below potential GDP, so cyclical unemployment is 1%. Since the
actual unemployment rate is 6%, the natural rate must be 5%.
(2) The natural rate equals the actual rate, so cyclical unemployment equals zero and there is no
output gap. Thus potential GDP equals 8100, the same as real GDP.
(3) Cyclical unemployment equals 4% – 4.5% = –0.5%, so by Okun’s Law the output is gap is –
1%. If real GDP exceeds potential GDP by 1%, we find that real GDP must equal 8282.
(4) Real GDP is 2% above potential GDP (the output gap is –2%), so cyclical unemployment is –
1%. As the natural unemployment rate is 5%, actual unemployment is 4%.
Sample Homework Assignment
1.
a.
b.
c.
d.
Given the data below on real GDP and potential GDP for the country Theta, determine each of the
following:
The year-to-year growth rates of real GDP.
The output gap.
The output gap as a percentage of potential GDP.
Whether the gap is expansionary or recessionary.
Year
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Real GDP
17,500
18,200
18,500
18,200
18,600
19,000
19,400
19,900
20,600
21,600
Potential GDP
17,300
17,800
18,300
18,800
19,300
19,800
20,800
20,900
21,100
21,500
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2.
According to Okun’s law, if a country’s output gap grows by an amount equal to 4% of potential
output, its cyclical unemployment rate will grow by how much?
Multiple Choice Quiz
1.
a.
b.
c.
d.
e.
A period in which the economy is growing at a rate that is significantly above normal is called a(n)
expansion.
recession.
depression.
peak.
contraction.
2.
a.
b.
c.
d.
e.
The low point of economic activity prior to a recovery is called a(n)
expansion.
depression.
peak.
trough.
contraction.
3.
a.
b.
c.
d.
e.
Which of the following is not an indicator of short-term economic fluctuations?
Unemployment.
Inflation.
Sales of durable goods.
GDP.
Average labour productivity.
4.
a.
b.
c.
d.
e.
The amount of real GDP an economy can produce when using its resources at normal rates is called
potential output.
expansion output.
the output gap.
normal GDP.
employment potential.
5.
a.
b.
c.
d.
e.
A positive output gap (when actual output is below potential) is called a(n)
expansionary gap.
recessionary gap.
depressionary gap.
contractionary gap.
inflationary gap.
6.
a.
b.
c.
d.
e.
The natural rate of unemployment is the level of unemployment at which
unemployment is zero.
cyclical unemployment equals frictional unemployment.
all unemployment is structural.
there is an expansionary gap.
cyclical unemployment equals zero.
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3
7.
a.
b.
c.
d.
e.
8.
Okun’s law states that each extra percentage point of cyclical unemployment is associated with
about a _____ percentage-point increase in the output gap.
one
two
three
four
five
a.
b.
c.
d.
e.
The difference between the actual unemployment rate and the natural rate of unemployment is
________ unemployment.
structural
frictional
cyclical
seasonal
potential
9.
a.
b.
c.
d.
e.
Over the period since 1947, the highest unemployment rate during recessions in Canada has
increased.
decreased.
remained constant.
fluctuated dramatically.
fluctuated slightly.
10.
a.
b.
c.
d.
e.
The all-time record for the duration of a Canadian economic expansion was set in
2000.
1990.
1980.
1975.
1970.
Problems/Short Answer
1.
a.
b.
c.
d.
Given the data below on real GDP and potential GDP for the country Theta, determine each of the
following:
The year-to-year growth rates of real GDP.
The output gap.
The output gap as a percentage of potential GDP.
Whether the gap is expansionary or recessionary.
Year
2004
2005
2006
2007
2008
2.
Real GDP
19,000
19,400
19,900
20,600
21,600
Potential GDP
19,800
20,800
20,900
21,100
21,500
According to Okun’s law, if a country’s cyclical unemployment rate grows by 3%, its output gap
will grow by how much?
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Answer Key to Extra Questions in Instructor’s Manual
Sample Homework Assignment
1a. The year-to-year growth rates of real GDP:
2001
2002
2003
2004
2005
2006
2007
2008
2009
b.
The output gap:
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
c.
-200
-400
-200
600
700
800
1400
1000
500
-100
The output gap as a percentage of potential GDP:
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
d.
4.0%
1.6%
-1.6%
2.2%
2.2%
2.1%
2.6%
3.5%
4.9%
-1.2
-2.3
-1.1
3.2
3.6
4.0
6.7
4.8
2.4
-0.5
Whether the gap is expansionary or recessionary:
2000
2001
2002
2003
expansionary
expansionary
expansionary
recessionary
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5
2004
2005
2006
2007
2008
2009
2.
recessionary
recessionary
recessionary
recessionary
recessionary
expansionary
2%.
Multiple Choice
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
a
d
e
a
b
e
b
c
a
a
Problems/Short Answer
1a. The year-to-year growth rates of real GDP:
2005
2006
2007
2008
b.
The output gap:
2004
2005
2006
2007
2008
c.
800
1400
1000
500
-100
The output gap as a percentage of potential GDP:
2004
2005
2006
2007
2008
d.
2.1%
2.6%
3.5%
4.9%
4.0
6.7
4.8
2.4
-0.5
Whether the gap is expansionary or recessionary:
2004
recessionary
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6
2005
2006
2007
2008
2.
recessionary
recessionary
recessionary
expansionary
6%.
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