Exam Questions

Exam Essays

Why is there unemployment even when the economy is at “full employment”? Full employment is when the natural employment rate equals the unemployment rate which means there is unemployment occurring even at full employment. There is always going to be natural unemployment due to the fluctuations of the economy and the innovations in technology or cheaper labor elsewhere. So you imagine that if you have full employment then there is economic growth happening in an economy and there is no recession, which means there is no cyclical unemployment. With that happening you probably have frictional unemployment which is when you have people quitting their jobs to find better ones, but the firms won’t choose the first person who decides to apply and the workers won’t settle for the first job either. The other way is due to structural unemployment which happens from innovations in technology which requires a different skill set and outsourcing of jobs because of cheaper labor. This is why there is unemployment at full employment because of frictional and structural unemployment but this only can happen if we have no cyclical unemployment.

Is the CPI a perfect measure of the cost of living? In my opinion, the CPI isn’t the perfect measure of the cost of living because there are many factors that it doesn’t put into consideration. There are four biases that the CPI contains, which are the new goods bias, Quality Change Bias, commodity substitution bias, and the outlet substitution bias. These biases are very consequential in a measure of the cost of living. So the new goods bias is when a new good such as a lab top or computer replaces an old good like a typewriter, and we can’t compare these goods because we didn’t have the same baskets from either time period. This bias puts an upward bias into the measure of the inflation rate and the bias goes upwards. With the Quality Change Bias you items such as car getting better brakes, engines etc. and does the better quality of this car increase the cost or does it pay for itself. So with this the CPI adds too much of a price rise and this overstates inflation. Outlet substitution bias is when you go further to get cheaper prices such as with gas, but does going further really let you save on gas? The CPI only sees the ten cents cheaper on gas and not on what you paid to go further for the cheaper gas. Commodity substitution is when you buy another item in replacement of the more expensive such as with chicken and steak. The CPI only sees the consumption as meat and it completely ignores the substitution between goods which rises the prices of the meats. These biases cause the wages for workers to be either way more than needed or too little for the actual cost of living, this is the distortion of private contracts. There is also consequences on what the military tends to get since the military is worldwide this has an effect on their combat pay and it also effects social security as well. So this is why the CPI bias is not a good measure of the cost of living.