Topic 7

Question 1

IF EQUILIBRIUM OCCURS BELOW POTENTIAL OUTPUT
- Actual output Qe < potential output Qp
- Actual unemployment > natural unemployment
- Cyclical unemployment > 0
- The self-correcting mechanism works very slowly.
Competition for jobs –> wages fall (very slowly)
So AS shifts to the _____
May take a long time to reach potential output Qp
Cyclical unemployment persists (“stagnation”)

Answer 1

right

Question 2

Suppose the inflation rate rises –

• the purchasing power of financial assets will _____.
• consumers’ wealth falls in real terms
• so consumers _____ their expenditure (C)

Answer 2

fall; reduce

Question 3

Aggregate Demand curve

In summary, if the inflation rate rises –

• aggregate expenditure falls
• aggregate expenditure is real GDP on the ______ side (“the quantity of real GDP demanded”)

Answer 3

demand

Question 4

Aggregate Demand curve

So there is a ___________relationship between the inflation rate and real GDP demanded.

The AD curve shows this relationship

Answer 4

downward-sloping

Question 5

Three things make aggregate demand downward-sloping ?

Answer 5

1. Wealth effect
2. Saving interest rate effect
3. Exchange rate effect

Question 6

Potential GDP, or the natural rate of output, is the GDP level that would prevail if __________ (“full employment”) apply

Answer 6

normal conditions

Question 7

Aggregate Supply curve

• If product prices in general rise, while costs of inputs (e.g. of labour, oil, etc.) are relatively steady
  + _______ increase
  + producers have to expand output
• So there is an upward-sloping relationship between the inflation rate and real GDP supplied
  The AS curve shows this relationship

Answer 7

profits; incentive

Question 8

Shifts in AS curve

• If real GDP supplied changes because of a change in a factor other than the inflation rate, the AS curve shifts.
• Examples of AS shifting to the left: higher costs due to:
  + _______ increasing while product prices are steady; or
  + a rise in world oil prices while most other prices remain stable.

Answer 8

wages

Question 9

Frictional unemployment arises when people are between jobs for _________.

Answer 9

normal reasons.

Question 10

Structural unemployment is caused by shifts in the pattern of demand, or _________, such that some industries become smaller, and some skills become obsolete.

Answer 10

technological changes

Question 11

________ unemployment = structural + frictional unemployment

Answer 11

Natural

Question 12

Natural unemployment is essentially ________ over the course of the business cycle.

Answer 12

steady

Question 13

Cyclical unemployment _____ with the business cycle, that is, it depends on the state of the economy:

• it rises when the economy is weak and
• falls when the economy is strong.

Answer 13

varies

Question 14

_______ unemployment = natural + cyclical unemployment

Answer 14

Actual

Question 15

Starting from Qe = Qp, an ________________ (e.g. oil price increase) will shift AS to the ______–

• Inflation rate will increase
• while output will fall
• so unemployment will rise

So we’ll have “stagflation”, a combination of “stagnation” and “inflation”

Answer 15

adverse supply-shock; left

Question 16

If equilibrium occurs ABOVE potential output
(Situation C)
- Actual output Qe > potential output Qp
- Actual unemployment < natural unemployment
- Cyclical unemployment < 0
- The economy has a self-correcting mechanism.
Competition for labour will drive up wages
So AS shifts to the ______(gradually)
Until Qe = Qp
Effect: ___________

Answer 16

left; inflation increases

Question 17

More likely: equilibrium occurs ____________ Qp.

Answer 17

below or above

Question 18

Unemployment results in

• Lost _______and incomes
• Lost ___________

Answer 18

production; human capital

Question 19

The loss of income is devastating for those who bear it. Employment benefits create _________ but don’t fully replace lost wages, and not everyone receives benefits.

Answer 19

a safety net

Question 20

Prolonged unemployment permanently damages a person’s job prospects by destroying __________.

Answer 20

human capital

Question 21

Inflation erodes the ________ of nominal wages
but often nominal wages rise just as fast as (or faster than) prices
- what is important is real wages (refer to last week’s lecture)
- Other types of income, e.g. indexed pension, real interest
==»Some people can ______ inflation (i.e. they can demand and get adequate compensation for it) but others are unable to do so

Answer 21

purchasing power; anticipate

Question 22

_________ redistributes wealth.

Unexpectedly high inflation redistributes wealth from the _______ to the ________

Answer 22

Unexpected inflation; lender (creditor); borrower (debtor)

Question 23

Many experts argue that once inflation takes hold and rises above moderate (e.g. single-digit) levels, it tends to become _________.

Answer 23

unpredictable

Question 24

There are short term ______ of real GDP around potential GDP.

Answer 24

fluctuations

Question 25

The long term trend (potential GDP) is _______.

Answer 25

rising

Question 26

Potential GDP is the quantity of real GDP produced when all the economy’s labour, capital, land, and entrepreneurial _________ are fully employed.

Answer 26

ability

Question 27

Cycical unemployment —-> ________ chair

Answer 27

not enough

Question 28

Friction unemployment —-> _____ chairs but people need to find them and they are switching chairs

Answer 28

enough

Question 29

Structural unemployment —> _______ chairs but the types of chairs do no match what people need

Answer 29

enough