Economics (McConnell) AP Edition, 19th Edition

Problem:

Recent data for the U.S. reveal the following (all figures in millions).

Use the data to find the following:

1. The size of the labor force.
2. The number classified as "not in the labor force."
3. The unemployment rate.

Answer:

1. The labor force consists of all those either employed or unemployed. The labor force in this period was 139.1 + 14.6 = 153.7 million people.
2. Those classified as "not in the labor force" are those individuals age 16 or older and not institutionalized who are neither employed nor unemployed. For the period given, this amounted to 307.0 – 69.3 – 139.1 – 14.6 = 84.0 million people.
3. The unemployment rate is found as the proportion of the labor force that is classified as unemployed. For this period, the unemployment rate was 14.6/153.7 = .095, or 9.5%.

Problem:

Suppose the natural rate of unemployment is 4.5% and the current unemployment rate is 6%.

1. According to Okun's law, what is the size of the GDP gap?
2. If potential GDP is $1,000 billion, how much output is being lost as a result of the economy being below its potential?
3. Recent data for the U.S. showed an unemployment rate of 9.5%. Suppose the natural rate at the time was 4.5%. What was the size of the GDP gap?
4. At that time, GDP was $14,592 billion. What was potential GDP?

Answer:

1. The GDP gap is the difference between actual GDP and potential GDP. Okun's law suggests a GDP gap of -2% for every 1% that the unemployment rate exceeds its natural rate. In this case, the GDP gap is (6.0 – 4.5) x -2 = -3%.
2. A GDP gap of -3% implies that $1,000 x .03 = $30 billion of output is being foregone.
3. The GDP gap was (9.5 – 4.5) x -2 = 10.0%.
4. By Okun's law, actual GDP of $14,592 billion was 10.0 percent below its potential. Equivalently, actual GDP is 90% of potential GDP. Potential GDP is then found as $14,592/.90 = $16,213 billion.

Problem:

The Bureau of Labor Statistics reported the CPI stood at 215.9 in December 2009, while one year earlier it was 210.2.

1. What was the annual rate of inflation measured from December to December?
2. At this rate of inflation, approximately how long will it take for the price level to double?
3. Suppose Janice's nominal income rose by 4% from December 2008 to December 2009 while Jeff's increased by only 2%. By what percentage did each of their real incomes change?

Answer:

1. The rate of inflation is measured by the percentage increase in the value of the CPI. In this case, the rate of inflation was [(215.9 – 210.2)/210.2] x 100 = 2.7%
2. Using the rule of 70, the price level will double in 70/2.7 = 25.9 years.
3. The percentage change in real income can be approximated as the difference between the percentage change in nominal income and the percentage change in the price level. For Janice, this was 4% – 2.7% = 1.3%, while Jeff's real income fell: 2% – 2.7% = -1.3%.