ECON 102 Question 1

ECON 102 6

ECON102

Question1

Inflationrefers to a sustained increase in general price , which results toa decline in the purchasing power of money. Demand pull inflation mayoccur when the aggregate demand grows at an unsustainable rate. Thefollowing diagram shows demand pull inflation

Averageprice level

LRAS

SRAS

P2

P1

AD1 AD2

Y1 Y2 Yp

Realnational output (Y)

Costpush inflation occurs the moment firms tend to respond to increasingcosts through increasing prices in order to protect their profits.The diagram below shows cost push inflation

Averageprice level LRAS

SRAS2

SRAS1

P2

P1

AD

Y2Y1 Yp Real national output (Y)

Differentcosts of inflation include paying high for commodities, may result tounemployment, can cause frustrations in investments, and may lead tothe closure of businesses. The central bank has a role in controllinginflation. The central bank controls inflation through maintainingthe public’s expectation of inflation being equal to its targetedinflation and through varying the rates of funds in a manner thatcauses the real interest track the natural rate (Mankiw,2009). Through maintaining expected inflation at its inflationtarget, inflation and money grow in line with the targeted inflation.

Question2

Thequantity theory of money (QTM) claims that aggregate price (P) andtotal money supply (M) are related by the equation P = VM/Y where Yis the real output and V is the velocity of money.

Parta

Fromthe QTM, P = VM/Y therefore, an increase in money supply (M) willresult in an increase in the aggregate prices since the numeratorwill increase with the increase in money supply. Thus, in case moneysupply increases, while real output remains unchanged, the aggregateprices will increase.

Partb

Thereal value of money refers to the nominal amount of money divided bythe price level in the economy. The real value of money determinesthe amount of commodities that the money can purchase. Thus, incase the nominal value of money is fixed, but the price levelincreases, then one can only purchase fewer commodities with themoney. This is an indication that the real value of money declineswith an increase in the price level.

Question3

Thereare four types of unemployment, which include seasonal, cyclical,structural, and frictional. Seasonal unemployment is a kind ofunemployment that results, when there is a limited need forperforming a certain type of work during given time of the year(Mankiw,2009). Frictional unemployment is a kind of unemployment that resultsfrom employees seeking job opportunities that best fits them.Structural unemployment entails a form of unemployment that resultsdue to changes in the demand patterns or as a result of technologyobsolescence, leading to retraining of employees and vast investmentsin new capital equipments. Conversely, cyclical unemployment is as aresult of the changing business cycles.

Parta

Theinflation rates and unemployment rates have an inverse relationship.This implies that when unemployment decreases, the inflationincreases (McEachern,2012). This relationship can be indicated through the short-runPhillips curve shown below

Inflationrate (%)

SRPC Unemployment rate (%)

Partb

Naturalrate of unemployment = U/L

=0.05 / (0.05 + 0.15)

=0.05/ 0.2

=0.25

References

Mankiw,N. G. (2009).&nbspPrinciplesof economics.Mason, OH: South-Western Cengage Learning.

McEachern,W. A. (2012).&nbspEconomics:A contemporary introduction.Mason, OH: South-Western Cengage Learning.