A) Why do economists refer to the economy as \"fully employed\" even when there

Question

A) Why do economists refer to the economy as "fully employed" even when there is measured unemployment as high as 4.5% -5% ? (Hint: begin your answer with a definition of full employment and then compare with the concept of natural rate of unemployment, NAIRU; what is it and why?). How do you relate the most recent unemployment rate (Look for Jan, 2012 data on unemployment rate in www.bls.gov) to your conclusion of this question indicating if the US economy is in a state of full employment? Feb 2012 unemployment data will be announced on March 2nd.

B) Why would you expect the inflation rate to accelerate if the actual unemployment rate declined to a level lower than the "full employment" unemployment rate (NAIRU)? Explain your answer in a few sentences. What state of business cycles (such as recession, trough, recovery or boom) does the current US economy face, and why?

C) Draw an AS/AD diagram illustrating your answer to part (B) That is, draw an AS/AD diagram which shows what happens if strong growth in AD has pushed actual RGDP to a level above potential (full employment) RGDP. Be sure to label all lines and axes in your diagram clearly.

Explanation / Answer

(A) Full employment is a situation in which all available labor resources are being used in the most economically efficient way. Full employment embodies the highest amount of skilled and unskilled labor that could be employed within an economy at any given time. Natural rate of unemployment is the lowest rate of unemployment that an economy can sustain over the long run. It represents the hypothetical unemployment rate consistent with aggregate production being at the "long-run" level. Since the natural rate of unemployment takes the long run consequences into account, we consider that the current labour force is working most efficiently from the economic point of view. The unemployment rate in jan 2012 was 8.3% according to bls.gov. (B)According to Keynesian theory, economists believe that a government can lower the rate of unemployment (i.e. employ more people) if it were willing to accept a higher level of inflation (the idea behind the Phillips Curve). However, critics of this say that the effect is temporary and that unemployment would bounce back up but inflation would stay high. There is a recorded Growth of 2%-2.3% in '12, up from 1.7% in '11. After the recession period, this indicates a recovery.

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