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CHAPTER 7
UNEMPLOYMENT AND INFLATION
In this chapter, you will find:
Chapter Outline with PowerPoint Script
Chapter Summary
Teaching Points (as on Prep Card)
Answers to the End-of-Book Questions and Problems for Chapter 7
Supplemental Cases, Exercises, and Problems
INTRODUCTION
This chapter examines the macroeconomic problems of unemployment and inflation. The idea is to show
what can go wrong with the economy, thereby providing the rationale for studying macroeconomics. If the
economy always operated smoothly, there would be less need to understand how it works. Four types of
unemployment are discussed: frictional, structural, seasonal, and cyclical. The composition and duration of
unemployment, along with unemployment insurance, are also examined. Inflation, deflation, disinflation (a
reduction in inflation), and changes in relative prices are covered in the second half of the chapter. This
chapter emphasizes the cost of unemployment and inflation, in addition to the shortcomings associated
with the official measurements, particularly in making international comparisons.
LEARNING OUTCOMES
1
Discuss the effects of unemployment on the economy
The unemployment rate is the number of people looking for work divided by the number in the labor force. The
unemployment rate masks differences among particular groups and across regions. The rate is lowest among
white adults and highest among black teenagers.
There are four sources of unemployment. Frictional unemployment arises because employers and qualified job seekers need time to find one another. Seasonal unemployment stems from the effects of weather and
the seasons on certain industries, such as construction and agriculture. Structural unemployment arises because
changes in tastes, technology, taxes, and competition reduce the demand for certain skills and increase the demand for other skills. And cyclical unemployment results from fluctuations in economic activity caused by the
business cycle. Policy makers and economists are less concerned with frictional and seasonal unemployment.
Full employment occurs when cyclical unemployment is zero.
2
Discuss the effects of inflation on the economy
Inflation is a sustained rise in the average price level. An increase in aggregate demand can cause demand-pull
inflation. A decrease in aggregate supply can cause cost-push inflation. Prior to World War II, both inflation and
deflation were common, but since then the price level has increased virtually every year.
Anticipated inflation causes fewer distortions in the economy than unanticipated inflation. Unanticipated inflation arbitrarily creates winners and losers, and forces people to spend more time and energy coping with
the effects of inflation. Because not all prices change by the same amount during inflationary periods, people
have trouble keeping track of the changes in relative prices. Unexpected inflation makes long-term planning
more difficult and more risky.
The intersection of the demand and supply curves for loanable funds yields the market interest rate. The
real interest rate is the nominal interest rate minus the inflation rate. Borrowers and lenders base decisions on the
expected real interest rate.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 7
Unemployment and Inflation
94
CHAPTER OUTLINE WITH POWERPOINT SCRIPT
USE POWERPOINT SLIDES 2-6 FOR THE FOLLOWING SECTION
Unemployment
Measuring Unemployment
 Labor force: Those in the adult population who are either working or looking for work.
 Unemployment rate: The number unemployed divided by the number in the labor force.
 Discouraged workers: People who have dropped out of the labor force.
USE POWERPOINT SLIDES 7-9 FOR THE FOLLOWING SECTION
Labor force participation rate: The number in the labor force divided by the adult population.
 The participation rates of men and women have converged since WWII.
 Participation rate climbs with education.
Unemployment over Time
 The unemployment rate experienced a downward trend between 1980-2000 due to the overall
economic upturn, and because there were fewer teenagers in the workforce.
 With the recession of 2001, the rate increased until it peaked at 6.0 percent in 2003. The rate then
declined over the next four years, but increased again during the recession of 2008–2009.
USE POWERPOINT SLIDES 10-12 FOR THE FOLLOWING SECTION
Unemployment in Various Groups
Unemployment rates are:
 Higher among blacks than among whites.
 Higher among teenagers than among those 20 and older.
USE POWERPOINT SLIDES 13-15 FOR THE FOLLOWING SECTION
Unemployment Varies across Occupations and Regions: The national unemployment rate reveals
nothing about the variation of unemployment rates across the country.
USE POWERPOINT SLIDES 16-18 FOR THE FOLLOWING SECTION
Sources of Unemployment
 Frictional Unemployment: Reflects the time required to bring together employers and job seekers.
 Seasonal Unemployment: Caused by seasonal changes in labor demand during the year.
 Structural Unemployment: Arises because of a mismatch of skills or geographic location.
 Cyclical Unemployment: Fluctuates with the business cycle, increasing during recessions and
decreasing during expansions.
USE POWERPOINT SLIDE 19 FOR THE FOLLOWING SECTION
The Meaning of Full Employment: There is no cyclical unemployment, but unemployment is not zero.
There will still be some frictional, structural, and seasonal unemployment in an economy considered to be
at full employment.
USE POWERPOINT SLIDE 20 FOR THE FOLLOWING SECTION
Unemployment Compensation
 Provides a safety net for the unemployed and is on average 40% of person’s take home pay
 May reduce the urgency of finding work, thereby increasing the average duration of unemployment
and the unemployment rate,
 Allows for a higher-quality job search.
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Chapter 7
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95
USE POWERPOINT SLIDES 21-22 FOR THE FOLLOWING SECTION
International Comparisons of Unemployment: Should be analyzed carefully because definitions of
unemployment vary across countries.
USE POWERPOINT SLIDES 23-24 FOR THE FOLLOWING SECTION
Problems with Official Unemployment Figures:
 Ignore discouraged workers and those who are underemployed, causing unemployment rates to be
underestimated.
 Unemployment benefits and most welfare programs require recipients to seek employment or at least
go through the motions even if they do not want a job. This overestimates unemployment.
 Additionally, those in the underground economy may not admit to having a job since they are
breaking the law, resulting again in an overestimate of unemployment.
USE POWERPOINT SLIDES 25-26 FOR THE FOLLOWING SECTION
Inflation: A sustained increase in the economy’s average price level.
 Hyperinflation: Extremely high inflation.
 Deflation: A sustained decrease in the average price level.
 Disinflation: A reduction in the rate of inflation.
USE POWERPOINT SLIDES 27-28 FOR THE FOLLOWING SECTION
Two Sources of Inflation
 Demand-pull: A rising aggregate demand pulls up the price level.
 Cost-push: Inflation caused by a decrease in aggregate supply. Therefore, increases in production
costs will push up the price level.
USE POWERPOINT SLIDES 29-31 FOR THE FOLLOWING SECTION
A Historical Look at Inflation and the Price Level
Prior to WW II, years of inflation and deflation balanced out over the long run. Since the end of WW II,
the CPI has increased by an average of 3.7% per year. Inflation erodes confidence in the value of the
dollar over the long term.
USE POWERPOINT SLIDE 32 FOR THE FOLLOWING SECTION
Anticipated Versus Unanticipated Inflation
 Anticipated Inflation: Is largely neutral in its effects on real GDP.
 Unanticipated Inflation: Arbitrarily creates economic winners (debtors and those on fixed incomes)
and losers (creditors).
USE POWERPOINT SLIDES 33-34 FOR THE FOLLOWING SECTION
The Transaction Costs of Variable Inflation: Increase as inflation becomes more unpredictable.
Inflation Obscures Relative Price Changes: During periods of volatile inflation, there is greater
uncertainty about the price of one good relative to another.
Inflation across Metropolitan Areas: Inflation rates differ across regions mostly because of differences
in housing prices.
USE POWERPOINT SLIDES 35-36 FOR THE FOLLOWING SECTION
International Comparisons of Inflation: Inflation is difficult to compare across countries. When
calculating a price index, less-developed countries sample fewer products and measure prices only in the
capital city.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 7
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USE POWERPOINT SLIDES 37-41 FOR THE FOLLOWING SECTION
Inflation and Interest Rates
 Interest: The dollar amount paid by borrowers to lenders.
 Supply of loanable funds: Slopes upward, represents the amount people are willing to lend.
 Demand for loanable funds: Slopes downward, represents the amount demanded to purchase goods
or finance deficits.
 Nominal interest rate: Interest in terms of current dollars paid. This is the rate that is seen on loan
agreements and is discussed in the media.
 Real interest rate: Is known only after the fact; that is, after inflation occurs.
– Equals the nominal interest rate minus the rate of inflation (CPI).
– The higher the expected inflation, the higher the nominal rate of interest.
USE POWERPOINT SLIDE 42 FOR THE FOLLOWING SECTION
Why Is Inflation Unpopular?
Unanticipated inflation:
 Arbitrarily redistributes income and wealth from one group to another;
 Reduces the ability to make long-term plans;
 Forces buyers and sellers to focus more on money and prices.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
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Chapter 7
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97
CHAPTER SUMMARY
The unemployment rate is the number of people in the labor force who are looking for work divided by the
number in the labor force. The unemployment rate masks differences among particular groups and across
regions. The rate is lowest among white adults and highest among black teenagers.
There are four sources of unemployment. Frictional unemployment arises because employers and qualified
job seekers need time to find one another. Seasonal unemployment stems from the effects of weather and
the seasons on certain industries, such as construction and agriculture. Structural unemployment arises
because changes in tastes, technology, taxes, and competition reduce the demand for certain skills and
increase the demand for other skills. And cyclical unemployment results from fluctuations in economic
activity cased by the business cycle. Policy makers and economists are less concerned with frictional and
seasonal unemployment. Full employment occurs when cyclical unemployment is zero.
Unemployment often creates both an economic and a psychological hardship. For some, this burden is
reduced by an employed spouse and by unemployment insurance. Unemployment insurance provides a
safety net for some and that’s good, but it may also reduce incentives to find work for some, as is the case
in Europe, and that’s an unintended consequence.
Inflation is a sustained rise in the average price level. An increase in aggregate demand can cause demandpull inflation. A decrease in aggregate supply can cause cost-push inflation. Prior to World War II, both
inflation and deflation were common, but since then the price level has increased virtually every year.
Anticipated inflation causes fewer distortions in the economy than unanticipated inflation. Unanticipated
inflation arbitrarily creates winners and losers and forces people to spend more time and energy coping
with the effects of inflation. The negative effects of high and variable inflation on productivity can be
observed in countries that have experienced hyperinflation, such as Zimbabwe.
Because not all prices change by the same amount during inflationary periods, people have trouble
keeping track of the changes in relative prices. Unexpected inflation makes long-term planning more
difficult and more risky.
The intersection of the demand and supply curves for loanable funds yields the market interest rate. The
real interest rate is the nominal interest rate minus the inflation rate. Borrowers and lenders base decisions
on the expected real interest rate.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 7
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TEACHING POINTS
1. This chapter discusses two important macroeconomic problems, inflation and unemployment.
Although these subjects are often discussed in the news, they are widely misunderstood by the general
public.
2. Most students will believe that the only people hurt when the unemployment rate rises are those who
lose their jobs. Society as a whole, however, loses output because of underutilization of resources.
Crime rates rise during this time. Government budget deficits, which also rise during this time,
typically create political pressure for tax hikes to balance the budget (however misguided this policy
may be). Those with jobs lose bargaining power in seeking higher wages. The list can go on.
Unemployment imposes a variety of costs.
3. You might choose to list and give examples of each of the four types of unemployment. For example,
frictional—an electrical engineer, seasonal—orange pickers in Florida during the off-season,
structural—a blacksmith, and cyclical—autoworkers during an economic contraction.
4. Some students will believe that those who are unemployed represent a group of people who are
perpetually without jobs. This is untrue. The group of individuals currently unemployed is constantly
changing. Although some population subgroups have been unemployed for significant periods of time,
many of the unemployed find work within a relatively short period of time or give up seeking work
(and fall into the discouraged worker pool).
5. The idea that “full employment” includes frictional, structural, and seasonal unemployment needs to
be emphasized. You should emphasize that while all unemployment has costs, frictional
unemployment and seasonal unemployment are short-term phenomena and therefore are less
personally devastating to those who fall into these categories. The idea that structural unemployment
(which may not be temporary because solving it requires retraining or new skills development, which
may be extremely difficult for some elements of the work force) occurs at full employment should not
be construed as implying that its costs are not a source of concern. You might point out, however, that
lowering structural unemployment requires significant effort in developing new job skills.
6. Inflation can be as confusing as unemployment for the student. Most students believe that inflation is a
unique and precisely measured concept. It is easy to dispel this myth. The measured inflation rate
depends on, among other things, which prices are used in the price index and what weights are
assigned to each price change. Usually economists choose the price index that most closely fits the
object of their study. For example, if they wish to track movements in consumer standards of living,
the CPI would be used.
7. You may wish to emphasize that although unemployment and inflation are the most commonly
discussed topics in macroeconomics, there are other topics that macroeconomists study as well, such
as economic growth, international finance, and welfare economics.
8. A discussion of frictional and structural unemployment is important, since it lays the foundation for
the discussion of potential output found in Chapter 9 on Aggregate Expenditure.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
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Chapter 7
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99
ANSWERS TO END-OF-BOOK QUESTIONS AND PROBLEMS
1.1
(Measuring Unemployment) Determine the impact on each of the following if 2 million formerly
unemployed workers decide to return to school full time and stop looking for work:
a. The labor force participation rate
b. The size of the labor force
c. The unemployment rate
a. The labor force participation rate drops since these workers have left the labor force.
b. The size of the labor force drops by 2 million.
c. The unemployment rate drops since the percentage drop in the number of unemployed is
greater than the percentage drop in the labor force.
1.2
(Measuring Unemployment) Suppose that the U.S. noninstitutional adult population is 230 million
and the labor force participation rate is 67 percent.
a. What would be the size of the U.S. labor force?
b. If 85 million adults are not working, what is the unemployment rate?
a. Of 230 million, 67 percent, or 154.1 million.
b. Of the 230 million adults in the population, 154.1 million are in the labor force. The
population (230 million) minus the number in the labor force (154.1 million) gives the number
of people outside the labor force who are not working (75.9 million). Statistics given say that
85 million adults are not working, thus 85 million minus 75.9 million gives the number of
people in the labor force who are not working (9.1 million) which is the number that
represents the unemployed. The unemployment rate is the percentage of the labor force (not
the population) that is unemployed. The unemployment rate is equal to the number of people
counted as unemployed (9.1 million) divided by the labor force (154.1 million) expressed as a
percentage (5.9 percent).
1.3
(Types of Unemployment) Determine whether each of the following would be considered frictional,
structural, seasonal, or cyclical unemployment:
a. A UPS employee who was hired for the Christmas season is laid off after Christmas.
b. A worker who is laid off due to reduced aggregate demand in the economy.
c. A worker in a DVD rental store becomes unemployed as video-on-demand cable service
becomes more popular.
d. A new college graduate is looking for employment.
a.
b.
c.
d.
Seasonal
Cyclical
Structural
Frictional
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Chapter 7
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2.1 (Inflation) Here are some recent data on the U.S. consumer price index:
Year CPI
Year CPI
Year CPI
1992 140.3
1998 163.0
2004 188.9
1993 144.5
1999 166.6
2005 195.3
1994 148.2
2000 172.2
2006 201.6
1995 152.4
2001 177.1
2007 207.3
1996 156.9
2002 179.9
2008 215.3
1997 160.5
2003 184.0
2009 214.5
Compute the inflation rate for each year 1993-2009 and determine which years were years of
inflation. In which years did deflation occur? In which years did disinflation occur? Was there
hyperinflation in any year?
Deflation, an actual decrease in the price level, occurred during the recession year of 2009.
Inflation occurred in all the other years given. Disinflation, a decrease in the rate of inflation,
occurred in 1994, 1997, 1998, 2001, 2002, 2006, and 2007. Hyperinflation, a very high rate of
inflation, did not occur over this period.
The rate is calculated as: [(CPI in a given year minus CPI from the prior year)/CPI prior year]
multiplied by 100.
Year
1993
1994
1995
1996
1997
2.2
Inflation
Rate (%)
Year
1998
2.99 Inflation 1999
2.56 Disinflation 2000
2.83 Inflation 2001
2.95 Inflation 2002
2.29 Disinflation 2003
Inflation
Rate (% )
Year
1.56 Disinflation 2004
2.21 Inflation
2005
3.36 Inflation
2006
2.85 Disinflation 2007
1.58 Disinflation 2008
2.28 Inflation 2009
Inflation
Rate (%)
2.66 Inflation
3.39 Inflation
3.23 Disinflation
2.83 Disinflation
3.86 Inflation
−0,37 Deflation
(Sources of Inflation) Using the concepts of aggregate supply and aggregate demand, explain why
inflation usually accelerates during wartime.
One of the most important reasons why prices rise so quickly during wartime is that household
incomes increase as more workers are employed in the armed forces. Fewer consumer goods are
available as production shifts towards military goods. Military spending by the government also
rises. Thus, the aggregate demand curve shifts to the right. In some countries, war creates a
reduction in aggregate supply if many of the plants and much of the equipment are destroyed. This
occurred in both Germany and Japan during World War II. Increasing aggregate demand and
falling aggregate supply both lead to higher prices.
2.3
(Inflation and Interest Rates) Using a demand-supply diagram for loanable funds (like Exhibit 10),
show what happens to the nominal interest rate and the equilibrium quantity of loans when both
borrowers and lenders increase their estimates of the expected inflation rate from 5 percent to 10
percent.
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Chapter 7
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Higher expected inflation reduces the real rate of interest for a given nominal rate. Therefore, at
each nominal rate, suppliers are less willing to lend and demanders are more willing to borrow.
As a result, supply falls, demand rises, and the equilibrium nominal rate rises. Since both sides of
the market experience the same change in expectations, the nominal rate should adjust to exactly
compensate for the higher expected inflation and the total quantity of loans should not change.
SUPPLEMENTAL CASES, EXERCISES, AND PROBLEMS
Case Studies
These cases are available to students online at www.cengagebrain.com.
“Hiring Picks Up, But Jobless Rate Rises”
So reads the headline describing the April 2010 jobs report. In a burst of hiring, the U.S. economy added
290,000 jobs, for what was then the biggest monthly gain in four years. That sure sounds like good
news—until you learn that the U.S. unemployment rate climbed too, from 9.7 percent to 9.9 percent. How
could that rate rise when the economy was adding so many jobs?
Because of a severe recession, the number of unemployed increased by over 8 million between early
2008 and early 2010. But even that total understates the number who wanted jobs. Recall that to be counted as unemployed, those wanting work must have looked for a job in the prior four weeks. With 8 million
people looking for work, and with firms more likely to be firing than hiring, the chances of finding a job
diminished. In frustration, some gave up their search, and these people are called discouraged workers, a
term already introduced. But the U.S. Labor Department identifies a second group of people who wanted a
job but did not look for work in the prior four weeks. This group faced transportation problems, family
problems, or some other snag that kept them from looking. It wasn’t that they were frustrated with their
search, they just got sidetracked with some personal issues. Discouraged workers and this group that got
sidetracked are considered marginally attached to the labor force.
At the beginning of 2010, an estimated 2.4 million people were marginally attached to the labor force.
This was 1.1 million more than before the recession began. Thus, when the economy started showing signs
of life, as it did in early 2010, some people who had been sidelined for one reason or another took notice
and decided to look for work, thus joining or rejoining the labor force. In April 2010 the labor force increased by about 800,000 people from the month earlier. Most of those people didn’t find jobs right away,
so they swelled the ranks of the unemployed. Even though the economy created 290,000 jobs during the
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Chapter 7
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102
month, that was not enough to offset the spike in the labor force. Thus, we get the seeming paradox of
healthy job growth but a rising unemployment rate.
The same happened during the recession of 2001; the unemployment rate did not start to decline until
two years after the recession ended. That’s why the unemployment rate is often considered a lagging indicator of economic activity. Even after the economy starts to recover from a recession, the unemployment
rate continues to increase for reasons that are not all bad. Those who want a job are encouraged enough by
the uptick in jobs to look for one.
Sources: Jeannine Aversa, “Hiring Picks Up, But Jobless Rate Rises,” Arizona Republic, 8 May 2010;
Sara Murray and Joe Light, “Job Gains Speed Up and More Seek Work,” Wall Street Journal, 8 May
2008; “Ranks of Discouraged Workers and Others Marginally Attached to the Labor Force Rise During
Recession,” Issues in Labor Statistics, (April 2009); and figures from the U.S. Bureau of Labor Statistics
at http://www.bls.gov/.
Hyperinflation in Zimbabwe
In the troubled nation of Zimbabwe in southern Africa, the Zimbabwean dollar was once worth about 1.59
U.S. dollars. But the collapse of the economy in the early 2000s severely devalued the Zimbabwean dollar.
The government tried paying its bills by printing huge amounts of money, and the result was inflation on
an epic scale—hyperinflation. Consider this: The price level at the end of 2008 was 150 million times
higher than at the beginning of that year. To put that in perspective, with such inflation in the United
States, a gallon of gasoline that sold for $2.75 at the beginning of the year would cost $412.5 million by
year-end. Jeans that sold for $25 would cost $3.8 billion at year-end. With the value of the Zimbabwean
dollar cheapening by the hour, nobody wanted to hold any for long. Those fortunate enough to have jobs
in this wreck of an economy wanted to get paid at least daily; they then immediately spent their pay before
prices climbed more.
With such wild inflation, everyone, including merchants, had trouble keeping up with prices. Different
price increases among sellers of the same product encouraged buyers to shop around more. Even though
the government was printing money at an astounding rate, the huge spike in prices meant that it took
mountains of cash to buy anything, an amount both difficult to round up and onerous to carry. For months,
the maximum amount people could withdraw daily from their bank had the purchasing power of one U.S.
dollar. Because carrying enough money for even small purchases became physically impossible, currency
in Zimbabwe was issued in ever higher denominations, with the highest being a $100 trillion dollar note;
that’s $100,000,000,000,000. In addition to issuing these higher denominations, three times the central
bank issued an entirely new series of notes, each a huge multiple of the previous one, while doing away
with the old series. For example, the new Zimbabwean dollar issued in February 2009 exchanged for
1,000,000,000,000 of the dollars it replaced. Larger denominations and new series of notes facilitated
transactions but fed inflation, which raged all the more.
Many merchants would accept only stable currencies such as the U.S. dollar or the South African rand,
and would rather barter than accept Zimbabwean currency. No question, the country had all kinds of other
problems, but hyperinflation made everything worse. For example, Zimbabwe’s GDP plunged 75 percent
between 2006 and 2009, and the unemployment rate reached 90 percent.
As a way out of the mess, by mid-2009 the government allowed all transactions to be conducted in
foreign currencies, something that was already happening. The local currency, already worthless (a $100
trillion note was worth only U.S. pennies), mostly disappeared. Thus, Zimbabwe is now under what it calls
a “multiple currency system” and the country plans to operate that way until at least through 2012. Price
inflation grew only five percent in 2009 under the multiple currency system. Although Zimbabwe ended
its inflation nightmare, hyperinflation is usually flaring up somewhere in the world, as yet another country
looks to print money as a “free lunch” solution to budget problems. For example, inflation in Venezuela
reached 30 percent in 2010
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Chapter 7
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Sources: “Zimbabwe: Reaching Rock Bottom,” The Economist, 8 December 2008; Douglas Rogers,
“Zimbabwe’s Accidental Triumph,” New York Times, 14 April 2010; and Zimbabwe’s Federal Reserve
Bank at http://www.rbz.co.zw/. This case study also drew on the author’s visit to Zimbabwe in September
2008.
Experiential Exercises
1. The chapter explains the definitions the government employs in measuring unemployment. Have
students interview 10 members of their class to determine labor market status—employed, unemployed,
or not in the labor force. The interviewers should include themselves, and then compute the
unemployment rate and the labor force participation rate for the group of 11 people.
2. In recent years, how has the U.S. inflation rate compared with rates in other industrial economies? Why
should we be careful in comparing inflation rates across countries? The Federal Reserve Bank of St.
Louis maintains a Web page devoted to international economic trends: http://www.stls.frb.org/
publications/iet/. Ask students to choose two countries and compare the countries’ recent inflation
experiences. (If students have Adobe Acrobat Reader, they can look at bar charts of the data.)
3. Have students scan the Economy page in the first section of today’s Wall Street Journal. They are
almost sure to find a discussion of a policy proposal that will affect unemployment, inflation, or both.
Ask them to use the aggregate demand and supply model to describe the effect of the proposal—if
enacted—on the U.S. unemployment and inflation rates.
4. Inflation-indexed bonds pay a fixed rate of interest, and the par value of the bonds is increased each
year by the rate of inflation, as measured by the CPI. Have students look in the Money & Investing
section of the Wall Street Journal on the page where U.S. Treasury bond information is provided. Ask
them to compare the rates on these inflation-indexed bonds with non-indexed U.S. Treasury bonds.
5. (Global Economic Watch and Case Study: Hyperinflation in Zimbabwe) Go to the Global Economic
Crisis Resource Center. Select Global Issues in Context. In the Basic Search box at the top of the page,
enter the word "hyperinflation." On the Results page, go to the Magazines Section. Click on the link for
the February 2, 2009, article "What Currency Crisis?" At the time of publication of the article, what
was the price in Zimbabwean dollars of a loaf of bread?
According to the article, a loaf of bread costs about 300 billion Zimbabwean dollars.
6. (Global Economic Watch) Go to the Global Economic Crisis Resource Center. Select Global Issues in
Context. Go to the menu at the top of the page and click on the tab for Browse Issues and Topics.
Choose Business and Economy. Click on the link for Unemployment and Joblessness. Find an article
from the past three years about unemployment in a foreign country. What is the trend? Is there any information about the causes of and solutions to unemployment in that country?
Student answers will vary. Be sure that students have understood how official unemployment is calculated in the countries analyzed.
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Chapter 7
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104
Additional Questions and Problems
(From student Web site at www.cengagebrain.com)
1. (Labor Force) Refer to Exhibit 1 in the chapter to determine whether the following statements are
true or false.
a. Some people who are officially unemployed are not in the labor force.
b. Some people in the labor force are not working.
c. Everyone who is not unemployed is in the labor force.
d. Some people who are not working are not unemployed.
a.
b.
c.
d.
False. To be unemployed, a person must be looking for a job.
True. This would be the unemployed.
False. Some adults are not looking for a job, or they choose not to work.
True. To be classified as unemployed, a person must be looking for a job. However, there will
be some adults who choose not to do so. There will also be discouraged workers who
technically are not unemployed.
2. (Unemployment in Various Groups) Does the overall unemployment rate provide an accurate
picture of the impact of unemployment on all U.S. population groups?
No, the overall unemployment rate does not show the wide differences that occur across age, race,
and gender categories. For example, blacks have a higher unemployment rate than whites.
Teenagers also have higher unemployment rates than adults. Wide disparities also exist across
geographical regions in the country. For example, unemployment in Michigan substantially
exceeds the overall unemployment rate. The unemployment rate also does not indicate the
duration of unemployment. This is important because, the longer an individual is unemployed, the
greater is its impact.
3. (The Meaning of Full Employment) When the economy is at full employment, is the unemployment
rate at 0 percent? Why or why not? How would a more generous unemployment insurance system
affect the full employment figure?
No, even at “full employment,” frictional, seasonal and structural unemployment still exist. Full
employment implies that only cyclical unemployment is zero. A more generous system might lead
to more unemployment since incentives to work would be lower and more people could qualify for
benefits for, perhaps, a longer period of time.
4. (International Comparisons of Unemployment) How has the U.S. unemployment rate compared
with rates in other major economies? Why should we be careful in comparing unemployment rates
across countries?
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Major economies show a similar trend, with declining inflation, or disinflation, during the first
half of the 1980s, rising inflation during the second half of the 1980s to a peak in the early 1990s,
and then another trend lower. The overall trend since 1980 has been toward lower inflation.
International comparisons of unemployment data should be made carefully. The definitions of
unemployment differ across countries with respect to age limits, the criteria used to determine
whether a person is looking for work, the way layoffs are treated, how those in the military are
treated, and many other subtle ways.
5. (Official Unemployment Figures) Explain why most experts believe that official U.S. data
underestimate the actual rate of unemployment. What factors could make the official rate overstate
the actual unemployment rate?
The official unemployment rate does not include discouraged workers—those who have given up
searching for work in the belief that it is futile. In addition, the official rate does not account for
underemployment.
Because unemployment insurance and most welfare programs require recipients to seek
employment, some people may act as if they are looking for work just to qualify for such
programs. If these people do not in fact want to find a job, their inclusion among the unemployed
tends to overstate the official unemployment figures.
6. (Sources of Inflation) What are the two sources of inflation? How would you illustrate them
graphically?
Inflation that results from increases in aggregate demand is known as demand-pull inflation. The
price increases are combined with increases in aggregate output.
Inflation that results from decreases in aggregate supply is known as cost-push inflation. The price
increases are associated with decreases in aggregate output.
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7. (Anticipated versus Unanticipated Inflation) If actual inflation exceeds anticipated inflation, who
will lose purchasing power and who will gain?
In the case described, those who have borrowed at fixed nominal rates will gain purchasing
power, and those who have lent at such rates will lose. Also, workers whose wages are not tied
directly to the price level will lose.
8. (Inflation and Relative Price Changes) What does the consumer price index measure? Does the
index measure changes in relative prices? Why, or why not?
The consumer price index measures the price level as the cost of a fixed “market basket” of
consumer goods and services. Percentage changes in the cost of this basket are used as a measure
of inflation. Since it looks at the overall cost of that basket, it masks changes in relative prices.
Within the basket, prices of some goods may be falling, some may be rising more slowly than the
overall basket’s cost, and others may be rising more rapidly. Goods whose prices are rising more
rapidly have an increased relative price compared to goods whose prices are rising more slowly.
9. (Inflation and Interest Rates) Explain as carefully as you can why borrowers would be willing to
pay a higher rate of interest if they expected the inflation rate to increase in the future
The cost of borrowing is the opportunity cost today of purchasing power given up in the future.
Thus, an increase in the expected inflation rate means that borrowers can increase their nominal
repayment rate without increasing the lost future purchasing power. The real rate of interest falls
for the initial lower nominal rate
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Chapter 7
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10. (Inflation) Why is a relatively constant and predictable inflation rate less harmful to an economy
than a rate that fluctuates unpredictably?
A constant inflation rate means less uncertainty about real dollar flows (e.g., incomes, rents,
interest of payments) compared with a variable rate. Consequently, there is less risk associated
with lending and less unintended redistribution of real output because of unanticipated inflation.
11. (Inflation) Why do people dislike inflation?
Inflation distorts purchasing power and, especially if variable and unanticipated, causes other
problems including the arbitrary redistribution of income and wealth from one group to another, a
reduction in the ability to make long-term plans, and an increase in transaction costs due to less
transparent relative price changes that force buyers and sellers to pay more attention to prices.
ANSWERS TO ONLINE CASE STUDIES
1. (CaseStudy: Hiring Picks Up, But Jobless Rate Rises) Imagine that during an expansion the U.S.
economy adds 300,000 jobs. In addition, because of the improving economic conditions, the labor
force increases by 200,000. Would the unemployment rate go up or down?
The unemployment rate would decrease. This example is the opposite of the one described in the
case study. The high number of additional jobs would accommodate the increase in the labor force
and still reduce the unemployment rate.
2. (CaseStudy: Hyperinflation in Zimbabwe) In countries such as Zimbabwe, which had problems
with high inflation, the increased use of another country’s currency (such as the U.S. dollar or
South African rand) became common. Why do you suppose this occurred?
The desire to replace one’s currency with some other currency having stable value is the reason. If
successful, you don’t have to worry about a reduction in purchasing power due to your country’s
unstable currency because you have moved your cash into a more stable currency.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.