Chapter 06: Economic Growth, Business Cycles, and Structural Stagnation

Macroeconomics 9th Edition

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Chapter 6: Economic Growth, Business Cycles, and Structural Stagnation

Questions and Exercises

1. Classicals felt that if the wage level fell, the Depression would end. They saw
labor unions as preventing the fall in wages, and they believed that government
lacked the political will to break up unions.

2. Classical economics supported laissez-faire policies because they believed

business cycles were temporary glitches which the market would correct.

3. Keynesians are more likely to emphasize the fallacy of composition. The fallacy
of composition is the false assumption that what is true for a part will also be true
for the whole. Keynes carefully distinguished the adjustment process for a single
market from the adjustment process for the aggregate economy, arguing that the
effects differ significantly between the two.

4. Classical economics grew in importance in the 1970s because Keynesians didn't

have a model for inflation, whereas Classicals did.

5. Structural stagnation is neither a Keynesian nor a Classical theory. It includes

elements of both.

6. Per capita income rises by 4 percent.

(Note that this solution corresponds to the original question in the book, which is
replaced in the second printing of the book.)

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Chapter 06: Economic Growth, Business Cycles, and Structural Stagnation

Potential output is not purely a physical measure because unemployed workers do

not contribute to potential output, factories may be technologically obsolete, and
production must be sustainable to be equal to potential.
(Note that this solution corresponds to the new question located in the errata or
second printing of the book.)

7. Economic growth is measured by increases in total output and increases in output

per person.

8. Growth has slowed in recent years in both Western Europe and the United States.

9. From 1940 to 1970 the U.S. economy grew at a rate of about 2.5 percent per year,
which was lower than Western Europe and Japan but higher than many other
countries. In the following decades until 2000, U.S. growth was higher than most
except for India and China, which have experienced considerable growth. Since
2000 the U.S. economy has been slower than many countries, averaging about 1
percent per year in the first decade of the 2000s.

10. A representative business cycle is shown in the accompanying graph. Each of the
four phases—peak, downturn, trough, and upturn—is clearly labeled.

11. Structural stagnation is a period of protracted slow growth and high

unemployment. Because the expansion of the economy is slow with structural
stagnation, the economy does not return to its long-term trend. In contrast, a
recession is a short period of declining output followed by an expansionary period
that returns the economy to its long-term trend.

12. The structural stagnation theory is more pessimistic because it argues that the
economy must undergo structural changes before it will return to its long-term
growth trend. An example is that with structural stagnation, workers will have to
accept lower wages or learn new skills before the economy returns to its potential.
In the conventional business cycle view, the economic recession is short-lived.
Continuing the comparison with structural stagnation, those who become

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Chapter 06: Economic Growth, Business Cycles, and Structural Stagnation

unemployed will be rehired without having to accept lower wages or learn new
skills.

13. Structural unemployment is unemployment caused by the institutional structure of

an economy or by economic restructuring making some skills obsolete, whereas
cyclical unemployment is unemployment resulting from fluctuations in economic
activity. A fall in structural unemployment requires structural changes; a fall in
cyclical unemployment does not.

14. Structural unemployment, because it results from changes in the structure of the
economy, is best studied in the long-run framework.

15. Cyclical unemployment, which results from fluctuations in economic activity, is

best studied in the short-run framework.

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website, in whole or part.
Chapter 06: Economic Growth, Business Cycles, and Structural Stagnation

Questions from Alternative Perspectives

1. Austrian

Austrians believe that government’s attempts to deal with business cycles can
often lead to the creation of government programs that cost a lot but have little
benefit. Therefore, when government tries to solve problems, it often creates
greater problems.

2. Institutionalist

Institutionalists believe that this proposition is very reasonable. Firms’ focus on

making money and the financial issues can leave real issues secondary and can
bring about waves of pessimism and optimism. Institutionalists believe that the
insight that the production of goods is a normal daily aspect of life in all societies
since the beginning of time was fundamental to Mitchell’s analysis. Production
occurs because it is necessary to reproduce culture. Institutionalists believe that
the money economy has perverted this timeless process by giving control to a
group that allows culture to reproduce itself only if that group is able to profit
from that activity. Thus, during the Great Depression, farmers destroyed their
crops while people went hungry; workers were available, yet factories were
empty. Business owners did not expect a profit and thus used their power to idle
the economy, imperiling the reproduction of culture and threatening democracy
itself.

3. Post-Keynesian

a. Since the Great Depression, the government has been more active in the economy
and has used monetary and fiscal policy to stabilize the economy. Post-
Keynesians believe that these policies are responsible for the avoidance of severe
depressions since that time.

b. These policies are definitely Keynesian.

c. Post-Keynesians believe that these policies are still relevant today, whereas
Classical economists argue that such policies will cause much more serious
consequences in the long term.

4. Radical

a. This is a judgment question, and judgments differ. Radical economists would

agree with Vickrey that unemployment should be very low.

b. Radical economists believe that unemployment tends to hurt the people who are
the weakest and poorest in society and who need the most help. If such policies
generate inflation, institutions should be changed to eliminate the inflation
through means other than unemployment.

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Chapter 06: Economic Growth, Business Cycles, and Structural Stagnation

c. Vickrey supported a plan put forward by Abba Lerner and the author of this
textbook. It was called a market anti-inflation plan in which a firm could raise its
prices only if it bought the right to do so from another firm that lowered its price
by an offsetting amount.

5. All

In natural science, there are controlled experiments which allow one to say when
a theory has failed and when it has not. In macroeconomics, controlled
experiments are much more difficult to conduct, which means that alternative
explanations can be given for why the existing theory failed. For example, it can
be argued that the theory was correct but the execution of the policy was flawed.
When such alternative explanations are possible, it is much more difficult to
overthrow a theory.

Issues to Ponder

1. Deciding what is the purpose of life and therefore what constitutes a desired
lifestyle is a complicated issue. To the extent that work provides a sense of self-
worth and identity, complete idleness is not desirable. This, however, is a
normative question. Unemployment within our culture and set of institutions
is a measure of aggregate well-being to the extent that employment provides
a sense of well-being and sufficient income to support a desired lifestyle. This
example shows that unemployment must be understood within this broader
framework; its meaning is specific to a set of institutions and a culture.

2. Reducing unemployment to 1.2 percent today is not likely for several reasons.
One is that a low inflation rate seems to be incompatible with low unemployment.
Another is that today’s economy differs from that of the World War II period,
when there was an enormous ideological commitment to the war effort and
acceptance of strong wage and price controls.

3. a. Possible explanations include Japanese cultural emphases on tradition, honor, and

loyalty. In Japan, firms are less willing to lay off workers in times of excess
supply and workers are less likely to change employers in search of higher
compensation. Another explanation is the nature of Japanese production. One
could suggest that Japanese production does not rely on a changing base of skills
so that the skills of workers always match the skills demanded by a particular
firm.

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Chapter 06: Economic Growth, Business Cycles, and Structural Stagnation

b. It is impossible to say which is better. Each needs to be judged within the broader
context of the national economy.
c. The answer to this question depends on the distribution of layoffs and hires in
each of the economies. If layoffs in Japan were unavoidable and occurred among
mid- to low-ranking employees, the average tenure of Japanese employees would
decline. If instead the elderly were asked to retire earlier, the average tenure
would decline much less. In the United States firms would have to lay off fewer
workers than usual as a result of the booming economy, and average tenure would
rise. If the new hires were laid off, the average tenure would rise.

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distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a
website, in whole or part.