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Chapter 7 Review.docx

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ECN 204
Thomas Barbiero

Chapter 7 Review Summary: 7.1 – The business cycle  Canada and other industrial economies have gone through periods of fluctuations in real GDP, employment, and price level. o Although they have certain phases in common:  Peak  Recession  Trough  Expansion o Business cycles vary in duration and intensity.  Although economists explain the business cycle in terms of underlying causal factors such as:  Major innovations  Productivity shocks  Money creation  Financial crises o They generally agree that the level of total spending is the immediate determinant of real output and employment.  The business cycle affects all sectors of the economy, though in varying ways and degrees. o The cycle has greater effects on output and employment in the capital goods and durable consumer goods industries than in the services and nondurable goods industries. 7.2 – Unemployment  Economists distinguish among four types of employment:  Frictional  Structural  Cyclical  Seasonal o The full-employment or natural rate of unemployment, which is made up of frictional and structural unemployment, is currently 6-7 percent. o The presence of part-time and discouraged workers makes it difficult to measure unemployment accurately.  The GDP gap, which can be either a positive or a negative value, is found by subtracting potential GDP from actual GDP. o The economic cost of unemployment, as measured by the GDP gap, consists of the goods and services forgone by society when its resources are involuntarily idle. o Okun’s law suggests that every increase in unemployment by 1 percent about the natural rate causes an additional 2 percent negative GDP gap.  Unemployment rates vary widely globally.  Unemployment rates differ because nations have different natural rates of unemployment and often are in different phases of their business cycles. 7.3 – Inflation  Inflation is a rise in the general price level and is measured in Canada by the Consumer Price Index (CPI) o When inflation occurs, each dollar of income will buy fewer goods and services than before. o That is, inflation reduces the purchasing power of money.  Economists distinguish between demand-pull and cost-push (supply-side) inflation. o Demand-pull inflation - results from an excess of total spending relative to the economy’s capacity to produce. o Cost-push inflation – results from abrupt and rapid increases in the prices of key resources. o These supply shocks push up per-unit production costs and ultimately the prices of consumer goods. 7.4 – Redistribution effects of inflation  Unanticipated inflation arbitrarily redistributes real income at the expense of people with a fixed income, creditors, and savers. o If inflation is anticipated, individuals and businesses may be able to take steps to lessen or eliminate adverse redistribution effects.  When inflation is anticipated, leaders add an inflation premium to the interest rate charged on loans o The nominal interest rate thus reflects the real interest rate plus the inflation premium (the expected rate of inflation). 7.5 – Effects of inflation on output  Cost-push inflation reduces real output and employment.  Proponents of zero inflation argue that even mild demand-pull inflation (1-3 percent) reduces the economy’s real output.  Other economists say that mild inflation may bye a necessary by-product of the high and growing spending that produces high levels of output, full employment, and economic growth.  Hyperinflation, caused by highly imprudent expansions of the money supply, may undermine the monetary system and cause severe declines in real output. Key Terms:  Economic theory – deriving economic principles from relevant economic facts; and economic principle.  Business cycle – recurring increases and decreases in the level o
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