Answers to Exercises

1. The labor force is the sum of all adults (persons older than 16 years of age) who are employed or unemployed but are currently seeking work minus those who are in institutions.

The second part of this question can be answered in two mutually exclusive ways. First, the definition of the labor force is a good one because it allows only those individuals who are actually working or are willing to supply labor resources to be counted in the labor force. Second, the definition of the labor force does not fully reflect available labor resources because people who are discouraged workers are not counted in the labor force. Furthermore, when workers would like to work full-time but are working part-time instead, they are in the labor force, but the labor resources they represent are undercounted.

2. Because of discouraged workers and the underemployed, the official unemployment rate understates the social burden of unemployment. Nevertheless, because many people who are officially counted as unemployed are actually employed in the underground economy, the official unemployment rate overstates true unemployment.

3. a. You are not officially unemployed because you are not willing to work.
b. You are not discouraged because you know you could find a job if you looked for one. In official terms you are "not in the labor force."

4. a. & b. The government may try to reduce frictional and structural unemployment by helping workers obtain information about available jobs and wages and by providing training to structurally unemployed workers. Beyond such measures, however, the government should not attempt to reduce these types of unemployment because they reflect a dynamic, efficient economy.
c. Cyclical unemployment represents an inefficiency that can be reduced by government macroeconomic policy.

5. No. The personal and social costs of unemployment are not measured by the GDP gap.

6. Teenagers have the highest unemployment rate because they typically have the fewest marketable skills.

7. You would expect to earn $11 after the raise. If you always receive the cost-of-living raise a year after the price rise, you will always lag behind the inflation rate, so your standard of living will tend to fall over time. However, if the CPI-based cost of living overstates your true living costs, then your standard of living could rise.

8. The real interest rate is the nominal interest rate (the rate that is quoted by the bank) less the rate of inflation that is expected over the term of the loan. When the inflation rate is unexpectedly high, lenders will make loans with nominal interest rates that are too low to compensate them for inflation and provide them with the real return that they expect. Debtors pay a lower than expected real interest rate on the money that they borrow. In this way unexpectedly high inflation redistributes income away from creditors and toward debtors.

9. The standard fixed-interest-rate mortgage commits a mortgage company to a fixed interest rate for 30 years. If the inflation rate turns out to be unexpectedly high, the mortgage company will end up with a lower real interest rate on the mortgage than expected when the loan was made. By allowing the interest rate to vary annually, the interest rate can be adjusted to changing economic conditions so that unexpected inflation will result in an increased interest rate.

10. Although the actual pattern of the business cycle is not as regular as is shown in Figure 2, the economy is subject to recurrent periods of expansion and contraction.

11. Changes in the average workweek are made in response to changes in economic conditions. It is easier for a firm to adopt to new economic conditions by adjusting the length of the workweek than it is to increase employment. When unemployment claims change, this indicates changes in the demand for labor as a result of changing economic conditions. Changes in new orders indicate future changes in output. Stock prices are based on what investors expect companies to earn in the future. Therefore, stock prices are forward looking. If people expect the economy to expand, they also expect the earnings for companies to increase. Therefore, stock price increases represent the expectation that the economy will expand in the future.

Businesses increase their orders for new plants and equipment because they plan to produce additional output, thus leading to economic expansion.

When a new building permit is issued, this represents new construction, which indicates that the economy will expand.

When it takes longer for firms to deliver goods, this means that in many cases they are receiving more orders than they can handle in a timely fashion. The money supply increases before an expansion because the Federal Reserve System engages in expansionary policy to move the economy out of a recession. People thus have additional money balances, which they spend on goods and services. This stimulates production.

When businesses and consumers feel confident that the economy will expand, they will feel comfortable taking on additional debt. Businesses borrow more to invest in plants and equipment in anticipation of expanding demand. Consumers, to the extent that they feel confident that they will receive a stable flow of income into the future, will borrow more to increase current consumption.

12. a. 460
b. 2.2 percent

13. a. 100 percent
b. Relative prices were unchanged

14. a. [MAKE GRAPHICS FROM IRM!!!!!]
b. [MAKE GRAPHICS FROM IRM!!!!!]

15. Because the value of money is the reciprocal of the price level, as the price level rises faster, the value of money falls faster. Because the Bolivian money was losing value at a high rate but U.S. dollars were retaining their value due to a much lower inflation rate in the United States, the Bolivians substituted away from the rapidly eroding peso toward the stable-valued dollar.

Answers to Study Guide Homework

1. U. S. resident, over 16 years old, not institutionalized, and either working or actively looking for work

2. Frictional: workers changing jobs or newly entering the labor force

Seasonal: workers in certain industries with regular, seasonally recurring changes in employment

Structural: workers who skills do not match job openings due to structural changes in the economy

Cyclical: workers who are unemployed due to a recession

3. Leading indicators (money supply, stock prices, and new building permits are up, coincident indicators (industrial production, personal income) are unchanged, while lagging indicator (unemployment duration) is down. Probably you are in the trough of the business cycle, with the expansion stage about to begin.

4. a. You would vote for Candidate B. You would gain from inflation; you would have to pay back your mortgage in dollars that were worth less.

b. Your banker would vote for Candidate M. The bank loses from inflation; the dollars you pay back are worth less.

5. Creating more jobs could reduce cyclical unemployment, but wouldn't affect frictional, structural, or seasonal unemployment.

Answers to Internet Exercise

This is an excellent exercise for emphasizing the difference between the nominal and real interest rate. By using historical interest rate data and inflation rates based on changes in the CPI, students will calculate a real interest rate on an investment and determine appropriate action.

5.09% - 2.91% = 2.18%

5.61% - 1.57% = 4.04%

Since the nominal interest rate of burying money in the backyard is 0, the real interest rate will be negative. For 1996, the real interest rate would be -2.91; for 1997, the real interest rate would be -1.57.

When nominal interest rates are low, you are still better off investing in risk-free U.S. government securities rather than burying money in the backyard.