Economics 101: Production, Unemployment, and Inflation Assignment

This economics assignment delves into the intricate relationships between production, unemployment, and inflation. It begins by defining full employment and differentiating between frictional and structural unemployment, while also outlining the costs associated with unemployment, such as a decline in the standard of living, erosion of skills, and adverse effects on mental and physical health, as well as increased government burdens. The assignment then scrutinizes the Consumer Price Index (CPI) as a measure of inflation, highlighting its biases, including the substitution bias, quality change bias, and the challenges in incorporating new products and outlets. Furthermore, the analysis explores how government tax revenue and spending are influenced by the state of the economy, with expansion leading to increased tax revenue and minimal spending, and contraction leading to decreased tax revenue and increased spending. Finally, the assignment examines the limitations of using GDP as a sole indicator of the standard of living, underscoring the exclusion of non-market activities, the failure to account for environmental quality, and the omission of leisure activities in GDP calculations.

Module 1 - Case
PRODUCTION, UNEMPLOYMENT, AND INFLATION
Student
[Pick the date]

Production, unemployment and inflation 1
1. Why is there unemployment even when the economy is at “full employment”?
What are some “costs of unemployment”?
Answer
Full employment occurs in an economy when all of the labor resources and the working
population of a country or place are engaged in some work, and they are being used in an
economically efficient manner (Ball, 2014). In full employment, all the people who are skilled,
unskilled, and semi-skilled and have the potential to get employed are embodied in work at a
particular point in time. This implies that all the people in an economy are working; they have
jobs and are employed.
But, even when the economy is at full employment, there is some amount of unemployment in
the economy. This is mainly the frictional unemployment and the structural unemployment.
When the people are engaged in the process of changing their jobs, then frictional unemployment
occurs, and when the industrial reorganization happens like the change in technology, then the
structural unemployment occurs as the people are kept away from work during the restructuring
phase. Thus, some amount of unemployment remains during the full employment.
There are some of the costs of unemployment which are as follows (Junankar, 2016):
 The standard of living of people declines; they save less and invest less. The level of
consumption falls too which is neither good for the individual, or for the economy.
 The skills of the people get eroded due to unemployment, and the talent gets wasted.
 There is the adverse impact on the mental health of workers; their physical health
deteriorates too, and their life span gets shorter.

Production, unemployment and inflation 2
 The government has to introduce unemployment benefits for the person which is an
additional burden on it.
 People pay less income tax, and thus the earnings of the government fall.

Production, unemployment and inflation 3
2. Is the CPI a biased measure of the inflation rate? Explain your answer.
Answer
Consumer price index is a statistical estimate that measures the changes in the level of prices of a
market basket of the consumer goods and services that the households buy (Level, 2015). With
the help of this measure, the rate of inflation of a country is determined.
But, it is considered as a biased measure of the inflation rate because CPI increases faster than
the actual rate of inflation so, it tends to overstate the rate of inflation for an economy. This
happened due to the following biases:
 The consumers have the choice of buying the substitute products. So, when they have
some product in their basket whose price has increased, they switch to other product that
has the comparatively lesser price. But, this switching of product and the increase in the
price of one good has the impact on the budget and the basket of consumers which is not
considered by the CPI index. This impact is not predicted by CPI accurately because it is
a fixed weight price index.
 The life and usefulness of the products are improved when the technology gets advanced.
These changes are good for the economy, and they must happen for the betterment of
products. But, the CPI does not consider these advances and the calculation that it makes
does not reflect such improvements. So, the cost of these improvements, the benefits are
not included in CPI.
 When the new products are introduced in the market, the index does not cover it until the
time these products are a common thing in the market.

Production, unemployment and inflation 4
 Also, the shift in the spending of people from old outlets or new outlets and the wholesale
clubs as well as the online retailing is not presented by CPI in a proper way.

Production, unemployment and inflation 5
3. Explain how some government tax revenue and spending can depend on the state of
the economy.
Answer
The state of the economy determines the revenue and the spending of government. When the
economy is in the phase of expansion, the income of the people goes up, and they spend more.
Thus, the government gets more income in the form of higher taxes paid by the people and the
tax revenue from the government increases (Corsetti, 2012). This generally happens when the
economy is experiencing inflation. Also, at this time, the government keeps its spending
minimal because the money is already floating in the economy and the people have higher
liquidity. So, it tries to spend less so that the rate of inflation does not go higher.
When the economy is in the phase of contraction, the income of the people falls down, and they
spend less. Thus, the government gets less income in the form of lower taxes paid by the people
and the tax revenue of the government decreases (Corsetti, 2012). This generally happens when
the economy is experiencing deflation. Also, at this time, the government keeps its spending
maximum because the money is not floating in the economy and the people have lower liquidity.
So, it tries to spend more so that the rate of deflation reduces.

Production, unemployment and inflation 6
4. Explain some limitations of using GDP as an indicator of standard of living.
Answer
GDP is not a perfect indicator for determining the standard of living because (Giannetti, 2015):
 There are some activities in the economy that do not have market transactions like the
people fix their water leaking problems themselves, they take care of their children, etc.
These are also the productive activities and contribute to the human development like
when the children are given good care; they become better human beings, get the good
education and finally contribute to the economy. Thus, the GDP does not consider these
activities, only the output produced and sold in the legal markets are included in GDP.
 The contribution of the output to the quality of life of people is not considered by GDP.
 Similarly, the quality of the environment is not measured by GDP. For example, the
output of the country might increase the level of pollution is reduced in the environment.
People will have the better quality of life, and they will become more efficient in their
work. But, this is not measured and considers when the GDP is calculated.
 The leisure activities are also not included in the calculation of GDP. The leisure time of
people improves their quality of life as they take rest and they regain their efficiency of
work. But, the efficient that leads to higher production is the only thing which is included
in GDP, not the time that the people spent in leisure activities.

Production, unemployment and inflation 7
References:
Ball, L., DeLong, B., & Summers, L. (2014). Fiscal policy and full employment. Center on
Budget and Policy Priorities, abril [en línea] http://www. pathtofullemployment. org/wp-
content/uploads/2014/04/delong_summers_ball. pdf.
Corsetti, G., Meier, A., & Müller, G. J. (2012). What determines government spending
multipliers?. Economic Policy, 27(72), 521-565.
Giannetti, B. F., Agostinho, F., Almeida, C. M. V. B., & Huisingh, D. (2015). A review of
limitations of GDP and alternative indices to monitor human wellbeing and to manage eco-
system functionality. Journal of Cleaner Production, 87, 11-25.
Junankar, P. R. (Ed.). (2016). Economics of the Labour Market: Unemployment, Long-Term
Unemployment and the Costs of Unemployment. Springer.
Level, P. C. O. Y. A. (2015). Consumer Price Index.