1. What does the CPI in the base year equal? Explain your answer.

In the base year, the Consumer Price Index (CPI) is set to 100. The
base year CPI is used as a standard comparison point for future
years. The value of 100 doesn't represent the actual prices but
rather acts as a reference to measure inflation or deflation. By
setting the base year CPI at 100, economists can calculate how
prices change over time in relation to this baseline. For instance, if
the CPI in a future year is 120, it indicates a 20% increase in the
average price level of goods and services since the base year. This
standardized starting point allows for clearer comparisons across
years, as any changes in the CPI reflect real shifts in purchasing
power and cost of living relative to the base year.

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2. Show that, if the percentage rise in prices is equal to the

percentage rise in nominal income, then one's real income does not
change.

Real income measures the purchasing power of nominal income,

which is the income in current dollars without adjustments for
inflation. If the percentage increase in prices (inflation rate) equals
the percentage increase in nominal income, the individual’s
purchasing power remains constant. For example, if nominal income
rises by 5% but prices also rise by 5%, the increased income is offset
by the increased cost of goods and services. Therefore, real income,
calculated as nominal income divided by the price level, stays the
same, meaning the person’s ability to buy goods and services hasn’t
changed. In short, nominal income growth matched by an
equivalent rise in prices means no real improvement in wealth or
standard of living.

3. When is the total dollar expenditure on the market basket in the

base year the same as in the current year?

The total dollar expenditure on the market basket in the base year is
the same as in the current year when there is zero inflation or price
stability. In this situation, prices of goods and services in the current
year match those of the base year, meaning no inflationary or
deflationary pressures have altered the cost of the market basket. If
the CPI remains at the base level of 100, it indicates that the price
level has not changed, and thus, the dollar expenditure required to
purchase the same goods and services remains constant. This
reflects a stable economy where the purchasing power of money
remains consistent over time, providing no extra burden or benefit
in terms of expenditures for the same goods.

4. How does structural unemployment differ from frictional

unemployment?

Structural unemployment occurs when there is a mismatch between

the skills workers possess and the skills demanded by employers,
often due to technological changes, globalization, or changes in
industry demand. Workers affected may need to retrain or relocate
to find new employment opportunities, which can result in long-
term unemployment. Frictional unemployment, on the other hand,
is short-term and arises from the normal job-seeking process, such
as when individuals voluntarily leave jobs to find better ones, or new
entrants into the workforce look for their first job. Unlike structural
unemployment, frictional unemployment is a natural part of a
dynamic economy and generally reflects short-term transitions.

5. What does it mean to say that the country is operating at full

employment?

Operating at full employment does not imply zero unemployment;

rather, it means that all available labor resources are being utilized
efficiently within the economy. At full employment, the
unemployment rate includes only natural unemployment,
composed of frictional and structural unemployment, and excludes
cyclical unemployment associated with economic downturns. In
other words, full employment is achieved when the economy is at
its potential output, with no demand-deficient unemployment. It
reflects an economy operating at its optimal productive capacity,
where the remaining unemployment is due to normal labor market
frictions and structural changes, not a lack of available jobs.

6. What is "natural" about natural unemployment?

Natural unemployment includes frictional and structural

unemployment, which are considered normal in a healthy, dynamic
economy. This "natural" rate reflects the minimum level of
unemployment that will always exist due to people transitioning
between jobs and the continual shifts in industry demands and
technology. Unlike cyclical unemployment, which varies with
economic cycles, natural unemployment persists even when the
economy is at full employment because it accounts for unavoidable
labor market factors like career changes, geographic relocation, and
skill mismatches. Therefore, it's "natural" because it reflects an
economy in which people voluntarily move between roles or
industries adapt to new demands, rather than indicating a recession.

7. What is the difference between the employment rate and the

labor force participation rate?

The employment rate measures the percentage of the labor force

that is currently employed, while the labor force participation rate
measures the proportion of the working-age population that is
either employed or actively seeking employment. The employment
rate is calculated by dividing the number of employed people by the
total labor force, focusing on those who have jobs out of those who
are willing to work. The labor force participation rate, on the other
hand, includes both employed and unemployed individuals actively
seeking work, giving an indication of the proportion of the
population engaged in or wanting to engage in the labor market.

8. If the unemployment rate is 4 percent, it does not follow that the

employment rate is 96 percent. Explain why.

The unemployment rate represents the percentage of the labor

force that is unemployed, not of the entire working-age population.
If the unemployment rate is 4%, this does not mean the
employment rate is 96% because some people within the working-
age population might not be part of the labor force (e.g., retirees,
students, or discouraged workers). The employment rate only
reflects the portion of the labor force currently working, whereas
the labor force excludes those not actively seeking work.
Consequently, the employment rate cannot be directly inferred
from the unemployment rate alone.

9. What criteria must be met for a person to be characterized as

unemployed?

To be characterized as unemployed, a person must be actively

seeking work, be available for work, and not be engaged in any form
of employment. This definition excludes individuals who are not
looking for work (such as retirees, students, or discouraged workers
who have given up on job searches). Only those actively searching
for work and willing to accept a job if offered are counted as
unemployed within the labor force. This definition aligns with
standards set by the International Labour Organization (ILO) and
allows for consistent unemployment measurements across different
economies.

10. What is the difference between a job leaver and a reentrant?

A job leaver is someone who voluntarily quits their job, often to
seek better opportunities, a career change, or for personal reasons.
In contrast, a reentrant is someone who has been out of the labor
force for a period (e.g., for education, family responsibilities, or
retirement) and is now reentering the labor force to seek
employment again. Job leavers tend to be people actively pursuing
new roles, whereas reentrants are individuals returning to work
after an extended break. Both affect labor market statistics but
reflect different employment motivations and histories.

11. How is a discouraged worker different from an unemployed

worker?

A discouraged worker is someone who has stopped actively seeking

employment due to repeated failures to find work, often stemming
from a belief that no suitable jobs are available. As they are not
actively job-seeking, discouraged workers are not considered part of
the labor force and, therefore, are not included in official
unemployment statistics. Unemployed workers, on the other hand,
are actively looking for work and are counted in the labor force. This
distinction can lead to an underestimation of true joblessness, as
discouraged workers, while technically not "unemployed," lack
employment and would likely prefer to work if viable opportunities
existed.

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12. If the price of, say, oranges has risen, does it follow that the
price level has risen too? Explain your answer.

An increase in the price of oranges does not necessarily mean that

the overall price level, or inflation, has risen. The price level is a
broad measure that represents the average prices of a wide range of
goods and services across the economy. A rise in the price of a single
item, like oranges, may be due to specific factors such as supply
issues, seasonal changes, or demand fluctuations. Inflation, on the
other hand, reflects a generalized increase in prices across the entire
economy. Therefore, while the cost of oranges may rise, it does not
imply a rise in the overall price level unless there is a consistent
increase across many goods and services.

13. What is the relationship between your nominal income and the
inflation rate if you are more than keeping up with inflation?
If your nominal income grows at a rate higher than the inflation
rate, then your real income, or purchasing power, is increasing. This
means that the income adjustments exceed the rise in the general
price level, enabling you to buy more goods and services over time.
For instance, if inflation is at 3% but your nominal income rises by
5%, your real income has grown by approximately 2%, reflecting an
improvement in your standard of living. Keeping up with or
surpassing inflation allows individuals to maintain or increase their
real income and purchasing power, even in an inflationary
environment.

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14. Explain how the CPI is computed.

The Consumer Price Index (CPI) is computed by selecting a "market

basket" of goods and services typically purchased by households and
tracking the price changes of these items over time. The Bureau of
Labor Statistics (BLS) collects price data for each item in the basket
across various regions. The CPI is then calculated by taking the total
cost of the basket in the current period and dividing it by the total
cost of the same basket in the base year, multiplied by 100 to
produce an index. This formula yields a percentage that shows the
relative price level compared to the base year. The CPI serves as a
key indicator of inflation, showing how prices change over time.