Question

The economy of Euphoria has the following economic data.

Year	2016	2017	2018
Nominal Gross Domestic Product ($ billions)	1,625	1,675	1,697.50
Real Gross Domestic Product ($ billions) 2015 = 1,568.5	1,625	1,649.75	1,702.50
GDP deflator	100	101.53	99.71
% change in real Consumption spending	3	1.75	2.8
% change in real Investment spending	2	-10	5
Net exports ($ billions)	-3,000	-6,000	-12,000
Unemployment rate (%)	5.3	5.8	5.2
Natural rate of unemployment	4.8	4.8	4.8
Index of production costs (2015 = 100)	104	105	104
Productivity index (2015 = 100)	101	103	106
Export price index (2015 = 100)	104	101	96
Import price index (2015 = 100)	106	108	104

1. Production costs are costs of raw materials, wages, capital goods and services.
2. Productivity index relates to all production inputs.

Examine the data relating to the economy of Euphoria above and answer the following questions.

Q1. What phase of the business cycle was the economy in 2018? Briefly give two reasons for your answer.                                                                                              

Q2. What was the likely cause of the change in the unemployment rate in 2018? What type of unemployment is likely to exist in Euphoria in 2018? Explain your answer.         

Q3. Identify and explain the likely cause of inflation / deflation in 2018?

Include in your answer the contribution that export and import prices made to inflation /   deflation in 2018.        

Answer 1

Answer 1:

In 2018, it can be observed that unemployment rate is higher than natural rate of unemployment in the economy and prices in the economy are falling, thus the economy is currently in the recessionary phase of the business cycle.

Answer 2:

The unemployment rate is higher than natural rate of unemployment in the economy because of high level of cyclical unemployment in the economy during the year 2018. The recession led to fall in the output which reduced labor demand and thus increased cyclical rate of unemployment in the economy.

Answer 3:

The Deflation in 2018 occurred due to fall in the level of aggregate demand in the economy. The Consumption and Investment expenditure in the economy are growing at a rapid rate but fall in aggregate demand occurred because of the fall in the level of Net exports in the economy. The Net exports have fallen significantly because of fall in the import prices in the economy which increased the level of imports more than the level of exports in the economy.