Chapter 17.1, Problem 1R

To determine

To evaluate the significance of stabilization policy, unemployment rate, full employment, the underground economy, demand pull inflation, stagflation and cost pull inflation.

Explanation of Solution

An approach adopted by a government or its central bank to sustain a stable level of economic growth and gradual changes in prices is called a stabilization policy. Sustaining a policy of stabilization involves tracking the market cycle and modifying benchmark interest rates as required to manage sudden increases in demand. Often the term stabilization policy is used to define intervention of the government responding to a crisis of economy or shock, such as a debt of sovereign or a crash of stock market. The responses can include emergency measures and changes to legislation.

The unemployment rate reflects the proportion of the jobless population. It is a lagging measure, which means it normally rises or falls in the wake of shifting economic conditions instead of predicting them. The unemployment rate can be expected to increase when the economy is in bad shape and jobs are scarce. If the economy rises at a steady rate, and jobs are relatively abundant, it can be expected to decline.

Full employment is defined as the ideal rate of employment in an economy where there is no unemployment that is involuntary amongst workers. Full employment of labor is one element of an economy which operates at its maximum productive potential and produces at one point along the production possibility frontier. If there is some unemployment then the economy may not necessarily perform at maximum capacity, and there could be some increase in economic performance. That being said, because the reduction of all unemployment from all sources may not be technically feasible, full jobs may not necessarily be attainable.

The underground economy refers to commercial transactions that are considered to be illegal, either because of illicit nature of the goods or services exchanged, or because transactions fail to meet government disclosure laws. Often known as the shadow economy, the black market, or the illicit economy, the United States underground economy consists primarily of the selling of street narcotics and illegal prostitution. 

Typically, the term inflation with demand-pull defines a common phenomenon. That is, as market demand outstrips the existing supply of several forms of consumer goods, demand-pull inflation sets in, causing an overall cost of living rise. A rise in jobs in Keynesian economic theory contributes to an increase in overall demand for consumer goods. Companies recruit more workers in response to the demand, so they can increase their production. The more workers businesses recruit, the higher the jobs. The demand for consumer products inevitably outstrips manufacturers' capacity to produce them.

Stagflation is a contradictory phenomenon often defined by relatively high unemployment, slow economic growth, or stagnation of the economy, followed by rising prices (i.e. inflation) simultaneously. Alternatively, stagflation also can be characterized as an inflation period combined with a fall in gross domestic product (GDP).

Cost-push inflation happens when the average costs (inflation) rise due to labor and cost of raw material rises. Higher production costs in the economy will lower the aggregate supply (the sum of total output). Because demand for goods has not changed, the price rises resulting from output are transferred on to customers causing the cost-push inflation.

Economics Concept Introduction

Introduction: An economy is the broad set of interconnected production and consumption activities which help to decide how limited resources are distributed. The distribution and production of goods and services are used to meet the needs of those who live and work within the economy, often referred to as an economic system.