Question

1. Explain the difference between cyclical, frictional, and structural unemployment and how they relate to the natural rate of unemployment.
2. Our current inflation rate in the United States is 1.8%. Explain as clearly as possible what that number means, how it is calculated, and how it compares to our goal for inflation.
3. Explain why economists use models and what the AD/AS model helps us understand.
4. How are the Keynesian and neoclassical perspectives on the economy different, and how is it possible for one economist to accept both of these perspectives?
5. Explain why there is an expenditure multiplier and why it is expected to be different for government spending and taxation.

Answer 1

1.

Cyclical employment takes place due to change in the phases of the business cycle, but frictional employment is created when people change one job to another job. In contrast to it, structural unemployment is created due to the changes in he technology, policies and other shifts that make existing skills to be obsolete, creating unemployment. Cyclical unemployment can be eliminated with suitable policies, but frictional and structural unemployment cannot be eliminated. Hence, sum of frictional and structural unemployment is called as natural rate of unemployment. At this natural  rate of  unemployment, cyclical unemployment is zero.  Hence, an economy performing at the full employment level means, it has a natural rate of unemployment only and cyclical unemployment is zero.

2.

Current inflation rate is 1.8%. It means that it is the percentage rise in the price of the basket of goods  in most recent calculation. So, price of the basket of goods have increased by 1.8% at aggregate level. It is calculated by the using the consumer price index of two most recent period.

Let, for period 1, index is CPI1 and for period 2, CPI2, then:

Inflation rate in period 2 = (CPI2-CPI1)/CPI1

Though, inflation can also be calculated using the GDP deflator of two periods as above.

In general, the inflation rate target is 2%, set by the Fed. Hence, 1.8% inflation is lower than the expected inflation. It makes an inference that aggregate demand is less than the expected. It will make FED to continue its expansionary policies unless the inflation rate increases to the 2% level.

3.

Economists use model to solve the complex economic problems and propose the solutions that can help economy at aggregate level and firms at micro level to grow.  These models are based on certain assumptions and when assumptions are true, then models predict correctly. AD-AS model helps to know the output level and the price level in the economy. It helps to know the policies that can help economy achieve the desired GDP level. Here, intersection of AD and AS tells the real output or real GDP at a particular price level. It can be short run and or long run. If long run, then it is the potential GDP level where AD and AS cut at the LRAS curve.

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