HOMEWORK 4

Fourth Homework Andrena Athill

1.      How can inflation change the distribution of income?

·         An example of inflation affecting the distribution of income is the creditor/debtor relationship. To the extent that inflation is not anticipated, debtors will be paying back loans in inflated dollars compared to the money they borrowed. In effect, they will be paying back less than they borrowed, and creditors will be receiving back less than they loaned out. This helps to distribute income from creditors to debtors. 

It is very possible that the same forces that cause inflation can also lead to an increase in income, but it would be those outside forces, not the inflation itself, which causes a change in the level of income. For example, an increase in aggregate demand can cause both an increase in real GDP and an increase in inflation.

2.      Why don’t there seem to be costs to anticipated inflation?

·         When people/businesses can make accurate predictions of inflation, they can take steps 
to protect themselves from its effects. 

e.g. Households may also be able to switch savings into deposit accounts offering a 
higher nominal rate of interest or into other financial assets such as housing or equities 
where capital gains over a period of time might outstrip general price inflation. 

e.g. Companies can adjust prices and lenders can adjust interest rates. 

3.      Why do some individuals or firms experience a cost despite perfectly anticipated inflation?

Individuals or firms can experience a cost despite perfectly anticipated inflation because of internal factors that affect growth.

4.      Why do people dislike unanticipated inflation?

·         People dislike unanticipated inflation because they are not prepared for it and sometimes cannot handle the outcomes and effects that it has on the economy also because when inflation is volatile from year to year, it becomes difficult for individuals and businesses to correctly predict the rate of inflation in the near future. 

1.      Why does a new worker entering the labor force or a worker who has lost a job probably will not find an acceptable job right away?

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2.      What are the categories of unemployment and their defining characteristics?

·         Structural Unemployment, one of the three types of unemployment, is associated with the mismatch of jobs and workers due to the lack of skills or simply the wrong area desired for work. Structural unemployment depends on the social needs of the economy and dynamic changes in the economy. For instance,advances in technology and changes in market conditions often turn many skills obsolete; this typically increases the unemployment rate. For example, laborers who worked on cotton fields found their jobs obsolete with Eli Whitney's patenting of the cotton gin. Similarly, with the rise of computers, many jobs in manual book keeping have been replaced by highly efficient software. Workers who find themselves in this situation find that they need to acquire new skills in order to obtain a new job.

·         Frictional Unemployment is always present in the economy, resulting from temporary transitions made by workers and employers or from workers and employers having inconsistent or incomplete information. This type of unemployment is closely related to structural unemployment due to its dependence on the dynamics of the economy. It is caused because unemployed workers may not always take the first job offer they receive because of the wages and necessary skills. This type of unemployment is also caused by failing firms, poor job performance, or obsolete skills.  This may also be caused by workers who will quit their jobs in order to move to different parts of the country.

·         Unemployment that is attributed to economic contraction is called cyclical unemployment. The economy has the capacity to create jobs which increases economic growth. Therefore, an expanding economy typically has lower levels of unemployment. On the other hand, according to cyclical unemployment an economy that is in a recession faces higher levels of unemployment. When this happens there are more unemployed workers than job openings due to the breakdown of the economy. This type of unemployment is heavily concentrated on the activity in the economy.  To understand this better take a look at our Business Cycles section.

·         Frictional unemployment can be seen as a transaction cost of trying to find a new job; it is the result of imperfect information on available jobs. For instance, a case of frictional unemployment would be a college student quitting their fast-food restaurant job to get ready to find a job in their field after graduation. Unlike structural unemployment this process would not be long due to skills the college graduate has to offer a potential firm.

3.      What do people whose skill become obsolete and therefore unemployed do to become employed again? Give an example.

4.      Why do firms lay off workers during a recession and rehire during the following expansion?

·         Firms lay off workers during recessions because they cannot sustain wages and make a  profit simultaneously during recession however, during a recession they rehire because their sales increase and they can afford to pay more wages.

 

5.      What does the natural rate of unemployment consist of?

·         It represents the hypothetical unemployment rate consistent with aggregate production being at the "long-run" level. This level is consistent with aggregate production in the absence of various temporary frictions such as incomplete price adjustment in labor and goods markets. The natural rate of unemployment therefore corresponds to the unemployment rate prevailing under a classical view of determination of activity. It is mainly determined by the economy's supply side, and hence production possibilities and economic institutions. If these institutional features involve permanent mismatches in the labor market or real wage rigidities, the natural rate of unemployment may feature involuntary unemployment. The natural rate of unemployment is a combination of frictional and structural unemployment that persists in an efficient, expanding economy when labor and resource markets are in equilibrium.