Question

1. Suppose you are given the following data for a small economy:

• The number of unemployed workers: 1,000,000.
• Labor force: 10,000,000.

Based on this data, answer the following:

• 1. What is the unemployment rate?
  2. Can you determine whether the economy is operating at its full-employment level?
  3. Now suppose people who had been seeking jobs become discouraged, and give up their job searches. The labour force shrinks to 900,500 workers, and unemployment falls to 500,000 workers. What is the unemployment rate now? Has the economy improved?

2. Nominal GDP for an economy is $10 trillion. Real GDP is $9 trillion. What is the value of the implicit price deflator?

3. Suppose you compare your income this year and last year and find that your nominal income fell but your real income rose. How could this have happened?

4. Suppose that people expect inflation to equal 3 percent, but in fact, prices rise by 5 percent. Indicate whether this unexpected higher rate of inflation would help or hurt each of the following groups.

• 1. a homeowner with a fixed-rate mortgage.
  2. a union worker with a fixed labour contract
  3. a company that has invested some of its endowment in government bonds which pays a fixed rate of return.

5. Indicate how each of the following events would affect the aggregate demand AD curve:

• 1. a short-run decrease in the price level
  2. an increase in consumer confidence on the price level and real GDP
  3. an increase in government purchases

Answer 1

Unemployment rate = Unemployed/ Labour force *100

1000,000/10,000,000 *100 = 10%; Thus the economy is not operating at its full-employment level.

New unemployment rate is 5,00,000/900,500 *100 = 55; hence the state of the economy has further detoriated.

The implicit price deflator is a price index of all the final goods and services produced.

Implicit price deflator = nominal GDP / real GDP

10/9 = 1.11

1.11 * 100 = 111 is the implicit price deflator.

Nominal income is the actual income & real income is adjusted for inflation.

Though nominal income fell, it is the real income which gives us the purchasing power of an individual. This is mainly on account of a fall in inflation.

A homeowner with a fixed-rate mortgage benefits.

Union worker with a fixed labour contract benefits.

A company that has invested some of its endowment in government bonds which pays a fixed rate of return losses. This is because inflation is not good for borrowers.

A short-run decrease in the price level will shift the AD curve to the left.

An increase in consumer confidence on the price level and real GDP will shift the AD curve to the right.

An increase in government purchases will shift the AD curve to the right.

Remenber the equation, AD=C+I+G+NX; where,

C consumption

I investment

G govermnent expenditure

NX net export

An increase on any of the above, shifts the AD curve to the right.