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# PS3solutions - Econ 201 PROBLEM SET 3 SOLUTIONS Prof Shea 1...

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Econ 201 PROBLEM SET 3 SOLUTIONS Prof. Shea 1. Consider the picture below, which shows the path of GDP (Y) over time (Year). Which point in time is likely to have the highest unemployment rate? (Draw a similar picture on your answer sheet and indicate which year is likely to have the highest rate of unemployment) Which type of unemployment (frictional, structural or cyclical) will be high in that year? ANSWER: Boom Recession As shown in the picture above, the time path of output can be decomposed into two components: trend Y, corresponding to a smoothly rising component due to long run growth; and the business cycle, corresponding to fluctuations of actual Y around trend Y. Recall from the class discussion that a boom occurs when actual Y is above trend Y, such as at point A. A recession occurs when actual Y is below trend Y, such as at point B. I also mentioned in class that unemployment is systematically related to the business cycle, falling during booms and rising during recessions. The UR will thus likely be highest in a year like point B, where output is far below its trend. Cyclical unemployment will be the type of unemployment that will be especially high in this period because it is a period corresponding to a recession or downturn in the economy. 2. You have just invented a time machine and can go back to whatever year you want. You have a \$10 bill that you can bring with you. Suppose you want to go back in time and buy as much candy with your \$10 as you can.

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Assuming that candy prices have behaved just like the US CPI over time, which year would you rather go back to:
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PS3solutions - Econ 201 PROBLEM SET 3 SOLUTIONS Prof Shea 1...

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