Problem Set #8. Inflation

Economics 116a: Fall 1999 Problem due before class Tuesday, November 9

Messrs. Nordhaus, Hall, and staff

Answer succinctly. Long-winded and vague answers will be penalized.

1. Different brands of unemployment.

What would be the effect on voluntary and involuntary unemployment of the following measures? Explain your answers briefly.

1. The minimum wage is increased by 50%.

2. Internet job matching makes it easier for workers to search for jobs from work.

2. Professor Phillips meets Presidential Adviser Okun.

1. State Okun=s Law.

2. The Phillips curve is a relation between inflation and unemployment. Suppose the short- run Phillips curve in 1999 is:

ΔP/P = 3 - 0.5 (U - LSUR)

where ΔP/P is the inflation rate (percent), U is the unemployment rate (percent), and LSUR is the lowest sustainable unemployment rate. Combine the Phillips curve with Okun's law to show how inflation is related to the output gap (the percent difference between potential and actual GDP). Explain in words and in a diagram.

3. The Shoot Out at Inflation Corral

In 1979 the Fed decided to get tough on inflation and embarked on a tight monetary policy to fight inflation, which exceeded 10 percent per year at the time. Use the short-run and long-run Phillips curves to show how tight money affected inflation and unemployment during the period of tight money. How would your answer change if prices and wages were perfectly flexible? (You may want to review the relevant macroeconomic data at http://www.econ.yale.edu/~ghall/econ116a/data.htm)

4. Economic Policy and the Lowest Sustainable Unemployment

he following are current policy proposals. Explain in two or three sentences the likely effect of each on the LSUR.

1. Raising the minimum wage from $5.35 to $7 per hour.

2. Abolishing all welfare benefits and unemployment insurance.

3.

5. Dr. Eli at the Bureau of Labor Statistics

1. There are five different commodities in the consumer price index. These have weights of 15 percent (food), 10 percent (clothing), 40 percent (housing), 15 percent (health care), and 20 percent for computers. The following are the prices for the different commodities for three years:

Sector	1997	1998	1999
Food Clothing Housing Medical care Computers	100 100 100 100 100	101 105 105 110 105	100 120 110 120 110
Consumer Price Index (BLS calculation) Consumer Price Index (using hedonic price index)	100 100	_____ _____	_____ _____

Using fixed weights, calculate the BLS consumer price index for 1998 and 1999. What are the annual rates of inflation for 1998 and 1999?

(b) Ella T. Eli, a staff economist at the Bureau of Labor Statistics, completes a study indicating that there was substantial quality change in computers. She finds that the average 1998 computer delivered 50 percent more computer power (measured as the cost to solve certain benchmark programs per minute) per dollar than the 1997 computer, while the 1999 computer delivered 100 percent more computing power per dollar than the 1997 computer.

Dr. Eli proposes using a Ahedonic price index@ which corrects for quality change. Calculate the corrected CPI and the corrected rates of inflation. [Historical note: The government actually did introduce such a correction for computers into its price indexes in 1990.]