AP_Krugman_Textbook

b.When the unemployment rate is low, frictional

unemployment will account for a larger share of

total unemployment because other sources of unemploy-

ment will be diminished. So the share of total unemploy-

ment composed of the frictionally unemployed will rise.

2. A binding minimum wage represents a price floor below
   which wages cannot fall. As a result, actual wages cannot
   move toward equilibrium. So a minimum wage causes the
   quantity of labor supplied to exceed the quantity of labor
   demanded. Because this surplus of labor reflects unem-
   ployed workers, it affects the unemployment rate.
   Collective bargaining has a similar effect—unions are able
   to raise the wage above the equilibrium level. This will act
   like a minimum wage by causing the number of job seek-
   ers to be larger than the number of workers firms are
   willing to hire. Collective bargaining causes the unem-
   ployment rate to be higher than it otherwise would be, as
   shown in the accompanying figure.


3. An increase in unemployment benefits reduces the cost to
   individuals of being unemployed, causing them to spend
   more time searching for a new job. So the natural rate of
   unemployment would increase.

Tackle the Test:

Multiple-Choice Questions

1. a


2. c


3. b


4. d


5. e

Tackle the Test:

Free-Response Question

2. a.Frictional. Melanie is between jobs.
   b.Structural. Melanie is unemployed because wages are not
   at the market equilibrium.
   c.Cyclical. Melanie is unemployed due to an economic
   slowdown (recession).

Module 14

Check Your Understanding

1. Shoe-leather costs as a result of inflation will be lower
   because it is now less costly for individuals to manage
   their assets in order to economize on their money hold-

Wage

rate

Quantity

of labor

QD QE

WU

WE

QS

Labor supply

Labor demand

E

Unemployed

Union-

negotiated

wage

ings. ATM machines, for example, give customers

24-hour access to cash in thousands of locations. This

reduction in the cost of obtaining money translates into

lower shoe-leather costs.

2. If inflation came to a complete stop for several years, the
   inflation rate of zero would be less than the expected in -
   flation rate of 2–3%. Because the real interest rate is the
   nominal interest rate minus the inflation rate, the real
   interest rates on loans would be higher than expected,
   and lenders would gain at the expense of borrowers.
   Borrowers would have to repay their loans with funds
   that had a higher real value than had been expected.
   Tackle the Test:
   Multiple-Choice Questions


3. e


4. c


5. b


6. d


7. c
   Tackle the Test:
   Free-Response Question


8. a.0%
   b.You borrowed enough money to buy a couch and paid
   back just enough to buy the same couch (after inflation).
   Therefore, you gained the benefit of the loan without
   paying any real interest for it.
   c.Whoever gave you the loan lost. The loan was paid back
   after prices unexpectedly increased, so the lender received
   a real interest rate of 0% for letting you use the money
   for a year.

Module 15

Check Your Understanding

1. Pre – frost, this market basket costs (100 ×$0.20) +(50 ×
   $0.60) +(200 ×$0.25) =$20 +$30 +$50 =$100. The
   same market basket, post - frost, costs (100 ×$0.40) +
   (50 ×$1.00) +(200 ×$0.45) =$40 +$50 +$90 =$180.
   So the price index is ($100/$100) × 100 =100 before the
   frost and ($180/$100) × 100 =180 after the frost, imply-
   ing a rise in the price index of 80%. This increase in the
   price index is less than the 84.2% increase calculated in
   the text. The reason for this difference is that the new
   market basket of 100 oranges, 50 grapefruit, and 200
   lemons contains proportionately more of an item that
   has experienced a relatively small price increase (the
   lemons, the price of which has increased by 80%) and
   proportionately fewer of an item that has experienced a
   relatively large price increase (the oranges, the price of
   which has increased by 100%). This shows that the price
   index can be very sensitive to the composition of the
   market basket. If the market basket contains a large pro-
   portion of goods whose prices have risen faster than the
   prices of other goods, it will lead to a higher estimate of
   the increase in the price level. If it contains a large pro-
   portion of goods whose prices have risen more slowly
   than the prices of other goods, it will lead to a lower esti-
   mate of the increase in the price level.

SOLUTIONS TO AP REVIEW QUESTIONS S-9