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Chapter 21: Problem 2

Briefly describe the effect of the business cycle on the inflation rate and the unemployment rate. Why might the unemployment rate continue to rise during the early stages of an expansion?

Short Answer

Expert verified
The business cycle affects the inflation and unemployment rates. During an expansion, demand for goods and services increase, leading to higher inflation and lower unemployment due to increased labor demand. Conversely, during a recession, demand decreases, potentially causing deflation and higher unemployment. During the early stages of expansion, unemployment might still rise due to businesses' uncertainty about the economy's outlook. Until they're confident about stability, they might opt not to hire immediately.

Step by step solution

01

Understanding key terms

It's crucial to understand the key terms in this exercise. The business cycle refers to an economic cycle that consists of periods of economic expansion and recession. Inflation rate is the rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. Unemployment rate is the percentage of the total labor force that is jobless and looking for work.
02

Describing the effect of business cycle on inflation and unemployment rates

Generally, during an expansion or boom, the economy is performing well, people are getting jobs, demand for goods and services increase which often leads to higher inflation rate. Meanwhile, the unemployment rate often decreases due to increased labor demand. On the other hand, during a recession, the economy slows down, demand for goods and services decrease which can result in lowering inflation or even deflation. Unemployment rate often increases as businesses decrease production and lay off workers.
03

Hypothesis on why unemployment might rise despite expansion

During the early stages of an expansion, businesses may still be wary and uncertain of the economic outlook. As a result, they may choose not to immediately hire more workers until they are more confident in the economy's stability. Therefore, unemployment rate might continue to rise for a short period at the beginning of an expansion.

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Most popular questions from this chapter

What is potential GDP? Does potential GDP remain constant over time?

What are the names of the following events that occur during a business cycle? a. The high point of economic activity b. The low point of economic activity c. The period between the high point of economic activity and the following low point d. The period between the low point of economic activity and the following high point

The National Bureau of Economic Research, a private group, is responsible for declaring when recessions begin and end in the United States. Can you think of reasons the Bureau of Economic Analysis, part of the federal government, might not want to take on this responsibility?

Suppose you can receive an interest rate of 2 percent on a certificate of deposit at a bank that is charging borrowers 6 percent on new car loans. Why might you be unwilling to loan money directly to someone who wants to borrow from you to buy a new car, even if that person offers to pay you an interest rate higher than 2 percent?

The federal government in the United States has been running large budget deficits. Suppose that Congress and the president take actions that turn the budget deficits into budget surpluses. a. Use a market for loanable funds graph to illustrate the effect of the federal budget surpluses. What happens to the equilibrium real interest rate and the quantity of loanable funds? What happens to the level of saving and investment? b. Now suppose that households believe that surpluses will result in Congress and the president cutting taxes in the near future in order to move from budget surpluses to balanced budgets. As a result, households increase their consumption spending in anticipation of paying lower taxes. Briefly explain how your analysis in part (a) will be affected.
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