Chapter 8, Problem 1QAP

a)

To determine

The validity of the statement that the negative relationship between the concepts of unemployment and inflation is being shown by the original Phillips curve that was observed first in the United Kingdom.

Answer to Problem 1QAP

True

Explanation of Solution

The original Phillips curve is considered as a simple trade-off between inflation and unemployment, as Suggested by W.P.. This was stated at a time when the expectations on inflation was quite stable. Accordingly, when an economy goes through a growth period, the price levels would increase. Further, to cater to the output level required, more employment would be needed. Thus, the unemployment level would come down.

Economics Concept Introduction

Introduction:The Phillips curve has been named so after W.P. who initially came up with the idea behind it. According to him inflation and unemployment are two concepts that have a solid, negative relationship. As per the theory, when economic growth takes place, inflation level rises. This then leads to the creation of more employment opportunities, declining the level of unemployment.

b)

To determine

The validity of the statement that the ideology behind the initial Phillips curve has been proven to be true in many countries over time.

Answer to Problem 1QAP

False

Explanation of Solution

As per the original ideology behind the Phillips curve, there is a very firm, negative relationship between inflation and unemployment. However, in reality it has not been so in many countries. The curve has been related to the situation faced by the US economy during the 1970’s which is not the case of every economy. According to experts, the curve would shift over time due to expectations of inflation.

Economics Concept Introduction

Introduction:The Phillips curve was introduced by W.P. According to him, the curve shows the firm, negative relationship between inflation and unemployment within an economy. Ideally, when an economy goes through a period of growth, the price levels would go up, creating inflation. Then there would be a necessity to produce more, which in turn creates jobs and reduces unemployment.

c)

To determine

The validity of the statement that inflation in some years are good predictors of the same in the future years to come and in some years they are not so.

Answer to Problem 1QAP

True

Explanation of Solution

Inflation is the measurement of the increase in general price levels of an economy’s goods and services. It is one of the key economic indicators used for economic predictions. The general understanding is that the inflation rate of a particular year could be used as an indication of what it would be in the year to come. This has been done by many economies in the world. However, there are instances where such predictions have gone wrong. Predictions done based on such rates have actually become much different in some cases. For example, before the 1960’s the inflation rate in the US was very unpredictable. Nevertheless, it become much persistent during the 1970’s.

Economics Concept Introduction

Introduction:Inflation is an indicator that is being much spoken of within the field of economics. It is the increase in general price levels within an economy. Inflation is an indicator that is being used for many economic predictions as well as the inflation rate itself in future periods. However, there had been instances where the inflation rates in consecutive period have taken figures that are much different from each other.

d)

To determine

The validity of the statement that the trade-off between inflation and unemployment could be exploited by policy makers only on a temporary basis.

Answer to Problem 1QAP

True

Explanation of Solution

The inverse relationship between the concepts of inflation and unemployment is true only in the short run. This would be so only till the expected inflation rate is fixed. In an instance where the rising levels of expected inflation starts reducing real wages, more individuals would obtain employment and thus the unemployment rate would come down. In the medium term, the natural unemployment rate however is consistent against any level of stable inflation. Hence it cannot be reduced through inflation changes.

Economics Concept Introduction

Introduction:Inflation and unemployment are two economic concepts that are much relevant in economic policy making. The trade-off between the two has been instrumental to a number of economic theories and concepts. It is said that this trade-off is being manipulated by policy makers in many instances.

e)

To determine

The validity of the statement that the rates of expected and actual inflation are always the same.

Answer to Problem 1QAP

False

Explanation of Solution

As inflation and expected inflation both are important concepts in economic predictions and policy making, it is important to know the difference between the two. Inflation is the increase in the general prices of goods and services of an economy. Expected inflation is the inflation expected by that particular economy with regard to a particular time period. These two concepts are not the same. These would become the same only when the level of unemployment is set at its natural rate.

Economics Concept Introduction

Introduction:Inflation and expected inflation are two concepts that are very similar in nature. However, they are not the same. Inflation refers to the increase in the general price levels of an economy. Expected inflation is the inflation rate applicable for a period to come as expected by the economy’s participants.

f)

To determine

The validity of the statement that policy makers have the ability to obtain an unemployment rate as low as they want as suggested by renowned economists in the 1960’s.

Answer to Problem 1QAP

False

Explanation of Solution

Even though policy makers thought that they could reduce the rate of unemployment as much as they want, as suggested by scholars, it is not the reality. The rising expected inflation rate was the reason behind this. Furthermore it must not be forgotten that there is always a rate of natural unemployment within an economy. The only means economists could use to do so is to trick the participants of the economy by increasing the prices over the rate of expected prices.

Economics Concept Introduction

Introduction:Unemployment is an important indication used in economic analysis, poly making and predictions. It suggests the number of individuals who are over a specific age level that do not engage in any form of paid employment and are available for work.

g)

To determine

The validity of the statement that provided that an assumption of the inflation rate being the same as the previous year will make the relation of the Phillips curve a relation among the unemployment rate and the change in the rate of inflation.

Answer to Problem 1QAP

True

Explanation of Solution

As mentioned in the question, if individuals of an economy assumes that the inflation rate of a particular year would be same as the previous year, the relation of the Phillips curve would be a relation among the change in the rate of unemployment and a change in the rate of inflation. This would be called as the augmented Phillips curve.

Economics Concept Introduction

Introduction:Phillips curve is an economic concept that is being used widely. It states the relationship between the inflation rate and the unemployment rate of an economy. The said relationship is stated as a solid, inverse relationship according to scholars.

h)

To determine

The validity of the statement that the rate of natural unemployment of a given economy would be constant over time.

Answer to Problem 1QAP

False

Explanation of Solution

The natural rate of unemployment cannot be constant over time as it is an indication of many characteristics of the labor market. Such characteristics are subject to change over time. Thus, the rate of natural unemployment too changes accordingly.

Economics Concept Introduction

Introduction:Natural rate of unemployment is as important as unemployment in economic analysis. It states of the minimum level of unemployment in an economy that prevails due to real economic forces.

i)

To determine

The validity of the statement that the rate of natural unemployment is same across small economies.

Answer to Problem 1QAP

False

Explanation of Solution

The natural rate of unemployment is the minimum level of unemployment within a given economy. Natural unemployment in an economy shows the number of unemployed individuals due to the structure of that economy’s labor force. For example, there may be individuals who lack skills necessary to do a job. Further, due to technological enhancements, some may have lost their jobs. Such factors of the labor force is different from country to country. Hence, the natural rate of unemployment would not be the same across countries.

Economics Concept Introduction

Introduction:Natural rate of unemployment is something that could be seen in any economy around the world. It is the minimum level of unemployment that prevails in any economy and are resulted from real factors impacting upon the economy.

j)

To determine

The validity of the statement that deflation is the inflation rate being negative.

Answer to Problem 1QAP

True

Explanation of Solution

Inflation refers to the general price levels of the goods and services getting increased within a given period of time. Deflation could be considered as the opposite of inflation. It is the situation where inflation decreases over time. In other words, if the inflation rate goes further below zero, it could be considered as inflation. It could also be called as negative inflation.

Economics Concept Introduction

Introduction:Inflation is an economic variable that is widely being used in economic analysis and policy making. It suggests the increase in general price level of the goods and services in an economy. Deflation is also an important concept that goes hand in hand with inflation. It is important to know the connection between the two concepts with emphasis on economic analysis.