Question

Suppose that in Workolia: Population = 440 million, Ineligible Population = 140 m, Labor Force Participation Rate = 60%, Number of Employed = 172m and the Natural Rate of Unemployment = 5%. How much cyclical unemployment is there in Workolia?

a. - 1.4%

b. -.6%

c. 1.4%

d. 2.6%

If unemployment is below the natural level of unemployment, which one of these statements MUST be true? Check all the ones that are true?

a. Cyclical unemployment must be negative

b. The unemployment rate must be zero

c. Employment is above 95%

Which of the following are likely to cause cost-pushed inflation? Check all the ones that apply.

a. A depreciation in the US dollar

b. A rise in consumer confidence

Answer 1

Part a

Population = 440 million, Ineligible Population = 140 million

Eligible Population = Population - Ineligible Population

= 440 - 140 = 300 Million

Labour Force Participation Rate = 60%

Formula for Labour Force Participation Rate = Labour Force / Eligible Population * 100

Plugging Values in above formula

60 = Labour Force / 300 * 100

Labour Force = 60 * 300 / 100 = 180 Million

Also, Labour Force = Total Employed + Total Unemployed

Plugging Values in above Equaation

180 = 172 + Total Unemployed

Total Unemployed = 180 - 172 = 8 Million

Unemployment Rate = Number of Unemployed / Labour Force * 100

= 8 / 180 * 100 = 4.4%

Total Rate of Unemployment = 4.4%

Total Rate of Unemployment = Natural Rate of Unemployment + Cyclical Rate of Unemployment

4.4% = 5% + Cyclical Rate of Unemployment

Cyclical Rate of Unemployment = 4.4% - 5% = -0.6%

Option B is Correct

Part b

Option A is correct

If Unemployment rate is lower than natural rate, then cyclical rate of unemployment will be negative.

Unemployment Rate = (Frictional Unemployment Rate + Structural Unemployment Rate) + Cyclical Unemployment rate

Also, Natural Rate of Unemployment = Frictional Unemployment Rate + Structural Unemployment Rate

This means

Unemployment Rate = Natural Rate of Unemployment + Cyclical Unemployment Rate

As per this equation, if Unemployment rate is less than natural rate then cyclical rate of unemployment will be negative.

Option B is wrong

Unemployment rate can never be zero. There is always some unemployment even when economy is doing well. There will always be some natural unemployment in the economy which consists of frictional and structural unemployment. Also we have seen above that even if unemploymment rate is not zero, then cyclical rate of unemployment is negative.

Option C is wrong

Let us suppose that Employment rate is below 95% ie 94%. Then Unemployment Rate = 100 - Employment Rate = 100 - 94% = 6%. If Unemployment rate is lower than Natural rate of unemployment, then let us suppose that natural rate is 7%. Then in this case cyclical unemployment rate = 6 - 7 = -1% which is negative. Even if employment rate is below 95%, then cyclical unemployment can be negative.

Part c

Option A is correct. A depreciation in the US dollar

Cost-push inflation occur prices rise due to higher costs of production and higher costs of raw materials. Cost-push inflation is determined by supply-side factors, such as higher wages and higher oil prices. With the depriciation of US exchange rate i.e. depriciation of US Dollars, the price of imported goods will increase, thus reducing aggregate supply of goods, which results in cost push inflation.

Option B is wrong.

Increase in consumer confidence will result in demand pull inflation. When consumers are confident, they spend more, take more debt and thus aggregate demand exceeds aggregate supply. This results into shortage which put upward pressure on price and hence prices rise.