Question

Complete the following questions:

1. Describe what is meant by full employment and cyclical unemployment.

2. Explain the importance of cyclical unemployment.

3. How do you calculate the CPI?

4. How does the CPI tend to overstate inflation?

5. How do relative price changes affect the CPI?

Answer 1

1. Full employment is a level of output where all resources like labor and capital are fully utilized and no wastage. It is a situation popularly discussed in the classical theory of economics.

Cyclical unemployment refers to the form of unemployment due to changing business cycle like recession creates a situation of very low output and high unemployment.

2. Cyclical unemployment is an important form of unemployment which is related to the cyclical trends in the economy. It emphasises that business cycle fluctuations should be monitored and stimulated to avoid cyclical unemployment.

3. Consumer price index is a commonly used measure of inflation. It is calculated as the price index in current year divided by price index in base year and the ratio is multiplied by 100 to express in percentage terms.

4. CPI can overstate inflation as there are factors which can influence the measure of CPI. There can be substitution bias in which case, if the price of a good increases in consumer basket then it is  replaced by a good which is cheaper.

5. CPI is affected by relative price changes as when the base year changes it influences the measure. Also, when the basket combination of goods changes does the same.