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Inflationary Gaps and Unemployment
hard

In an economy experiencing demand-pull inflation, what is the likely relationship between cyclical unemployment and the inflationary gap during a recessionary period?

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Choose the Best Answer

A

Cyclical unemployment decreases as demand increases, reducing the inflationary gap.

B

Cyclical unemployment remains constant while demand-pull inflation rises.

C

Cyclical unemployment increases as demand decreases, widening the inflationary gap.

D

Cyclical unemployment decreases and the inflationary gap narrows simultaneously.

Understanding the Answer

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Answer

In an economy facing demand-pull inflation, demand for goods and services is higher than what the economy can produce, leading to rising prices. During a recession, however, the economy is not performing well, and many people are out of work, which increases cyclical unemployment. In this situation, the inflationary gap, which is the difference between what the economy is producing and what it could produce at full employment, tends to be negative or less significant. For example, if a country has a potential output of 1 million goods but is only producing 800,000 during a recession, the inflationary gap is negative because people are unemployed and not contributing to production. Therefore, during a recession, cyclical unemployment rises, and the inflationary gap typically narrows, showing that demand is insufficient to push prices higher.

Detailed Explanation

When demand decreases during a recession, fewer people are needed to produce goods. Other options are incorrect because This option suggests that more demand means fewer job losses, which is not true in a recession; This choice implies that unemployment stays the same while inflation rises, which is confusing.

Key Concepts

cyclical unemployment
demand-pull inflation
recessionary gap.
Topic

Inflationary Gaps and Unemployment

Difficulty

hard level question

Cognitive Level

understand

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