Question

Sing a neoclassical model, what will the level of cyclical unemployment be when an economy is producing at potential GDP?

A. zero
B. never 0%
C. 1% - 3%
D. 3% - 5%

Answer 1

Tje correct answer is option A. In a neoclassical model, the level of cyclical unemployment is zero when an economy is producing at potential GDP. However, due to frictional and structural factors, the total unemployment rate never reaches 0%.

Step-by-step explanation:

Using a neoclassical model, when an economy is producing at potential GDP, the level of cyclical unemployment will be zero. This condition is due to the fact that in a neoclassical model, equilibrium near potential GDP implies that the economy is not experiencing the boom and bust cycles that create cyclical unemployment. However, it is crucial to understand that the unemployment rate will never actually fall to 0% due to the presence of frictional unemployment and structural unemployment, which are part of the natural rate of unemployment.

Fighting Unemployment or Inflation? section explains that cyclical unemployment is a product of the business cycle and is eliminated when an economy is producing at potential GDP. Labor market dynamics ensure that there is always some level of natural unemployment, as some workers are transitionally between jobs or seeking better job matches. Therefore, the correct answer to the question is: A. zero.

Answer 2

When an economy is producing at potential GDP according to the neoclassical model, cyclical unemployment will be zero, but the overall unemployment rate will never be at 0% due to frictional and structural unemployment.

Step-by-step explanation:

Using a neoclassical model, when an economy is producing at potential GDP, the level of cyclical unemployment will be zero (A). This is because cyclical unemployment is the result of fluctuations in the business cycle and occurs when the economy is producing below its potential GDP. At potential GDP, the economy is considered to be at full employment, although this doesn't mean the unemployment rate will be at 0% due to the presence of frictional and structural unemployment. It's important to note that labor market dynamics, such as the entry and exit of people into the labor force, cause the unemployment rate to never fall to absolute zero.

Within the neoclassical zone, shifts in aggregate demand (AD) have negligible effects on output levels and employment because the economy is already at or near full capacity. The key way to increase real GDP in this zone is through a shift in aggregate supply (AS) to the right. Shifts in AD mainly create price level changes rather than affect employment levels. The natural rate of unemployment, which consists of frictional and structural unemployment, is what remains even when the economy is at potential GDP.