Chapter 12, Problem 1SPA

To determine

Identify the business cycle theory which states that most of the unemployment is cyclical and which states that it is an increase in the natural rate.

Explanation of Solution

The Keynesian and the new Keynesian theory state that most of the unemployment is cyclical. The cyclical unemployment depends upon the changes in recession and inflation. According to Keynesian theory, all decisions in the economy will be influenced by aggregate demand. Also, they believed in the government intervention in the market as a power full one. This idea is well portrayed in the Philips curve, that is, the increase in inflation will decrease the unemployment for short run.

However, this case is argued by the monetarists because they believed in the free economy. According to the monetarist theory, they believed in the natural rate of unemployment and they say that the natural rate of unemployment only carry nearly 5 or 6 percentage of unemployment that includes both frictional and structural unemployment. Also, they believe that the full employment is the natural case and any deviation from it is an abnormal one.

Economics Concept Introduction

Cyclical unemployment: Unemployment related to the ups and downs of the business cycle is known as cyclical unemployment.

Natural rate of unemployment: Natural rate of unemployment is the situation of full employment with only a small percentage of unemployment.

Frictional unemployment: Frictional unemployment is a short-term unemployment that is resulted by the active searching of a person with job for a better paying job.

Structural unemployment: Structural unemployment is the unemployment that arises due to the lack of workers’ skill in their works.