GDP ndash measures legal production in the US in one year

GDP measures all final goodsservices produced by workers and capital located in the US regardless of ownership [Domestically located resources] Final goods are goods ready for consumption

>

1 Second Hand Sales[no production]2 PublicPrivate Transfer Payments3 Purely Financial Transactions4 Intermediate Goods

5 US Corporations producing overseas6 Non-market transactions [household or volunteer work]Underground Economy7 Illegal business activity8 Unreported legal business activity

Intermediate Goods ndash components of the final good A Ford buys batteries or tires for its cars

B KFC buys chickens to eventually sell to customers

>

[It has not been produced again in 2010 amp would not count]

2nd Hand Sales ndash no current production A 1957 Chevy bought in 2010

The salesman is doing productive work His commission would count

B Boots produced in 1980 are bought in a Thrift Store in 2011They also have not been produced againSalesmanrsquos commission would countYou are buying his services

Salesman

Shoe salesman

57 Chevy

This falls under the rule of ldquoDo Not Double Countrdquo

>

>

>

>

>

>

>

>

Purely Financial Transactions ndash stocks bonds CDs There is no current production Ex If 100 shares of Dell stock is bought

Irsquom not buying a Dell computerbut part ownership of Dell

Exchanging one financial asset for anotherThis represents transfer of ownership fromone shareholder to another[swapping bits of paper]

Buying stock is not buying a product but buying ownership of the firm Buying bonds is making a loan

>

>

A Public Transfer Paymentsndashwelfare unemployment social security [There is no contribution to final production]

ldquoNow that Irsquove gotten my welfare check I can get a white iPad 2rdquo

B Private Transfer Payments like your parents giving you $250 cash for Christmas or - $100 for making an ldquoArdquo in economics [Just transferring funds from one private individual to another private individual]

>

Unreported ldquolegalrdquo business activity does not countThis is two-thirds of the ldquounderground economyrdquo

Then he has LASIK but the

surgeon doesnrsquot report $500 of his $3400 bill

And what if thiswaitress doesnrsquotreport all tips

And what if the dentist doesnrsquot report $400 forteeth whitening

Before LASIK Surgery

>

>

>

>

>

Illegal business activity because it goes unreported also

does not count Making up 13 of the ldquounderground economyrdquo also called the [ldquoblack marketrdquo] It includes murder for hire gambling drugs prostitution and money laundering

ldquoIda Hordquo

ldquoGive me the money inyour purse At least itwill not count in GDPrdquo

Money LaunderingMaking money illegally (drug money)and making it look like it was legallyearned (like buying a laundry mator car wash that deal in cash) and report it as legally earned

And what is money laundering

>

>

>

>

>

>

>

Self Employed $255

Other Legal $25Rents amp Royalties $30

Corporate Profits $50

Interest $55

Wages andSalaries $185

Drugs $120

Bribery $35Gambling andLoan Sharking $10Pornography $20

Fraud $30

Other I

llegal $

20

Prost

itutio

n $30

Sto

len

Goo

ds $

35

Illegal$300 B

Legal$600 B

What gets reported isthe ldquoAbove Groundrdquo

What doesnrsquot get reportedis the ldquoUndergroundrdquo

>

Work in your own household or volunteer work in the community does not count because there was no payment

You need to do some of

this housework

>

Work in your own household or volunteer work in the community does not count because there was no payment

So donrsquot marry your maid yardman or fitness instructor or you will hurt GDP

>

If U S corporations produce goods overseas it does not count in GDP but would count in GNPRemember we are measuring production insidethe US Imports represent production outside ofthe US

GM in France

Nike in Indonesia

>

___ ___ 1 New Toyota Tundra truck manufactured in San Antonio and sold to your economics teacher the year it was produced

___ ___ 2 You buy a new Wii at GameStop in 2009 Does it count if you resell it on eBay in March of 2010

On the next slide read each sentence and determineldquoTo Be or Not To Be Countedrdquo That is the question

If ldquoYesrdquo put ldquoYrdquo and tell if it is ldquoCrdquo ldquoIgrdquo ldquoGrdquo or ldquoXrdquo

If ldquoNordquo put ldquoNrdquo and give the number from below on why it is not counted in GDPGDP DOES NOT INCLUDE1 Second hand sales [no current production] [but the salesmanrsquos commission counts]2 PublicPrivate transfer payments [no current production]3 Purely financial transactions [no current production] [brokerrsquos fees do count]4 Intermediate goods [component of final good]5 US corporations producing overseas6 Non-market transactions [ household or volunteer work

Underground Economy [not reported]7 Illegal business activity [prostitution murder-for-hire illegal drugs etc]8 Unreported legal business activity [ldquooff the booksrdquo]

ExampleYC

1 N

___ ___ 1 You buy a purple ldquoTinky Winkyrdquo [produced in TX] from Wal-Mart___ ___ 2 You and your family paint your house [labor involved]___ ___ 3 You marry your housemaid [ldquoworking-for-loverdquo] [her services]___ ___ 4 You buy 100 shares of Microsoft Corporation___ ___ 5 You volunteer to babysit your little sister to help your parents while they work___ ___ 6 Bob buys a 1965 ford Mustang convertible in 2010 which is in mint condition___ ___ 7 The salesman gets a commission [pay] for selling that 1965 Ford Mustang in 2010___ ___ 8 You and your friend volunteer to cook at the senior class picnic___ ___ 9 Dr Payne does $1000 worth of dental work but reports only $500 of it

Does the $500 the dentist keeps and doesnrsquot report count___ ___ 10 You are given suitcase full of $100 bills from the sale of smuggled drugs___ ___ 11 Your mother is teaching you to read [amp not having much success]___ ___ 12 Your dad bakes you a home-baked loaf of bread [his labor]___ ___ 13 You buy a loaf of bread from Krogerrsquos Grocery Store___ ___ 14 The US government purchases 5 B-2 Bombers for $2 B each___ ___ 15 Ford buys a ton of sheet metal used in making car doors___ ___ 16 You buy a new ldquoiPad 2rdquo [produced in China] from the Apple store ___ ___ 17 You send in a $90 check to your dentist for cleaning your teeth___ ___ 18 Your family buys a new house next to the mansion of Bill Gates___ ___ 19 100 additional teachers are hired by the Frisco ISD___ ___ 20 GM invest in $500 million worth of robots to assemble their cars___ ___ 21 You volunteer 10 hours a week of your time to work for senior citizens___ ___ 22 Ford produces 25000 F150s in Denver which are not sold by the end of the year___ ___ 23 Russia buys 3000 Dell computers produced in NY as they become Rusky Dell Dudes___ ___ 24 A manrsquos wife does all his cooking and sewing working for him 16 hours per day___ ___ 25 Nike produces $10 million worth of Nike Air Jordanrsquos in Vietnam

YCN6N6N3N6N1YCN

8 NN7N6

6

N6YCYGN4N5YCYIgYGYIgN6YIgYXN6N5

1 2nd Hd sales2 Transfers3 Financial4 Intermediate5 Overseas6 Non-market7 Illegal8 Unreported

bull Gross Domestic ProductGDP= C +I+G+Xn = Consumption + Investment +Government

Spending+ Net Exports [(all exports) X-M (all imports)]bull Net Domestic Product (your value-what you could sell if ya

had to)

NDP= GDP- Depreciation (the loss of value over time- replacement cost)

bull National IncomeNI= NDP +NFFIEUS-Statistical Discrepancy Net Foreign Factor Income earned in USbull Personal Income (what you can pay in taxes spend or save)

PI= NI- Undistributed Corporate ProfitsndashCorporate Income Taxes -Social Security-Taxes on production amp iMports +Transfer Payments

bull Disposable Income (what you can spend or save)

DI= PI- personal income taxes

National Income Accounting

U Can See The Toilet Paper

NDP NI PIDIG

DP

>

- Personnel Taxes-$1102

$10 089[ldquoCrdquo]

Consumption[66]

$12392

[births-deaths]

ldquoAvailablefor salerdquo

$12026

PI is what we can spend save

or pay in taxes

ldquoIncome received by

householdswhether earned orunearnedrdquo

$10924

DIis what we can

SPENDor

SAVE

Y receivednot earned

Y earnednot received

GDPGross Domestic Product

$14256

NDPNational Domestic Product

$12392

NINational Income

$12288

PIPersonal income

$12026

DIDisposable Income

$10924

Gross PrivateDomestic Investment

$1 628GovernmentPurchases

$2931

Xn(X-M) -$392

-Depreciation[Replacement Cap]

$1864

$12288

ldquoIncome earnedby US resourcesrdquoplus taxes on pro-duction amp imports

-Statistical Discrep

$209[to make the income approach match the

expenditure approach]

+NFFI$105

+$2528 Trans Pay

-$418 Undis Cor Pro-$315 Corp Inc Tax -$967Soc Sec Con

-1090 Taxes on proamp M

ROW[$264]

US [$159]

NFFI = $105

ldquoU Can See The ToiletPaperrdquo

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

1 Second Hand Sales[no production]2 PublicPrivate Transfer Payments3 Purely Financial Transactions4 Intermediate Goods

5 US Corporations producing overseas6 Non-market transactions [household or volunteer work]Underground Economy7 Illegal business activity8 Unreported legal business activity

Intermediate Goods ndash components of the final good A Ford buys batteries or tires for its cars

B KFC buys chickens to eventually sell to customers

>

[It has not been produced again in 2010 amp would not count]

2nd Hand Sales ndash no current production A 1957 Chevy bought in 2010

The salesman is doing productive work His commission would count

B Boots produced in 1980 are bought in a Thrift Store in 2011They also have not been produced againSalesmanrsquos commission would countYou are buying his services

Salesman

Shoe salesman

57 Chevy

This falls under the rule of ldquoDo Not Double Countrdquo

>

>

>

>

>

>

>

>

Purely Financial Transactions ndash stocks bonds CDs There is no current production Ex If 100 shares of Dell stock is bought

Irsquom not buying a Dell computerbut part ownership of Dell

Exchanging one financial asset for anotherThis represents transfer of ownership fromone shareholder to another[swapping bits of paper]

Buying stock is not buying a product but buying ownership of the firm Buying bonds is making a loan

>

>

A Public Transfer Paymentsndashwelfare unemployment social security [There is no contribution to final production]

ldquoNow that Irsquove gotten my welfare check I can get a white iPad 2rdquo

B Private Transfer Payments like your parents giving you $250 cash for Christmas or - $100 for making an ldquoArdquo in economics [Just transferring funds from one private individual to another private individual]

>

Unreported ldquolegalrdquo business activity does not countThis is two-thirds of the ldquounderground economyrdquo

Then he has LASIK but the

surgeon doesnrsquot report $500 of his $3400 bill

And what if thiswaitress doesnrsquotreport all tips

And what if the dentist doesnrsquot report $400 forteeth whitening

Before LASIK Surgery

>

>

>

>

>

Illegal business activity because it goes unreported also

does not count Making up 13 of the ldquounderground economyrdquo also called the [ldquoblack marketrdquo] It includes murder for hire gambling drugs prostitution and money laundering

ldquoIda Hordquo

ldquoGive me the money inyour purse At least itwill not count in GDPrdquo

Money LaunderingMaking money illegally (drug money)and making it look like it was legallyearned (like buying a laundry mator car wash that deal in cash) and report it as legally earned

And what is money laundering

>

>

>

>

>

>

>

Self Employed $255

Other Legal $25Rents amp Royalties $30

Corporate Profits $50

Interest $55

Wages andSalaries $185

Drugs $120

Bribery $35Gambling andLoan Sharking $10Pornography $20

Fraud $30

Other I

llegal $

20

Prost

itutio

n $30

Sto

len

Goo

ds $

35

Illegal$300 B

Legal$600 B

What gets reported isthe ldquoAbove Groundrdquo

What doesnrsquot get reportedis the ldquoUndergroundrdquo

>

Work in your own household or volunteer work in the community does not count because there was no payment

You need to do some of

this housework

>

Work in your own household or volunteer work in the community does not count because there was no payment

So donrsquot marry your maid yardman or fitness instructor or you will hurt GDP

>

If U S corporations produce goods overseas it does not count in GDP but would count in GNPRemember we are measuring production insidethe US Imports represent production outside ofthe US

GM in France

Nike in Indonesia

>

___ ___ 1 New Toyota Tundra truck manufactured in San Antonio and sold to your economics teacher the year it was produced

___ ___ 2 You buy a new Wii at GameStop in 2009 Does it count if you resell it on eBay in March of 2010

On the next slide read each sentence and determineldquoTo Be or Not To Be Countedrdquo That is the question

If ldquoYesrdquo put ldquoYrdquo and tell if it is ldquoCrdquo ldquoIgrdquo ldquoGrdquo or ldquoXrdquo

If ldquoNordquo put ldquoNrdquo and give the number from below on why it is not counted in GDPGDP DOES NOT INCLUDE1 Second hand sales [no current production] [but the salesmanrsquos commission counts]2 PublicPrivate transfer payments [no current production]3 Purely financial transactions [no current production] [brokerrsquos fees do count]4 Intermediate goods [component of final good]5 US corporations producing overseas6 Non-market transactions [ household or volunteer work

Underground Economy [not reported]7 Illegal business activity [prostitution murder-for-hire illegal drugs etc]8 Unreported legal business activity [ldquooff the booksrdquo]

ExampleYC

1 N

___ ___ 1 You buy a purple ldquoTinky Winkyrdquo [produced in TX] from Wal-Mart___ ___ 2 You and your family paint your house [labor involved]___ ___ 3 You marry your housemaid [ldquoworking-for-loverdquo] [her services]___ ___ 4 You buy 100 shares of Microsoft Corporation___ ___ 5 You volunteer to babysit your little sister to help your parents while they work___ ___ 6 Bob buys a 1965 ford Mustang convertible in 2010 which is in mint condition___ ___ 7 The salesman gets a commission [pay] for selling that 1965 Ford Mustang in 2010___ ___ 8 You and your friend volunteer to cook at the senior class picnic___ ___ 9 Dr Payne does $1000 worth of dental work but reports only $500 of it

Does the $500 the dentist keeps and doesnrsquot report count___ ___ 10 You are given suitcase full of $100 bills from the sale of smuggled drugs___ ___ 11 Your mother is teaching you to read [amp not having much success]___ ___ 12 Your dad bakes you a home-baked loaf of bread [his labor]___ ___ 13 You buy a loaf of bread from Krogerrsquos Grocery Store___ ___ 14 The US government purchases 5 B-2 Bombers for $2 B each___ ___ 15 Ford buys a ton of sheet metal used in making car doors___ ___ 16 You buy a new ldquoiPad 2rdquo [produced in China] from the Apple store ___ ___ 17 You send in a $90 check to your dentist for cleaning your teeth___ ___ 18 Your family buys a new house next to the mansion of Bill Gates___ ___ 19 100 additional teachers are hired by the Frisco ISD___ ___ 20 GM invest in $500 million worth of robots to assemble their cars___ ___ 21 You volunteer 10 hours a week of your time to work for senior citizens___ ___ 22 Ford produces 25000 F150s in Denver which are not sold by the end of the year___ ___ 23 Russia buys 3000 Dell computers produced in NY as they become Rusky Dell Dudes___ ___ 24 A manrsquos wife does all his cooking and sewing working for him 16 hours per day___ ___ 25 Nike produces $10 million worth of Nike Air Jordanrsquos in Vietnam

YCN6N6N3N6N1YCN

8 NN7N6

6

N6YCYGN4N5YCYIgYGYIgN6YIgYXN6N5

1 2nd Hd sales2 Transfers3 Financial4 Intermediate5 Overseas6 Non-market7 Illegal8 Unreported

bull Gross Domestic ProductGDP= C +I+G+Xn = Consumption + Investment +Government

Spending+ Net Exports [(all exports) X-M (all imports)]bull Net Domestic Product (your value-what you could sell if ya

had to)

NDP= GDP- Depreciation (the loss of value over time- replacement cost)

bull National IncomeNI= NDP +NFFIEUS-Statistical Discrepancy Net Foreign Factor Income earned in USbull Personal Income (what you can pay in taxes spend or save)

PI= NI- Undistributed Corporate ProfitsndashCorporate Income Taxes -Social Security-Taxes on production amp iMports +Transfer Payments

bull Disposable Income (what you can spend or save)

DI= PI- personal income taxes

National Income Accounting

U Can See The Toilet Paper

NDP NI PIDIG

DP

>

- Personnel Taxes-$1102

$10 089[ldquoCrdquo]

Consumption[66]

$12392

[births-deaths]

ldquoAvailablefor salerdquo

$12026

PI is what we can spend save

or pay in taxes

ldquoIncome received by

householdswhether earned orunearnedrdquo

$10924

DIis what we can

SPENDor

SAVE

Y receivednot earned

Y earnednot received

GDPGross Domestic Product

$14256

NDPNational Domestic Product

$12392

NINational Income

$12288

PIPersonal income

$12026

DIDisposable Income

$10924

Gross PrivateDomestic Investment

$1 628GovernmentPurchases

$2931

Xn(X-M) -$392

-Depreciation[Replacement Cap]

$1864

$12288

ldquoIncome earnedby US resourcesrdquoplus taxes on pro-duction amp imports

-Statistical Discrep

$209[to make the income approach match the

expenditure approach]

+NFFI$105

+$2528 Trans Pay

-$418 Undis Cor Pro-$315 Corp Inc Tax -$967Soc Sec Con

-1090 Taxes on proamp M

ROW[$264]

US [$159]

NFFI = $105

ldquoU Can See The ToiletPaperrdquo

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Intermediate Goods ndash components of the final good A Ford buys batteries or tires for its cars

B KFC buys chickens to eventually sell to customers

>

[It has not been produced again in 2010 amp would not count]

2nd Hand Sales ndash no current production A 1957 Chevy bought in 2010

The salesman is doing productive work His commission would count

B Boots produced in 1980 are bought in a Thrift Store in 2011They also have not been produced againSalesmanrsquos commission would countYou are buying his services

Salesman

Shoe salesman

57 Chevy

This falls under the rule of ldquoDo Not Double Countrdquo

>

>

>

>

>

>

>

>

Purely Financial Transactions ndash stocks bonds CDs There is no current production Ex If 100 shares of Dell stock is bought

Irsquom not buying a Dell computerbut part ownership of Dell

Exchanging one financial asset for anotherThis represents transfer of ownership fromone shareholder to another[swapping bits of paper]

Buying stock is not buying a product but buying ownership of the firm Buying bonds is making a loan

>

>

A Public Transfer Paymentsndashwelfare unemployment social security [There is no contribution to final production]

ldquoNow that Irsquove gotten my welfare check I can get a white iPad 2rdquo

B Private Transfer Payments like your parents giving you $250 cash for Christmas or - $100 for making an ldquoArdquo in economics [Just transferring funds from one private individual to another private individual]

>

Unreported ldquolegalrdquo business activity does not countThis is two-thirds of the ldquounderground economyrdquo

Then he has LASIK but the

surgeon doesnrsquot report $500 of his $3400 bill

And what if thiswaitress doesnrsquotreport all tips

And what if the dentist doesnrsquot report $400 forteeth whitening

Before LASIK Surgery

>

>

>

>

>

Illegal business activity because it goes unreported also

does not count Making up 13 of the ldquounderground economyrdquo also called the [ldquoblack marketrdquo] It includes murder for hire gambling drugs prostitution and money laundering

ldquoIda Hordquo

ldquoGive me the money inyour purse At least itwill not count in GDPrdquo

Money LaunderingMaking money illegally (drug money)and making it look like it was legallyearned (like buying a laundry mator car wash that deal in cash) and report it as legally earned

And what is money laundering

>

>

>

>

>

>

>

Self Employed $255

Other Legal $25Rents amp Royalties $30

Corporate Profits $50

Interest $55

Wages andSalaries $185

Drugs $120

Bribery $35Gambling andLoan Sharking $10Pornography $20

Fraud $30

Other I

llegal $

20

Prost

itutio

n $30

Sto

len

Goo

ds $

35

Illegal$300 B

Legal$600 B

What gets reported isthe ldquoAbove Groundrdquo

What doesnrsquot get reportedis the ldquoUndergroundrdquo

>

Work in your own household or volunteer work in the community does not count because there was no payment

You need to do some of

this housework

>

Work in your own household or volunteer work in the community does not count because there was no payment

So donrsquot marry your maid yardman or fitness instructor or you will hurt GDP

>

If U S corporations produce goods overseas it does not count in GDP but would count in GNPRemember we are measuring production insidethe US Imports represent production outside ofthe US

GM in France

Nike in Indonesia

>

___ ___ 1 New Toyota Tundra truck manufactured in San Antonio and sold to your economics teacher the year it was produced

___ ___ 2 You buy a new Wii at GameStop in 2009 Does it count if you resell it on eBay in March of 2010

On the next slide read each sentence and determineldquoTo Be or Not To Be Countedrdquo That is the question

If ldquoYesrdquo put ldquoYrdquo and tell if it is ldquoCrdquo ldquoIgrdquo ldquoGrdquo or ldquoXrdquo

If ldquoNordquo put ldquoNrdquo and give the number from below on why it is not counted in GDPGDP DOES NOT INCLUDE1 Second hand sales [no current production] [but the salesmanrsquos commission counts]2 PublicPrivate transfer payments [no current production]3 Purely financial transactions [no current production] [brokerrsquos fees do count]4 Intermediate goods [component of final good]5 US corporations producing overseas6 Non-market transactions [ household or volunteer work

Underground Economy [not reported]7 Illegal business activity [prostitution murder-for-hire illegal drugs etc]8 Unreported legal business activity [ldquooff the booksrdquo]

ExampleYC

1 N

___ ___ 1 You buy a purple ldquoTinky Winkyrdquo [produced in TX] from Wal-Mart___ ___ 2 You and your family paint your house [labor involved]___ ___ 3 You marry your housemaid [ldquoworking-for-loverdquo] [her services]___ ___ 4 You buy 100 shares of Microsoft Corporation___ ___ 5 You volunteer to babysit your little sister to help your parents while they work___ ___ 6 Bob buys a 1965 ford Mustang convertible in 2010 which is in mint condition___ ___ 7 The salesman gets a commission [pay] for selling that 1965 Ford Mustang in 2010___ ___ 8 You and your friend volunteer to cook at the senior class picnic___ ___ 9 Dr Payne does $1000 worth of dental work but reports only $500 of it

Does the $500 the dentist keeps and doesnrsquot report count___ ___ 10 You are given suitcase full of $100 bills from the sale of smuggled drugs___ ___ 11 Your mother is teaching you to read [amp not having much success]___ ___ 12 Your dad bakes you a home-baked loaf of bread [his labor]___ ___ 13 You buy a loaf of bread from Krogerrsquos Grocery Store___ ___ 14 The US government purchases 5 B-2 Bombers for $2 B each___ ___ 15 Ford buys a ton of sheet metal used in making car doors___ ___ 16 You buy a new ldquoiPad 2rdquo [produced in China] from the Apple store ___ ___ 17 You send in a $90 check to your dentist for cleaning your teeth___ ___ 18 Your family buys a new house next to the mansion of Bill Gates___ ___ 19 100 additional teachers are hired by the Frisco ISD___ ___ 20 GM invest in $500 million worth of robots to assemble their cars___ ___ 21 You volunteer 10 hours a week of your time to work for senior citizens___ ___ 22 Ford produces 25000 F150s in Denver which are not sold by the end of the year___ ___ 23 Russia buys 3000 Dell computers produced in NY as they become Rusky Dell Dudes___ ___ 24 A manrsquos wife does all his cooking and sewing working for him 16 hours per day___ ___ 25 Nike produces $10 million worth of Nike Air Jordanrsquos in Vietnam

YCN6N6N3N6N1YCN

8 NN7N6

6

N6YCYGN4N5YCYIgYGYIgN6YIgYXN6N5

1 2nd Hd sales2 Transfers3 Financial4 Intermediate5 Overseas6 Non-market7 Illegal8 Unreported

bull Gross Domestic ProductGDP= C +I+G+Xn = Consumption + Investment +Government

Spending+ Net Exports [(all exports) X-M (all imports)]bull Net Domestic Product (your value-what you could sell if ya

had to)

NDP= GDP- Depreciation (the loss of value over time- replacement cost)

bull National IncomeNI= NDP +NFFIEUS-Statistical Discrepancy Net Foreign Factor Income earned in USbull Personal Income (what you can pay in taxes spend or save)

PI= NI- Undistributed Corporate ProfitsndashCorporate Income Taxes -Social Security-Taxes on production amp iMports +Transfer Payments

bull Disposable Income (what you can spend or save)

DI= PI- personal income taxes

National Income Accounting

U Can See The Toilet Paper

NDP NI PIDIG

DP

>

- Personnel Taxes-$1102

$10 089[ldquoCrdquo]

Consumption[66]

$12392

[births-deaths]

ldquoAvailablefor salerdquo

$12026

PI is what we can spend save

or pay in taxes

ldquoIncome received by

householdswhether earned orunearnedrdquo

$10924

DIis what we can

SPENDor

SAVE

Y receivednot earned

Y earnednot received

GDPGross Domestic Product

$14256

NDPNational Domestic Product

$12392

NINational Income

$12288

PIPersonal income

$12026

DIDisposable Income

$10924

Gross PrivateDomestic Investment

$1 628GovernmentPurchases

$2931

Xn(X-M) -$392

-Depreciation[Replacement Cap]

$1864

$12288

ldquoIncome earnedby US resourcesrdquoplus taxes on pro-duction amp imports

-Statistical Discrep

$209[to make the income approach match the

expenditure approach]

+NFFI$105

+$2528 Trans Pay

-$418 Undis Cor Pro-$315 Corp Inc Tax -$967Soc Sec Con

-1090 Taxes on proamp M

ROW[$264]

US [$159]

NFFI = $105

ldquoU Can See The ToiletPaperrdquo

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

[It has not been produced again in 2010 amp would not count]

2nd Hand Sales ndash no current production A 1957 Chevy bought in 2010

The salesman is doing productive work His commission would count

B Boots produced in 1980 are bought in a Thrift Store in 2011They also have not been produced againSalesmanrsquos commission would countYou are buying his services

Salesman

Shoe salesman

57 Chevy

This falls under the rule of ldquoDo Not Double Countrdquo

>

>

>

>

>

>

>

>

Purely Financial Transactions ndash stocks bonds CDs There is no current production Ex If 100 shares of Dell stock is bought

Irsquom not buying a Dell computerbut part ownership of Dell

Exchanging one financial asset for anotherThis represents transfer of ownership fromone shareholder to another[swapping bits of paper]

Buying stock is not buying a product but buying ownership of the firm Buying bonds is making a loan

>

>

A Public Transfer Paymentsndashwelfare unemployment social security [There is no contribution to final production]

ldquoNow that Irsquove gotten my welfare check I can get a white iPad 2rdquo

B Private Transfer Payments like your parents giving you $250 cash for Christmas or - $100 for making an ldquoArdquo in economics [Just transferring funds from one private individual to another private individual]

>

Unreported ldquolegalrdquo business activity does not countThis is two-thirds of the ldquounderground economyrdquo

Then he has LASIK but the

surgeon doesnrsquot report $500 of his $3400 bill

And what if thiswaitress doesnrsquotreport all tips

And what if the dentist doesnrsquot report $400 forteeth whitening

Before LASIK Surgery

>

>

>

>

>

Illegal business activity because it goes unreported also

does not count Making up 13 of the ldquounderground economyrdquo also called the [ldquoblack marketrdquo] It includes murder for hire gambling drugs prostitution and money laundering

ldquoIda Hordquo

ldquoGive me the money inyour purse At least itwill not count in GDPrdquo

Money LaunderingMaking money illegally (drug money)and making it look like it was legallyearned (like buying a laundry mator car wash that deal in cash) and report it as legally earned

And what is money laundering

>

>

>

>

>

>

>

Self Employed $255

Other Legal $25Rents amp Royalties $30

Corporate Profits $50

Interest $55

Wages andSalaries $185

Drugs $120

Bribery $35Gambling andLoan Sharking $10Pornography $20

Fraud $30

Other I

llegal $

20

Prost

itutio

n $30

Sto

len

Goo

ds $

35

Illegal$300 B

Legal$600 B

What gets reported isthe ldquoAbove Groundrdquo

What doesnrsquot get reportedis the ldquoUndergroundrdquo

>

Work in your own household or volunteer work in the community does not count because there was no payment

You need to do some of

this housework

>

Work in your own household or volunteer work in the community does not count because there was no payment

So donrsquot marry your maid yardman or fitness instructor or you will hurt GDP

>

If U S corporations produce goods overseas it does not count in GDP but would count in GNPRemember we are measuring production insidethe US Imports represent production outside ofthe US

GM in France

Nike in Indonesia

>

___ ___ 1 New Toyota Tundra truck manufactured in San Antonio and sold to your economics teacher the year it was produced

___ ___ 2 You buy a new Wii at GameStop in 2009 Does it count if you resell it on eBay in March of 2010

On the next slide read each sentence and determineldquoTo Be or Not To Be Countedrdquo That is the question

If ldquoYesrdquo put ldquoYrdquo and tell if it is ldquoCrdquo ldquoIgrdquo ldquoGrdquo or ldquoXrdquo

If ldquoNordquo put ldquoNrdquo and give the number from below on why it is not counted in GDPGDP DOES NOT INCLUDE1 Second hand sales [no current production] [but the salesmanrsquos commission counts]2 PublicPrivate transfer payments [no current production]3 Purely financial transactions [no current production] [brokerrsquos fees do count]4 Intermediate goods [component of final good]5 US corporations producing overseas6 Non-market transactions [ household or volunteer work

Underground Economy [not reported]7 Illegal business activity [prostitution murder-for-hire illegal drugs etc]8 Unreported legal business activity [ldquooff the booksrdquo]

ExampleYC

1 N

___ ___ 1 You buy a purple ldquoTinky Winkyrdquo [produced in TX] from Wal-Mart___ ___ 2 You and your family paint your house [labor involved]___ ___ 3 You marry your housemaid [ldquoworking-for-loverdquo] [her services]___ ___ 4 You buy 100 shares of Microsoft Corporation___ ___ 5 You volunteer to babysit your little sister to help your parents while they work___ ___ 6 Bob buys a 1965 ford Mustang convertible in 2010 which is in mint condition___ ___ 7 The salesman gets a commission [pay] for selling that 1965 Ford Mustang in 2010___ ___ 8 You and your friend volunteer to cook at the senior class picnic___ ___ 9 Dr Payne does $1000 worth of dental work but reports only $500 of it

Does the $500 the dentist keeps and doesnrsquot report count___ ___ 10 You are given suitcase full of $100 bills from the sale of smuggled drugs___ ___ 11 Your mother is teaching you to read [amp not having much success]___ ___ 12 Your dad bakes you a home-baked loaf of bread [his labor]___ ___ 13 You buy a loaf of bread from Krogerrsquos Grocery Store___ ___ 14 The US government purchases 5 B-2 Bombers for $2 B each___ ___ 15 Ford buys a ton of sheet metal used in making car doors___ ___ 16 You buy a new ldquoiPad 2rdquo [produced in China] from the Apple store ___ ___ 17 You send in a $90 check to your dentist for cleaning your teeth___ ___ 18 Your family buys a new house next to the mansion of Bill Gates___ ___ 19 100 additional teachers are hired by the Frisco ISD___ ___ 20 GM invest in $500 million worth of robots to assemble their cars___ ___ 21 You volunteer 10 hours a week of your time to work for senior citizens___ ___ 22 Ford produces 25000 F150s in Denver which are not sold by the end of the year___ ___ 23 Russia buys 3000 Dell computers produced in NY as they become Rusky Dell Dudes___ ___ 24 A manrsquos wife does all his cooking and sewing working for him 16 hours per day___ ___ 25 Nike produces $10 million worth of Nike Air Jordanrsquos in Vietnam

YCN6N6N3N6N1YCN

8 NN7N6

6

N6YCYGN4N5YCYIgYGYIgN6YIgYXN6N5

1 2nd Hd sales2 Transfers3 Financial4 Intermediate5 Overseas6 Non-market7 Illegal8 Unreported

bull Gross Domestic ProductGDP= C +I+G+Xn = Consumption + Investment +Government

Spending+ Net Exports [(all exports) X-M (all imports)]bull Net Domestic Product (your value-what you could sell if ya

had to)

NDP= GDP- Depreciation (the loss of value over time- replacement cost)

bull National IncomeNI= NDP +NFFIEUS-Statistical Discrepancy Net Foreign Factor Income earned in USbull Personal Income (what you can pay in taxes spend or save)

PI= NI- Undistributed Corporate ProfitsndashCorporate Income Taxes -Social Security-Taxes on production amp iMports +Transfer Payments

bull Disposable Income (what you can spend or save)

DI= PI- personal income taxes

National Income Accounting

U Can See The Toilet Paper

NDP NI PIDIG

DP

>

- Personnel Taxes-$1102

$10 089[ldquoCrdquo]

Consumption[66]

$12392

[births-deaths]

ldquoAvailablefor salerdquo

$12026

PI is what we can spend save

or pay in taxes

ldquoIncome received by

householdswhether earned orunearnedrdquo

$10924

DIis what we can

SPENDor

SAVE

Y receivednot earned

Y earnednot received

GDPGross Domestic Product

$14256

NDPNational Domestic Product

$12392

NINational Income

$12288

PIPersonal income

$12026

DIDisposable Income

$10924

Gross PrivateDomestic Investment

$1 628GovernmentPurchases

$2931

Xn(X-M) -$392

-Depreciation[Replacement Cap]

$1864

$12288

ldquoIncome earnedby US resourcesrdquoplus taxes on pro-duction amp imports

-Statistical Discrep

$209[to make the income approach match the

expenditure approach]

+NFFI$105

+$2528 Trans Pay

-$418 Undis Cor Pro-$315 Corp Inc Tax -$967Soc Sec Con

-1090 Taxes on proamp M

ROW[$264]

US [$159]

NFFI = $105

ldquoU Can See The ToiletPaperrdquo

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Purely Financial Transactions ndash stocks bonds CDs There is no current production Ex If 100 shares of Dell stock is bought

Irsquom not buying a Dell computerbut part ownership of Dell

Exchanging one financial asset for anotherThis represents transfer of ownership fromone shareholder to another[swapping bits of paper]

Buying stock is not buying a product but buying ownership of the firm Buying bonds is making a loan

>

>

A Public Transfer Paymentsndashwelfare unemployment social security [There is no contribution to final production]

ldquoNow that Irsquove gotten my welfare check I can get a white iPad 2rdquo

B Private Transfer Payments like your parents giving you $250 cash for Christmas or - $100 for making an ldquoArdquo in economics [Just transferring funds from one private individual to another private individual]

>

Unreported ldquolegalrdquo business activity does not countThis is two-thirds of the ldquounderground economyrdquo

Then he has LASIK but the

surgeon doesnrsquot report $500 of his $3400 bill

And what if thiswaitress doesnrsquotreport all tips

And what if the dentist doesnrsquot report $400 forteeth whitening

Before LASIK Surgery

>

>

>

>

>

Illegal business activity because it goes unreported also

does not count Making up 13 of the ldquounderground economyrdquo also called the [ldquoblack marketrdquo] It includes murder for hire gambling drugs prostitution and money laundering

ldquoIda Hordquo

ldquoGive me the money inyour purse At least itwill not count in GDPrdquo

Money LaunderingMaking money illegally (drug money)and making it look like it was legallyearned (like buying a laundry mator car wash that deal in cash) and report it as legally earned

And what is money laundering

>

>

>

>

>

>

>

Self Employed $255

Other Legal $25Rents amp Royalties $30

Corporate Profits $50

Interest $55

Wages andSalaries $185

Drugs $120

Bribery $35Gambling andLoan Sharking $10Pornography $20

Fraud $30

Other I

llegal $

20

Prost

itutio

n $30

Sto

len

Goo

ds $

35

Illegal$300 B

Legal$600 B

What gets reported isthe ldquoAbove Groundrdquo

What doesnrsquot get reportedis the ldquoUndergroundrdquo

>

Work in your own household or volunteer work in the community does not count because there was no payment

You need to do some of

this housework

>

Work in your own household or volunteer work in the community does not count because there was no payment

So donrsquot marry your maid yardman or fitness instructor or you will hurt GDP

>

If U S corporations produce goods overseas it does not count in GDP but would count in GNPRemember we are measuring production insidethe US Imports represent production outside ofthe US

GM in France

Nike in Indonesia

>

___ ___ 1 New Toyota Tundra truck manufactured in San Antonio and sold to your economics teacher the year it was produced

___ ___ 2 You buy a new Wii at GameStop in 2009 Does it count if you resell it on eBay in March of 2010

On the next slide read each sentence and determineldquoTo Be or Not To Be Countedrdquo That is the question

If ldquoYesrdquo put ldquoYrdquo and tell if it is ldquoCrdquo ldquoIgrdquo ldquoGrdquo or ldquoXrdquo

If ldquoNordquo put ldquoNrdquo and give the number from below on why it is not counted in GDPGDP DOES NOT INCLUDE1 Second hand sales [no current production] [but the salesmanrsquos commission counts]2 PublicPrivate transfer payments [no current production]3 Purely financial transactions [no current production] [brokerrsquos fees do count]4 Intermediate goods [component of final good]5 US corporations producing overseas6 Non-market transactions [ household or volunteer work

Underground Economy [not reported]7 Illegal business activity [prostitution murder-for-hire illegal drugs etc]8 Unreported legal business activity [ldquooff the booksrdquo]

ExampleYC

1 N

___ ___ 1 You buy a purple ldquoTinky Winkyrdquo [produced in TX] from Wal-Mart___ ___ 2 You and your family paint your house [labor involved]___ ___ 3 You marry your housemaid [ldquoworking-for-loverdquo] [her services]___ ___ 4 You buy 100 shares of Microsoft Corporation___ ___ 5 You volunteer to babysit your little sister to help your parents while they work___ ___ 6 Bob buys a 1965 ford Mustang convertible in 2010 which is in mint condition___ ___ 7 The salesman gets a commission [pay] for selling that 1965 Ford Mustang in 2010___ ___ 8 You and your friend volunteer to cook at the senior class picnic___ ___ 9 Dr Payne does $1000 worth of dental work but reports only $500 of it

Does the $500 the dentist keeps and doesnrsquot report count___ ___ 10 You are given suitcase full of $100 bills from the sale of smuggled drugs___ ___ 11 Your mother is teaching you to read [amp not having much success]___ ___ 12 Your dad bakes you a home-baked loaf of bread [his labor]___ ___ 13 You buy a loaf of bread from Krogerrsquos Grocery Store___ ___ 14 The US government purchases 5 B-2 Bombers for $2 B each___ ___ 15 Ford buys a ton of sheet metal used in making car doors___ ___ 16 You buy a new ldquoiPad 2rdquo [produced in China] from the Apple store ___ ___ 17 You send in a $90 check to your dentist for cleaning your teeth___ ___ 18 Your family buys a new house next to the mansion of Bill Gates___ ___ 19 100 additional teachers are hired by the Frisco ISD___ ___ 20 GM invest in $500 million worth of robots to assemble their cars___ ___ 21 You volunteer 10 hours a week of your time to work for senior citizens___ ___ 22 Ford produces 25000 F150s in Denver which are not sold by the end of the year___ ___ 23 Russia buys 3000 Dell computers produced in NY as they become Rusky Dell Dudes___ ___ 24 A manrsquos wife does all his cooking and sewing working for him 16 hours per day___ ___ 25 Nike produces $10 million worth of Nike Air Jordanrsquos in Vietnam

YCN6N6N3N6N1YCN

8 NN7N6

6

N6YCYGN4N5YCYIgYGYIgN6YIgYXN6N5

1 2nd Hd sales2 Transfers3 Financial4 Intermediate5 Overseas6 Non-market7 Illegal8 Unreported

bull Gross Domestic ProductGDP= C +I+G+Xn = Consumption + Investment +Government

Spending+ Net Exports [(all exports) X-M (all imports)]bull Net Domestic Product (your value-what you could sell if ya

had to)

NDP= GDP- Depreciation (the loss of value over time- replacement cost)

bull National IncomeNI= NDP +NFFIEUS-Statistical Discrepancy Net Foreign Factor Income earned in USbull Personal Income (what you can pay in taxes spend or save)

PI= NI- Undistributed Corporate ProfitsndashCorporate Income Taxes -Social Security-Taxes on production amp iMports +Transfer Payments

bull Disposable Income (what you can spend or save)

DI= PI- personal income taxes

National Income Accounting

U Can See The Toilet Paper

NDP NI PIDIG

DP

>

- Personnel Taxes-$1102

$10 089[ldquoCrdquo]

Consumption[66]

$12392

[births-deaths]

ldquoAvailablefor salerdquo

$12026

PI is what we can spend save

or pay in taxes

ldquoIncome received by

householdswhether earned orunearnedrdquo

$10924

DIis what we can

SPENDor

SAVE

Y receivednot earned

Y earnednot received

GDPGross Domestic Product

$14256

NDPNational Domestic Product

$12392

NINational Income

$12288

PIPersonal income

$12026

DIDisposable Income

$10924

Gross PrivateDomestic Investment

$1 628GovernmentPurchases

$2931

Xn(X-M) -$392

-Depreciation[Replacement Cap]

$1864

$12288

ldquoIncome earnedby US resourcesrdquoplus taxes on pro-duction amp imports

-Statistical Discrep

$209[to make the income approach match the

expenditure approach]

+NFFI$105

+$2528 Trans Pay

-$418 Undis Cor Pro-$315 Corp Inc Tax -$967Soc Sec Con

-1090 Taxes on proamp M

ROW[$264]

US [$159]

NFFI = $105

ldquoU Can See The ToiletPaperrdquo

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

A Public Transfer Paymentsndashwelfare unemployment social security [There is no contribution to final production]

ldquoNow that Irsquove gotten my welfare check I can get a white iPad 2rdquo

B Private Transfer Payments like your parents giving you $250 cash for Christmas or - $100 for making an ldquoArdquo in economics [Just transferring funds from one private individual to another private individual]

>

Unreported ldquolegalrdquo business activity does not countThis is two-thirds of the ldquounderground economyrdquo

Then he has LASIK but the

surgeon doesnrsquot report $500 of his $3400 bill

And what if thiswaitress doesnrsquotreport all tips

And what if the dentist doesnrsquot report $400 forteeth whitening

Before LASIK Surgery

>

>

>

>

>

Illegal business activity because it goes unreported also

does not count Making up 13 of the ldquounderground economyrdquo also called the [ldquoblack marketrdquo] It includes murder for hire gambling drugs prostitution and money laundering

ldquoIda Hordquo

ldquoGive me the money inyour purse At least itwill not count in GDPrdquo

Money LaunderingMaking money illegally (drug money)and making it look like it was legallyearned (like buying a laundry mator car wash that deal in cash) and report it as legally earned

And what is money laundering

>

>

>

>

>

>

>

Self Employed $255

Other Legal $25Rents amp Royalties $30

Corporate Profits $50

Interest $55

Wages andSalaries $185

Drugs $120

Bribery $35Gambling andLoan Sharking $10Pornography $20

Fraud $30

Other I

llegal $

20

Prost

itutio

n $30

Sto

len

Goo

ds $

35

Illegal$300 B

Legal$600 B

What gets reported isthe ldquoAbove Groundrdquo

What doesnrsquot get reportedis the ldquoUndergroundrdquo

>

Work in your own household or volunteer work in the community does not count because there was no payment

You need to do some of

this housework

>

Work in your own household or volunteer work in the community does not count because there was no payment

So donrsquot marry your maid yardman or fitness instructor or you will hurt GDP

>

If U S corporations produce goods overseas it does not count in GDP but would count in GNPRemember we are measuring production insidethe US Imports represent production outside ofthe US

GM in France

Nike in Indonesia

>

___ ___ 1 New Toyota Tundra truck manufactured in San Antonio and sold to your economics teacher the year it was produced

___ ___ 2 You buy a new Wii at GameStop in 2009 Does it count if you resell it on eBay in March of 2010

On the next slide read each sentence and determineldquoTo Be or Not To Be Countedrdquo That is the question

If ldquoYesrdquo put ldquoYrdquo and tell if it is ldquoCrdquo ldquoIgrdquo ldquoGrdquo or ldquoXrdquo

If ldquoNordquo put ldquoNrdquo and give the number from below on why it is not counted in GDPGDP DOES NOT INCLUDE1 Second hand sales [no current production] [but the salesmanrsquos commission counts]2 PublicPrivate transfer payments [no current production]3 Purely financial transactions [no current production] [brokerrsquos fees do count]4 Intermediate goods [component of final good]5 US corporations producing overseas6 Non-market transactions [ household or volunteer work

Underground Economy [not reported]7 Illegal business activity [prostitution murder-for-hire illegal drugs etc]8 Unreported legal business activity [ldquooff the booksrdquo]

ExampleYC

1 N

___ ___ 1 You buy a purple ldquoTinky Winkyrdquo [produced in TX] from Wal-Mart___ ___ 2 You and your family paint your house [labor involved]___ ___ 3 You marry your housemaid [ldquoworking-for-loverdquo] [her services]___ ___ 4 You buy 100 shares of Microsoft Corporation___ ___ 5 You volunteer to babysit your little sister to help your parents while they work___ ___ 6 Bob buys a 1965 ford Mustang convertible in 2010 which is in mint condition___ ___ 7 The salesman gets a commission [pay] for selling that 1965 Ford Mustang in 2010___ ___ 8 You and your friend volunteer to cook at the senior class picnic___ ___ 9 Dr Payne does $1000 worth of dental work but reports only $500 of it

Does the $500 the dentist keeps and doesnrsquot report count___ ___ 10 You are given suitcase full of $100 bills from the sale of smuggled drugs___ ___ 11 Your mother is teaching you to read [amp not having much success]___ ___ 12 Your dad bakes you a home-baked loaf of bread [his labor]___ ___ 13 You buy a loaf of bread from Krogerrsquos Grocery Store___ ___ 14 The US government purchases 5 B-2 Bombers for $2 B each___ ___ 15 Ford buys a ton of sheet metal used in making car doors___ ___ 16 You buy a new ldquoiPad 2rdquo [produced in China] from the Apple store ___ ___ 17 You send in a $90 check to your dentist for cleaning your teeth___ ___ 18 Your family buys a new house next to the mansion of Bill Gates___ ___ 19 100 additional teachers are hired by the Frisco ISD___ ___ 20 GM invest in $500 million worth of robots to assemble their cars___ ___ 21 You volunteer 10 hours a week of your time to work for senior citizens___ ___ 22 Ford produces 25000 F150s in Denver which are not sold by the end of the year___ ___ 23 Russia buys 3000 Dell computers produced in NY as they become Rusky Dell Dudes___ ___ 24 A manrsquos wife does all his cooking and sewing working for him 16 hours per day___ ___ 25 Nike produces $10 million worth of Nike Air Jordanrsquos in Vietnam

YCN6N6N3N6N1YCN

8 NN7N6

6

N6YCYGN4N5YCYIgYGYIgN6YIgYXN6N5

1 2nd Hd sales2 Transfers3 Financial4 Intermediate5 Overseas6 Non-market7 Illegal8 Unreported

bull Gross Domestic ProductGDP= C +I+G+Xn = Consumption + Investment +Government

Spending+ Net Exports [(all exports) X-M (all imports)]bull Net Domestic Product (your value-what you could sell if ya

had to)

NDP= GDP- Depreciation (the loss of value over time- replacement cost)

bull National IncomeNI= NDP +NFFIEUS-Statistical Discrepancy Net Foreign Factor Income earned in USbull Personal Income (what you can pay in taxes spend or save)

PI= NI- Undistributed Corporate ProfitsndashCorporate Income Taxes -Social Security-Taxes on production amp iMports +Transfer Payments

bull Disposable Income (what you can spend or save)

DI= PI- personal income taxes

National Income Accounting

U Can See The Toilet Paper

NDP NI PIDIG

DP

>

- Personnel Taxes-$1102

$10 089[ldquoCrdquo]

Consumption[66]

$12392

[births-deaths]

ldquoAvailablefor salerdquo

$12026

PI is what we can spend save

or pay in taxes

ldquoIncome received by

householdswhether earned orunearnedrdquo

$10924

DIis what we can

SPENDor

SAVE

Y receivednot earned

Y earnednot received

GDPGross Domestic Product

$14256

NDPNational Domestic Product

$12392

NINational Income

$12288

PIPersonal income

$12026

DIDisposable Income

$10924

Gross PrivateDomestic Investment

$1 628GovernmentPurchases

$2931

Xn(X-M) -$392

-Depreciation[Replacement Cap]

$1864

$12288

ldquoIncome earnedby US resourcesrdquoplus taxes on pro-duction amp imports

-Statistical Discrep

$209[to make the income approach match the

expenditure approach]

+NFFI$105

+$2528 Trans Pay

-$418 Undis Cor Pro-$315 Corp Inc Tax -$967Soc Sec Con

-1090 Taxes on proamp M

ROW[$264]

US [$159]

NFFI = $105

ldquoU Can See The ToiletPaperrdquo

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Unreported ldquolegalrdquo business activity does not countThis is two-thirds of the ldquounderground economyrdquo

Then he has LASIK but the

surgeon doesnrsquot report $500 of his $3400 bill

And what if thiswaitress doesnrsquotreport all tips

And what if the dentist doesnrsquot report $400 forteeth whitening

Before LASIK Surgery

>

>

>

>

>

Illegal business activity because it goes unreported also

does not count Making up 13 of the ldquounderground economyrdquo also called the [ldquoblack marketrdquo] It includes murder for hire gambling drugs prostitution and money laundering

ldquoIda Hordquo

ldquoGive me the money inyour purse At least itwill not count in GDPrdquo

Money LaunderingMaking money illegally (drug money)and making it look like it was legallyearned (like buying a laundry mator car wash that deal in cash) and report it as legally earned

And what is money laundering

>

>

>

>

>

>

>

Self Employed $255

Other Legal $25Rents amp Royalties $30

Corporate Profits $50

Interest $55

Wages andSalaries $185

Drugs $120

Bribery $35Gambling andLoan Sharking $10Pornography $20

Fraud $30

Other I

llegal $

20

Prost

itutio

n $30

Sto

len

Goo

ds $

35

Illegal$300 B

Legal$600 B

What gets reported isthe ldquoAbove Groundrdquo

What doesnrsquot get reportedis the ldquoUndergroundrdquo

>

Work in your own household or volunteer work in the community does not count because there was no payment

You need to do some of

this housework

>

Work in your own household or volunteer work in the community does not count because there was no payment

So donrsquot marry your maid yardman or fitness instructor or you will hurt GDP

>

If U S corporations produce goods overseas it does not count in GDP but would count in GNPRemember we are measuring production insidethe US Imports represent production outside ofthe US

GM in France

Nike in Indonesia

>

___ ___ 1 New Toyota Tundra truck manufactured in San Antonio and sold to your economics teacher the year it was produced

___ ___ 2 You buy a new Wii at GameStop in 2009 Does it count if you resell it on eBay in March of 2010

On the next slide read each sentence and determineldquoTo Be or Not To Be Countedrdquo That is the question

If ldquoYesrdquo put ldquoYrdquo and tell if it is ldquoCrdquo ldquoIgrdquo ldquoGrdquo or ldquoXrdquo

If ldquoNordquo put ldquoNrdquo and give the number from below on why it is not counted in GDPGDP DOES NOT INCLUDE1 Second hand sales [no current production] [but the salesmanrsquos commission counts]2 PublicPrivate transfer payments [no current production]3 Purely financial transactions [no current production] [brokerrsquos fees do count]4 Intermediate goods [component of final good]5 US corporations producing overseas6 Non-market transactions [ household or volunteer work

Underground Economy [not reported]7 Illegal business activity [prostitution murder-for-hire illegal drugs etc]8 Unreported legal business activity [ldquooff the booksrdquo]

ExampleYC

1 N

___ ___ 1 You buy a purple ldquoTinky Winkyrdquo [produced in TX] from Wal-Mart___ ___ 2 You and your family paint your house [labor involved]___ ___ 3 You marry your housemaid [ldquoworking-for-loverdquo] [her services]___ ___ 4 You buy 100 shares of Microsoft Corporation___ ___ 5 You volunteer to babysit your little sister to help your parents while they work___ ___ 6 Bob buys a 1965 ford Mustang convertible in 2010 which is in mint condition___ ___ 7 The salesman gets a commission [pay] for selling that 1965 Ford Mustang in 2010___ ___ 8 You and your friend volunteer to cook at the senior class picnic___ ___ 9 Dr Payne does $1000 worth of dental work but reports only $500 of it

Does the $500 the dentist keeps and doesnrsquot report count___ ___ 10 You are given suitcase full of $100 bills from the sale of smuggled drugs___ ___ 11 Your mother is teaching you to read [amp not having much success]___ ___ 12 Your dad bakes you a home-baked loaf of bread [his labor]___ ___ 13 You buy a loaf of bread from Krogerrsquos Grocery Store___ ___ 14 The US government purchases 5 B-2 Bombers for $2 B each___ ___ 15 Ford buys a ton of sheet metal used in making car doors___ ___ 16 You buy a new ldquoiPad 2rdquo [produced in China] from the Apple store ___ ___ 17 You send in a $90 check to your dentist for cleaning your teeth___ ___ 18 Your family buys a new house next to the mansion of Bill Gates___ ___ 19 100 additional teachers are hired by the Frisco ISD___ ___ 20 GM invest in $500 million worth of robots to assemble their cars___ ___ 21 You volunteer 10 hours a week of your time to work for senior citizens___ ___ 22 Ford produces 25000 F150s in Denver which are not sold by the end of the year___ ___ 23 Russia buys 3000 Dell computers produced in NY as they become Rusky Dell Dudes___ ___ 24 A manrsquos wife does all his cooking and sewing working for him 16 hours per day___ ___ 25 Nike produces $10 million worth of Nike Air Jordanrsquos in Vietnam

YCN6N6N3N6N1YCN

8 NN7N6

6

N6YCYGN4N5YCYIgYGYIgN6YIgYXN6N5

1 2nd Hd sales2 Transfers3 Financial4 Intermediate5 Overseas6 Non-market7 Illegal8 Unreported

bull Gross Domestic ProductGDP= C +I+G+Xn = Consumption + Investment +Government

Spending+ Net Exports [(all exports) X-M (all imports)]bull Net Domestic Product (your value-what you could sell if ya

had to)

NDP= GDP- Depreciation (the loss of value over time- replacement cost)

bull National IncomeNI= NDP +NFFIEUS-Statistical Discrepancy Net Foreign Factor Income earned in USbull Personal Income (what you can pay in taxes spend or save)

PI= NI- Undistributed Corporate ProfitsndashCorporate Income Taxes -Social Security-Taxes on production amp iMports +Transfer Payments

bull Disposable Income (what you can spend or save)

DI= PI- personal income taxes

National Income Accounting

U Can See The Toilet Paper

NDP NI PIDIG

DP

>

- Personnel Taxes-$1102

$10 089[ldquoCrdquo]

Consumption[66]

$12392

[births-deaths]

ldquoAvailablefor salerdquo

$12026

PI is what we can spend save

or pay in taxes

ldquoIncome received by

householdswhether earned orunearnedrdquo

$10924

DIis what we can

SPENDor

SAVE

Y receivednot earned

Y earnednot received

GDPGross Domestic Product

$14256

NDPNational Domestic Product

$12392

NINational Income

$12288

PIPersonal income

$12026

DIDisposable Income

$10924

Gross PrivateDomestic Investment

$1 628GovernmentPurchases

$2931

Xn(X-M) -$392

-Depreciation[Replacement Cap]

$1864

$12288

ldquoIncome earnedby US resourcesrdquoplus taxes on pro-duction amp imports

-Statistical Discrep

$209[to make the income approach match the

expenditure approach]

+NFFI$105

+$2528 Trans Pay

-$418 Undis Cor Pro-$315 Corp Inc Tax -$967Soc Sec Con

-1090 Taxes on proamp M

ROW[$264]

US [$159]

NFFI = $105

ldquoU Can See The ToiletPaperrdquo

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Illegal business activity because it goes unreported also

does not count Making up 13 of the ldquounderground economyrdquo also called the [ldquoblack marketrdquo] It includes murder for hire gambling drugs prostitution and money laundering

ldquoIda Hordquo

ldquoGive me the money inyour purse At least itwill not count in GDPrdquo

Money LaunderingMaking money illegally (drug money)and making it look like it was legallyearned (like buying a laundry mator car wash that deal in cash) and report it as legally earned

And what is money laundering

>

>

>

>

>

>

>

Self Employed $255

Other Legal $25Rents amp Royalties $30

Corporate Profits $50

Interest $55

Wages andSalaries $185

Drugs $120

Bribery $35Gambling andLoan Sharking $10Pornography $20

Fraud $30

Other I

llegal $

20

Prost

itutio

n $30

Sto

len

Goo

ds $

35

Illegal$300 B

Legal$600 B

What gets reported isthe ldquoAbove Groundrdquo

What doesnrsquot get reportedis the ldquoUndergroundrdquo

>

Work in your own household or volunteer work in the community does not count because there was no payment

You need to do some of

this housework

>

Work in your own household or volunteer work in the community does not count because there was no payment

So donrsquot marry your maid yardman or fitness instructor or you will hurt GDP

>

If U S corporations produce goods overseas it does not count in GDP but would count in GNPRemember we are measuring production insidethe US Imports represent production outside ofthe US

GM in France

Nike in Indonesia

>

___ ___ 1 New Toyota Tundra truck manufactured in San Antonio and sold to your economics teacher the year it was produced

___ ___ 2 You buy a new Wii at GameStop in 2009 Does it count if you resell it on eBay in March of 2010

On the next slide read each sentence and determineldquoTo Be or Not To Be Countedrdquo That is the question

If ldquoYesrdquo put ldquoYrdquo and tell if it is ldquoCrdquo ldquoIgrdquo ldquoGrdquo or ldquoXrdquo

If ldquoNordquo put ldquoNrdquo and give the number from below on why it is not counted in GDPGDP DOES NOT INCLUDE1 Second hand sales [no current production] [but the salesmanrsquos commission counts]2 PublicPrivate transfer payments [no current production]3 Purely financial transactions [no current production] [brokerrsquos fees do count]4 Intermediate goods [component of final good]5 US corporations producing overseas6 Non-market transactions [ household or volunteer work

Underground Economy [not reported]7 Illegal business activity [prostitution murder-for-hire illegal drugs etc]8 Unreported legal business activity [ldquooff the booksrdquo]

ExampleYC

1 N

___ ___ 1 You buy a purple ldquoTinky Winkyrdquo [produced in TX] from Wal-Mart___ ___ 2 You and your family paint your house [labor involved]___ ___ 3 You marry your housemaid [ldquoworking-for-loverdquo] [her services]___ ___ 4 You buy 100 shares of Microsoft Corporation___ ___ 5 You volunteer to babysit your little sister to help your parents while they work___ ___ 6 Bob buys a 1965 ford Mustang convertible in 2010 which is in mint condition___ ___ 7 The salesman gets a commission [pay] for selling that 1965 Ford Mustang in 2010___ ___ 8 You and your friend volunteer to cook at the senior class picnic___ ___ 9 Dr Payne does $1000 worth of dental work but reports only $500 of it

Does the $500 the dentist keeps and doesnrsquot report count___ ___ 10 You are given suitcase full of $100 bills from the sale of smuggled drugs___ ___ 11 Your mother is teaching you to read [amp not having much success]___ ___ 12 Your dad bakes you a home-baked loaf of bread [his labor]___ ___ 13 You buy a loaf of bread from Krogerrsquos Grocery Store___ ___ 14 The US government purchases 5 B-2 Bombers for $2 B each___ ___ 15 Ford buys a ton of sheet metal used in making car doors___ ___ 16 You buy a new ldquoiPad 2rdquo [produced in China] from the Apple store ___ ___ 17 You send in a $90 check to your dentist for cleaning your teeth___ ___ 18 Your family buys a new house next to the mansion of Bill Gates___ ___ 19 100 additional teachers are hired by the Frisco ISD___ ___ 20 GM invest in $500 million worth of robots to assemble their cars___ ___ 21 You volunteer 10 hours a week of your time to work for senior citizens___ ___ 22 Ford produces 25000 F150s in Denver which are not sold by the end of the year___ ___ 23 Russia buys 3000 Dell computers produced in NY as they become Rusky Dell Dudes___ ___ 24 A manrsquos wife does all his cooking and sewing working for him 16 hours per day___ ___ 25 Nike produces $10 million worth of Nike Air Jordanrsquos in Vietnam

YCN6N6N3N6N1YCN

8 NN7N6

6

N6YCYGN4N5YCYIgYGYIgN6YIgYXN6N5

1 2nd Hd sales2 Transfers3 Financial4 Intermediate5 Overseas6 Non-market7 Illegal8 Unreported

bull Gross Domestic ProductGDP= C +I+G+Xn = Consumption + Investment +Government

Spending+ Net Exports [(all exports) X-M (all imports)]bull Net Domestic Product (your value-what you could sell if ya

had to)

NDP= GDP- Depreciation (the loss of value over time- replacement cost)

bull National IncomeNI= NDP +NFFIEUS-Statistical Discrepancy Net Foreign Factor Income earned in USbull Personal Income (what you can pay in taxes spend or save)

PI= NI- Undistributed Corporate ProfitsndashCorporate Income Taxes -Social Security-Taxes on production amp iMports +Transfer Payments

bull Disposable Income (what you can spend or save)

DI= PI- personal income taxes

National Income Accounting

U Can See The Toilet Paper

NDP NI PIDIG

DP

>

- Personnel Taxes-$1102

$10 089[ldquoCrdquo]

Consumption[66]

$12392

[births-deaths]

ldquoAvailablefor salerdquo

$12026

PI is what we can spend save

or pay in taxes

ldquoIncome received by

householdswhether earned orunearnedrdquo

$10924

DIis what we can

SPENDor

SAVE

Y receivednot earned

Y earnednot received

GDPGross Domestic Product

$14256

NDPNational Domestic Product

$12392

NINational Income

$12288

PIPersonal income

$12026

DIDisposable Income

$10924

Gross PrivateDomestic Investment

$1 628GovernmentPurchases

$2931

Xn(X-M) -$392

-Depreciation[Replacement Cap]

$1864

$12288

ldquoIncome earnedby US resourcesrdquoplus taxes on pro-duction amp imports

-Statistical Discrep

$209[to make the income approach match the

expenditure approach]

+NFFI$105

+$2528 Trans Pay

-$418 Undis Cor Pro-$315 Corp Inc Tax -$967Soc Sec Con

-1090 Taxes on proamp M

ROW[$264]

US [$159]

NFFI = $105

ldquoU Can See The ToiletPaperrdquo

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Self Employed $255

Other Legal $25Rents amp Royalties $30

Corporate Profits $50

Interest $55

Wages andSalaries $185

Drugs $120

Bribery $35Gambling andLoan Sharking $10Pornography $20

Fraud $30

Other I

llegal $

20

Prost

itutio

n $30

Sto

len

Goo

ds $

35

Illegal$300 B

Legal$600 B

What gets reported isthe ldquoAbove Groundrdquo

What doesnrsquot get reportedis the ldquoUndergroundrdquo

>

Work in your own household or volunteer work in the community does not count because there was no payment

You need to do some of

this housework

>

Work in your own household or volunteer work in the community does not count because there was no payment

So donrsquot marry your maid yardman or fitness instructor or you will hurt GDP

>

If U S corporations produce goods overseas it does not count in GDP but would count in GNPRemember we are measuring production insidethe US Imports represent production outside ofthe US

GM in France

Nike in Indonesia

>

___ ___ 1 New Toyota Tundra truck manufactured in San Antonio and sold to your economics teacher the year it was produced

___ ___ 2 You buy a new Wii at GameStop in 2009 Does it count if you resell it on eBay in March of 2010

On the next slide read each sentence and determineldquoTo Be or Not To Be Countedrdquo That is the question

If ldquoYesrdquo put ldquoYrdquo and tell if it is ldquoCrdquo ldquoIgrdquo ldquoGrdquo or ldquoXrdquo

If ldquoNordquo put ldquoNrdquo and give the number from below on why it is not counted in GDPGDP DOES NOT INCLUDE1 Second hand sales [no current production] [but the salesmanrsquos commission counts]2 PublicPrivate transfer payments [no current production]3 Purely financial transactions [no current production] [brokerrsquos fees do count]4 Intermediate goods [component of final good]5 US corporations producing overseas6 Non-market transactions [ household or volunteer work

Underground Economy [not reported]7 Illegal business activity [prostitution murder-for-hire illegal drugs etc]8 Unreported legal business activity [ldquooff the booksrdquo]

ExampleYC

1 N

___ ___ 1 You buy a purple ldquoTinky Winkyrdquo [produced in TX] from Wal-Mart___ ___ 2 You and your family paint your house [labor involved]___ ___ 3 You marry your housemaid [ldquoworking-for-loverdquo] [her services]___ ___ 4 You buy 100 shares of Microsoft Corporation___ ___ 5 You volunteer to babysit your little sister to help your parents while they work___ ___ 6 Bob buys a 1965 ford Mustang convertible in 2010 which is in mint condition___ ___ 7 The salesman gets a commission [pay] for selling that 1965 Ford Mustang in 2010___ ___ 8 You and your friend volunteer to cook at the senior class picnic___ ___ 9 Dr Payne does $1000 worth of dental work but reports only $500 of it

Does the $500 the dentist keeps and doesnrsquot report count___ ___ 10 You are given suitcase full of $100 bills from the sale of smuggled drugs___ ___ 11 Your mother is teaching you to read [amp not having much success]___ ___ 12 Your dad bakes you a home-baked loaf of bread [his labor]___ ___ 13 You buy a loaf of bread from Krogerrsquos Grocery Store___ ___ 14 The US government purchases 5 B-2 Bombers for $2 B each___ ___ 15 Ford buys a ton of sheet metal used in making car doors___ ___ 16 You buy a new ldquoiPad 2rdquo [produced in China] from the Apple store ___ ___ 17 You send in a $90 check to your dentist for cleaning your teeth___ ___ 18 Your family buys a new house next to the mansion of Bill Gates___ ___ 19 100 additional teachers are hired by the Frisco ISD___ ___ 20 GM invest in $500 million worth of robots to assemble their cars___ ___ 21 You volunteer 10 hours a week of your time to work for senior citizens___ ___ 22 Ford produces 25000 F150s in Denver which are not sold by the end of the year___ ___ 23 Russia buys 3000 Dell computers produced in NY as they become Rusky Dell Dudes___ ___ 24 A manrsquos wife does all his cooking and sewing working for him 16 hours per day___ ___ 25 Nike produces $10 million worth of Nike Air Jordanrsquos in Vietnam

YCN6N6N3N6N1YCN

8 NN7N6

6

N6YCYGN4N5YCYIgYGYIgN6YIgYXN6N5

1 2nd Hd sales2 Transfers3 Financial4 Intermediate5 Overseas6 Non-market7 Illegal8 Unreported

bull Gross Domestic ProductGDP= C +I+G+Xn = Consumption + Investment +Government

Spending+ Net Exports [(all exports) X-M (all imports)]bull Net Domestic Product (your value-what you could sell if ya

had to)

NDP= GDP- Depreciation (the loss of value over time- replacement cost)

bull National IncomeNI= NDP +NFFIEUS-Statistical Discrepancy Net Foreign Factor Income earned in USbull Personal Income (what you can pay in taxes spend or save)

PI= NI- Undistributed Corporate ProfitsndashCorporate Income Taxes -Social Security-Taxes on production amp iMports +Transfer Payments

bull Disposable Income (what you can spend or save)

DI= PI- personal income taxes

National Income Accounting

U Can See The Toilet Paper

NDP NI PIDIG

DP

>

- Personnel Taxes-$1102

$10 089[ldquoCrdquo]

Consumption[66]

$12392

[births-deaths]

ldquoAvailablefor salerdquo

$12026

PI is what we can spend save

or pay in taxes

ldquoIncome received by

householdswhether earned orunearnedrdquo

$10924

DIis what we can

SPENDor

SAVE

Y receivednot earned

Y earnednot received

GDPGross Domestic Product

$14256

NDPNational Domestic Product

$12392

NINational Income

$12288

PIPersonal income

$12026

DIDisposable Income

$10924

Gross PrivateDomestic Investment

$1 628GovernmentPurchases

$2931

Xn(X-M) -$392

-Depreciation[Replacement Cap]

$1864

$12288

ldquoIncome earnedby US resourcesrdquoplus taxes on pro-duction amp imports

-Statistical Discrep

$209[to make the income approach match the

expenditure approach]

+NFFI$105

+$2528 Trans Pay

-$418 Undis Cor Pro-$315 Corp Inc Tax -$967Soc Sec Con

-1090 Taxes on proamp M

ROW[$264]

US [$159]

NFFI = $105

ldquoU Can See The ToiletPaperrdquo

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Work in your own household or volunteer work in the community does not count because there was no payment

You need to do some of

this housework

>

Work in your own household or volunteer work in the community does not count because there was no payment

So donrsquot marry your maid yardman or fitness instructor or you will hurt GDP

>

If U S corporations produce goods overseas it does not count in GDP but would count in GNPRemember we are measuring production insidethe US Imports represent production outside ofthe US

GM in France

Nike in Indonesia

>

___ ___ 1 New Toyota Tundra truck manufactured in San Antonio and sold to your economics teacher the year it was produced

___ ___ 2 You buy a new Wii at GameStop in 2009 Does it count if you resell it on eBay in March of 2010

On the next slide read each sentence and determineldquoTo Be or Not To Be Countedrdquo That is the question

If ldquoYesrdquo put ldquoYrdquo and tell if it is ldquoCrdquo ldquoIgrdquo ldquoGrdquo or ldquoXrdquo

If ldquoNordquo put ldquoNrdquo and give the number from below on why it is not counted in GDPGDP DOES NOT INCLUDE1 Second hand sales [no current production] [but the salesmanrsquos commission counts]2 PublicPrivate transfer payments [no current production]3 Purely financial transactions [no current production] [brokerrsquos fees do count]4 Intermediate goods [component of final good]5 US corporations producing overseas6 Non-market transactions [ household or volunteer work

Underground Economy [not reported]7 Illegal business activity [prostitution murder-for-hire illegal drugs etc]8 Unreported legal business activity [ldquooff the booksrdquo]

ExampleYC

1 N

___ ___ 1 You buy a purple ldquoTinky Winkyrdquo [produced in TX] from Wal-Mart___ ___ 2 You and your family paint your house [labor involved]___ ___ 3 You marry your housemaid [ldquoworking-for-loverdquo] [her services]___ ___ 4 You buy 100 shares of Microsoft Corporation___ ___ 5 You volunteer to babysit your little sister to help your parents while they work___ ___ 6 Bob buys a 1965 ford Mustang convertible in 2010 which is in mint condition___ ___ 7 The salesman gets a commission [pay] for selling that 1965 Ford Mustang in 2010___ ___ 8 You and your friend volunteer to cook at the senior class picnic___ ___ 9 Dr Payne does $1000 worth of dental work but reports only $500 of it

Does the $500 the dentist keeps and doesnrsquot report count___ ___ 10 You are given suitcase full of $100 bills from the sale of smuggled drugs___ ___ 11 Your mother is teaching you to read [amp not having much success]___ ___ 12 Your dad bakes you a home-baked loaf of bread [his labor]___ ___ 13 You buy a loaf of bread from Krogerrsquos Grocery Store___ ___ 14 The US government purchases 5 B-2 Bombers for $2 B each___ ___ 15 Ford buys a ton of sheet metal used in making car doors___ ___ 16 You buy a new ldquoiPad 2rdquo [produced in China] from the Apple store ___ ___ 17 You send in a $90 check to your dentist for cleaning your teeth___ ___ 18 Your family buys a new house next to the mansion of Bill Gates___ ___ 19 100 additional teachers are hired by the Frisco ISD___ ___ 20 GM invest in $500 million worth of robots to assemble their cars___ ___ 21 You volunteer 10 hours a week of your time to work for senior citizens___ ___ 22 Ford produces 25000 F150s in Denver which are not sold by the end of the year___ ___ 23 Russia buys 3000 Dell computers produced in NY as they become Rusky Dell Dudes___ ___ 24 A manrsquos wife does all his cooking and sewing working for him 16 hours per day___ ___ 25 Nike produces $10 million worth of Nike Air Jordanrsquos in Vietnam

YCN6N6N3N6N1YCN

8 NN7N6

6

N6YCYGN4N5YCYIgYGYIgN6YIgYXN6N5

1 2nd Hd sales2 Transfers3 Financial4 Intermediate5 Overseas6 Non-market7 Illegal8 Unreported

bull Gross Domestic ProductGDP= C +I+G+Xn = Consumption + Investment +Government

Spending+ Net Exports [(all exports) X-M (all imports)]bull Net Domestic Product (your value-what you could sell if ya

had to)

NDP= GDP- Depreciation (the loss of value over time- replacement cost)

bull National IncomeNI= NDP +NFFIEUS-Statistical Discrepancy Net Foreign Factor Income earned in USbull Personal Income (what you can pay in taxes spend or save)

PI= NI- Undistributed Corporate ProfitsndashCorporate Income Taxes -Social Security-Taxes on production amp iMports +Transfer Payments

bull Disposable Income (what you can spend or save)

DI= PI- personal income taxes

National Income Accounting

U Can See The Toilet Paper

NDP NI PIDIG

DP

>

- Personnel Taxes-$1102

$10 089[ldquoCrdquo]

Consumption[66]

$12392

[births-deaths]

ldquoAvailablefor salerdquo

$12026

PI is what we can spend save

or pay in taxes

ldquoIncome received by

householdswhether earned orunearnedrdquo

$10924

DIis what we can

SPENDor

SAVE

Y receivednot earned

Y earnednot received

GDPGross Domestic Product

$14256

NDPNational Domestic Product

$12392

NINational Income

$12288

PIPersonal income

$12026

DIDisposable Income

$10924

Gross PrivateDomestic Investment

$1 628GovernmentPurchases

$2931

Xn(X-M) -$392

-Depreciation[Replacement Cap]

$1864

$12288

ldquoIncome earnedby US resourcesrdquoplus taxes on pro-duction amp imports

-Statistical Discrep

$209[to make the income approach match the

expenditure approach]

+NFFI$105

+$2528 Trans Pay

-$418 Undis Cor Pro-$315 Corp Inc Tax -$967Soc Sec Con

-1090 Taxes on proamp M

ROW[$264]

US [$159]

NFFI = $105

ldquoU Can See The ToiletPaperrdquo

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Work in your own household or volunteer work in the community does not count because there was no payment

So donrsquot marry your maid yardman or fitness instructor or you will hurt GDP

>

If U S corporations produce goods overseas it does not count in GDP but would count in GNPRemember we are measuring production insidethe US Imports represent production outside ofthe US

GM in France

Nike in Indonesia

>

___ ___ 1 New Toyota Tundra truck manufactured in San Antonio and sold to your economics teacher the year it was produced

___ ___ 2 You buy a new Wii at GameStop in 2009 Does it count if you resell it on eBay in March of 2010

On the next slide read each sentence and determineldquoTo Be or Not To Be Countedrdquo That is the question

If ldquoYesrdquo put ldquoYrdquo and tell if it is ldquoCrdquo ldquoIgrdquo ldquoGrdquo or ldquoXrdquo

If ldquoNordquo put ldquoNrdquo and give the number from below on why it is not counted in GDPGDP DOES NOT INCLUDE1 Second hand sales [no current production] [but the salesmanrsquos commission counts]2 PublicPrivate transfer payments [no current production]3 Purely financial transactions [no current production] [brokerrsquos fees do count]4 Intermediate goods [component of final good]5 US corporations producing overseas6 Non-market transactions [ household or volunteer work

Underground Economy [not reported]7 Illegal business activity [prostitution murder-for-hire illegal drugs etc]8 Unreported legal business activity [ldquooff the booksrdquo]

ExampleYC

1 N

___ ___ 1 You buy a purple ldquoTinky Winkyrdquo [produced in TX] from Wal-Mart___ ___ 2 You and your family paint your house [labor involved]___ ___ 3 You marry your housemaid [ldquoworking-for-loverdquo] [her services]___ ___ 4 You buy 100 shares of Microsoft Corporation___ ___ 5 You volunteer to babysit your little sister to help your parents while they work___ ___ 6 Bob buys a 1965 ford Mustang convertible in 2010 which is in mint condition___ ___ 7 The salesman gets a commission [pay] for selling that 1965 Ford Mustang in 2010___ ___ 8 You and your friend volunteer to cook at the senior class picnic___ ___ 9 Dr Payne does $1000 worth of dental work but reports only $500 of it

Does the $500 the dentist keeps and doesnrsquot report count___ ___ 10 You are given suitcase full of $100 bills from the sale of smuggled drugs___ ___ 11 Your mother is teaching you to read [amp not having much success]___ ___ 12 Your dad bakes you a home-baked loaf of bread [his labor]___ ___ 13 You buy a loaf of bread from Krogerrsquos Grocery Store___ ___ 14 The US government purchases 5 B-2 Bombers for $2 B each___ ___ 15 Ford buys a ton of sheet metal used in making car doors___ ___ 16 You buy a new ldquoiPad 2rdquo [produced in China] from the Apple store ___ ___ 17 You send in a $90 check to your dentist for cleaning your teeth___ ___ 18 Your family buys a new house next to the mansion of Bill Gates___ ___ 19 100 additional teachers are hired by the Frisco ISD___ ___ 20 GM invest in $500 million worth of robots to assemble their cars___ ___ 21 You volunteer 10 hours a week of your time to work for senior citizens___ ___ 22 Ford produces 25000 F150s in Denver which are not sold by the end of the year___ ___ 23 Russia buys 3000 Dell computers produced in NY as they become Rusky Dell Dudes___ ___ 24 A manrsquos wife does all his cooking and sewing working for him 16 hours per day___ ___ 25 Nike produces $10 million worth of Nike Air Jordanrsquos in Vietnam

YCN6N6N3N6N1YCN

8 NN7N6

6

N6YCYGN4N5YCYIgYGYIgN6YIgYXN6N5

1 2nd Hd sales2 Transfers3 Financial4 Intermediate5 Overseas6 Non-market7 Illegal8 Unreported

bull Gross Domestic ProductGDP= C +I+G+Xn = Consumption + Investment +Government

Spending+ Net Exports [(all exports) X-M (all imports)]bull Net Domestic Product (your value-what you could sell if ya

had to)

NDP= GDP- Depreciation (the loss of value over time- replacement cost)

bull National IncomeNI= NDP +NFFIEUS-Statistical Discrepancy Net Foreign Factor Income earned in USbull Personal Income (what you can pay in taxes spend or save)

PI= NI- Undistributed Corporate ProfitsndashCorporate Income Taxes -Social Security-Taxes on production amp iMports +Transfer Payments

bull Disposable Income (what you can spend or save)

DI= PI- personal income taxes

National Income Accounting

U Can See The Toilet Paper

NDP NI PIDIG

DP

>

- Personnel Taxes-$1102

$10 089[ldquoCrdquo]

Consumption[66]

$12392

[births-deaths]

ldquoAvailablefor salerdquo

$12026

PI is what we can spend save

or pay in taxes

ldquoIncome received by

householdswhether earned orunearnedrdquo

$10924

DIis what we can

SPENDor

SAVE

Y receivednot earned

Y earnednot received

GDPGross Domestic Product

$14256

NDPNational Domestic Product

$12392

NINational Income

$12288

PIPersonal income

$12026

DIDisposable Income

$10924

Gross PrivateDomestic Investment

$1 628GovernmentPurchases

$2931

Xn(X-M) -$392

-Depreciation[Replacement Cap]

$1864

$12288

ldquoIncome earnedby US resourcesrdquoplus taxes on pro-duction amp imports

-Statistical Discrep

$209[to make the income approach match the

expenditure approach]

+NFFI$105

+$2528 Trans Pay

-$418 Undis Cor Pro-$315 Corp Inc Tax -$967Soc Sec Con

-1090 Taxes on proamp M

ROW[$264]

US [$159]

NFFI = $105

ldquoU Can See The ToiletPaperrdquo

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

If U S corporations produce goods overseas it does not count in GDP but would count in GNPRemember we are measuring production insidethe US Imports represent production outside ofthe US

GM in France

Nike in Indonesia

>

___ ___ 1 New Toyota Tundra truck manufactured in San Antonio and sold to your economics teacher the year it was produced

___ ___ 2 You buy a new Wii at GameStop in 2009 Does it count if you resell it on eBay in March of 2010

On the next slide read each sentence and determineldquoTo Be or Not To Be Countedrdquo That is the question

If ldquoYesrdquo put ldquoYrdquo and tell if it is ldquoCrdquo ldquoIgrdquo ldquoGrdquo or ldquoXrdquo

If ldquoNordquo put ldquoNrdquo and give the number from below on why it is not counted in GDPGDP DOES NOT INCLUDE1 Second hand sales [no current production] [but the salesmanrsquos commission counts]2 PublicPrivate transfer payments [no current production]3 Purely financial transactions [no current production] [brokerrsquos fees do count]4 Intermediate goods [component of final good]5 US corporations producing overseas6 Non-market transactions [ household or volunteer work

Underground Economy [not reported]7 Illegal business activity [prostitution murder-for-hire illegal drugs etc]8 Unreported legal business activity [ldquooff the booksrdquo]

ExampleYC

1 N

___ ___ 1 You buy a purple ldquoTinky Winkyrdquo [produced in TX] from Wal-Mart___ ___ 2 You and your family paint your house [labor involved]___ ___ 3 You marry your housemaid [ldquoworking-for-loverdquo] [her services]___ ___ 4 You buy 100 shares of Microsoft Corporation___ ___ 5 You volunteer to babysit your little sister to help your parents while they work___ ___ 6 Bob buys a 1965 ford Mustang convertible in 2010 which is in mint condition___ ___ 7 The salesman gets a commission [pay] for selling that 1965 Ford Mustang in 2010___ ___ 8 You and your friend volunteer to cook at the senior class picnic___ ___ 9 Dr Payne does $1000 worth of dental work but reports only $500 of it

Does the $500 the dentist keeps and doesnrsquot report count___ ___ 10 You are given suitcase full of $100 bills from the sale of smuggled drugs___ ___ 11 Your mother is teaching you to read [amp not having much success]___ ___ 12 Your dad bakes you a home-baked loaf of bread [his labor]___ ___ 13 You buy a loaf of bread from Krogerrsquos Grocery Store___ ___ 14 The US government purchases 5 B-2 Bombers for $2 B each___ ___ 15 Ford buys a ton of sheet metal used in making car doors___ ___ 16 You buy a new ldquoiPad 2rdquo [produced in China] from the Apple store ___ ___ 17 You send in a $90 check to your dentist for cleaning your teeth___ ___ 18 Your family buys a new house next to the mansion of Bill Gates___ ___ 19 100 additional teachers are hired by the Frisco ISD___ ___ 20 GM invest in $500 million worth of robots to assemble their cars___ ___ 21 You volunteer 10 hours a week of your time to work for senior citizens___ ___ 22 Ford produces 25000 F150s in Denver which are not sold by the end of the year___ ___ 23 Russia buys 3000 Dell computers produced in NY as they become Rusky Dell Dudes___ ___ 24 A manrsquos wife does all his cooking and sewing working for him 16 hours per day___ ___ 25 Nike produces $10 million worth of Nike Air Jordanrsquos in Vietnam

YCN6N6N3N6N1YCN

8 NN7N6

6

N6YCYGN4N5YCYIgYGYIgN6YIgYXN6N5

1 2nd Hd sales2 Transfers3 Financial4 Intermediate5 Overseas6 Non-market7 Illegal8 Unreported

bull Gross Domestic ProductGDP= C +I+G+Xn = Consumption + Investment +Government

Spending+ Net Exports [(all exports) X-M (all imports)]bull Net Domestic Product (your value-what you could sell if ya

had to)

NDP= GDP- Depreciation (the loss of value over time- replacement cost)

bull National IncomeNI= NDP +NFFIEUS-Statistical Discrepancy Net Foreign Factor Income earned in USbull Personal Income (what you can pay in taxes spend or save)

PI= NI- Undistributed Corporate ProfitsndashCorporate Income Taxes -Social Security-Taxes on production amp iMports +Transfer Payments

bull Disposable Income (what you can spend or save)

DI= PI- personal income taxes

National Income Accounting

U Can See The Toilet Paper

NDP NI PIDIG

DP

>

- Personnel Taxes-$1102

$10 089[ldquoCrdquo]

Consumption[66]

$12392

[births-deaths]

ldquoAvailablefor salerdquo

$12026

PI is what we can spend save

or pay in taxes

ldquoIncome received by

householdswhether earned orunearnedrdquo

$10924

DIis what we can

SPENDor

SAVE

Y receivednot earned

Y earnednot received

GDPGross Domestic Product

$14256

NDPNational Domestic Product

$12392

NINational Income

$12288

PIPersonal income

$12026

DIDisposable Income

$10924

Gross PrivateDomestic Investment

$1 628GovernmentPurchases

$2931

Xn(X-M) -$392

-Depreciation[Replacement Cap]

$1864

$12288

ldquoIncome earnedby US resourcesrdquoplus taxes on pro-duction amp imports

-Statistical Discrep

$209[to make the income approach match the

expenditure approach]

+NFFI$105

+$2528 Trans Pay

-$418 Undis Cor Pro-$315 Corp Inc Tax -$967Soc Sec Con

-1090 Taxes on proamp M

ROW[$264]

US [$159]

NFFI = $105

ldquoU Can See The ToiletPaperrdquo

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

___ ___ 1 New Toyota Tundra truck manufactured in San Antonio and sold to your economics teacher the year it was produced

___ ___ 2 You buy a new Wii at GameStop in 2009 Does it count if you resell it on eBay in March of 2010

On the next slide read each sentence and determineldquoTo Be or Not To Be Countedrdquo That is the question

If ldquoYesrdquo put ldquoYrdquo and tell if it is ldquoCrdquo ldquoIgrdquo ldquoGrdquo or ldquoXrdquo

If ldquoNordquo put ldquoNrdquo and give the number from below on why it is not counted in GDPGDP DOES NOT INCLUDE1 Second hand sales [no current production] [but the salesmanrsquos commission counts]2 PublicPrivate transfer payments [no current production]3 Purely financial transactions [no current production] [brokerrsquos fees do count]4 Intermediate goods [component of final good]5 US corporations producing overseas6 Non-market transactions [ household or volunteer work

Underground Economy [not reported]7 Illegal business activity [prostitution murder-for-hire illegal drugs etc]8 Unreported legal business activity [ldquooff the booksrdquo]

ExampleYC

1 N

___ ___ 1 You buy a purple ldquoTinky Winkyrdquo [produced in TX] from Wal-Mart___ ___ 2 You and your family paint your house [labor involved]___ ___ 3 You marry your housemaid [ldquoworking-for-loverdquo] [her services]___ ___ 4 You buy 100 shares of Microsoft Corporation___ ___ 5 You volunteer to babysit your little sister to help your parents while they work___ ___ 6 Bob buys a 1965 ford Mustang convertible in 2010 which is in mint condition___ ___ 7 The salesman gets a commission [pay] for selling that 1965 Ford Mustang in 2010___ ___ 8 You and your friend volunteer to cook at the senior class picnic___ ___ 9 Dr Payne does $1000 worth of dental work but reports only $500 of it

Does the $500 the dentist keeps and doesnrsquot report count___ ___ 10 You are given suitcase full of $100 bills from the sale of smuggled drugs___ ___ 11 Your mother is teaching you to read [amp not having much success]___ ___ 12 Your dad bakes you a home-baked loaf of bread [his labor]___ ___ 13 You buy a loaf of bread from Krogerrsquos Grocery Store___ ___ 14 The US government purchases 5 B-2 Bombers for $2 B each___ ___ 15 Ford buys a ton of sheet metal used in making car doors___ ___ 16 You buy a new ldquoiPad 2rdquo [produced in China] from the Apple store ___ ___ 17 You send in a $90 check to your dentist for cleaning your teeth___ ___ 18 Your family buys a new house next to the mansion of Bill Gates___ ___ 19 100 additional teachers are hired by the Frisco ISD___ ___ 20 GM invest in $500 million worth of robots to assemble their cars___ ___ 21 You volunteer 10 hours a week of your time to work for senior citizens___ ___ 22 Ford produces 25000 F150s in Denver which are not sold by the end of the year___ ___ 23 Russia buys 3000 Dell computers produced in NY as they become Rusky Dell Dudes___ ___ 24 A manrsquos wife does all his cooking and sewing working for him 16 hours per day___ ___ 25 Nike produces $10 million worth of Nike Air Jordanrsquos in Vietnam

YCN6N6N3N6N1YCN

8 NN7N6

6

N6YCYGN4N5YCYIgYGYIgN6YIgYXN6N5

1 2nd Hd sales2 Transfers3 Financial4 Intermediate5 Overseas6 Non-market7 Illegal8 Unreported

bull Gross Domestic ProductGDP= C +I+G+Xn = Consumption + Investment +Government

Spending+ Net Exports [(all exports) X-M (all imports)]bull Net Domestic Product (your value-what you could sell if ya

had to)

NDP= GDP- Depreciation (the loss of value over time- replacement cost)

bull National IncomeNI= NDP +NFFIEUS-Statistical Discrepancy Net Foreign Factor Income earned in USbull Personal Income (what you can pay in taxes spend or save)

PI= NI- Undistributed Corporate ProfitsndashCorporate Income Taxes -Social Security-Taxes on production amp iMports +Transfer Payments

bull Disposable Income (what you can spend or save)

DI= PI- personal income taxes

National Income Accounting

U Can See The Toilet Paper

NDP NI PIDIG

DP

>

- Personnel Taxes-$1102

$10 089[ldquoCrdquo]

Consumption[66]

$12392

[births-deaths]

ldquoAvailablefor salerdquo

$12026

PI is what we can spend save

or pay in taxes

ldquoIncome received by

householdswhether earned orunearnedrdquo

$10924

DIis what we can

SPENDor

SAVE

Y receivednot earned

Y earnednot received

GDPGross Domestic Product

$14256

NDPNational Domestic Product

$12392

NINational Income

$12288

PIPersonal income

$12026

DIDisposable Income

$10924

Gross PrivateDomestic Investment

$1 628GovernmentPurchases

$2931

Xn(X-M) -$392

-Depreciation[Replacement Cap]

$1864

$12288

ldquoIncome earnedby US resourcesrdquoplus taxes on pro-duction amp imports

-Statistical Discrep

$209[to make the income approach match the

expenditure approach]

+NFFI$105

+$2528 Trans Pay

-$418 Undis Cor Pro-$315 Corp Inc Tax -$967Soc Sec Con

-1090 Taxes on proamp M

ROW[$264]

US [$159]

NFFI = $105

ldquoU Can See The ToiletPaperrdquo

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

___ ___ 1 You buy a purple ldquoTinky Winkyrdquo [produced in TX] from Wal-Mart___ ___ 2 You and your family paint your house [labor involved]___ ___ 3 You marry your housemaid [ldquoworking-for-loverdquo] [her services]___ ___ 4 You buy 100 shares of Microsoft Corporation___ ___ 5 You volunteer to babysit your little sister to help your parents while they work___ ___ 6 Bob buys a 1965 ford Mustang convertible in 2010 which is in mint condition___ ___ 7 The salesman gets a commission [pay] for selling that 1965 Ford Mustang in 2010___ ___ 8 You and your friend volunteer to cook at the senior class picnic___ ___ 9 Dr Payne does $1000 worth of dental work but reports only $500 of it

Does the $500 the dentist keeps and doesnrsquot report count___ ___ 10 You are given suitcase full of $100 bills from the sale of smuggled drugs___ ___ 11 Your mother is teaching you to read [amp not having much success]___ ___ 12 Your dad bakes you a home-baked loaf of bread [his labor]___ ___ 13 You buy a loaf of bread from Krogerrsquos Grocery Store___ ___ 14 The US government purchases 5 B-2 Bombers for $2 B each___ ___ 15 Ford buys a ton of sheet metal used in making car doors___ ___ 16 You buy a new ldquoiPad 2rdquo [produced in China] from the Apple store ___ ___ 17 You send in a $90 check to your dentist for cleaning your teeth___ ___ 18 Your family buys a new house next to the mansion of Bill Gates___ ___ 19 100 additional teachers are hired by the Frisco ISD___ ___ 20 GM invest in $500 million worth of robots to assemble their cars___ ___ 21 You volunteer 10 hours a week of your time to work for senior citizens___ ___ 22 Ford produces 25000 F150s in Denver which are not sold by the end of the year___ ___ 23 Russia buys 3000 Dell computers produced in NY as they become Rusky Dell Dudes___ ___ 24 A manrsquos wife does all his cooking and sewing working for him 16 hours per day___ ___ 25 Nike produces $10 million worth of Nike Air Jordanrsquos in Vietnam

YCN6N6N3N6N1YCN

8 NN7N6

6

N6YCYGN4N5YCYIgYGYIgN6YIgYXN6N5

1 2nd Hd sales2 Transfers3 Financial4 Intermediate5 Overseas6 Non-market7 Illegal8 Unreported

bull Gross Domestic ProductGDP= C +I+G+Xn = Consumption + Investment +Government

Spending+ Net Exports [(all exports) X-M (all imports)]bull Net Domestic Product (your value-what you could sell if ya

had to)

NDP= GDP- Depreciation (the loss of value over time- replacement cost)

bull National IncomeNI= NDP +NFFIEUS-Statistical Discrepancy Net Foreign Factor Income earned in USbull Personal Income (what you can pay in taxes spend or save)

PI= NI- Undistributed Corporate ProfitsndashCorporate Income Taxes -Social Security-Taxes on production amp iMports +Transfer Payments

bull Disposable Income (what you can spend or save)

DI= PI- personal income taxes

National Income Accounting

U Can See The Toilet Paper

NDP NI PIDIG

DP

>

- Personnel Taxes-$1102

$10 089[ldquoCrdquo]

Consumption[66]

$12392

[births-deaths]

ldquoAvailablefor salerdquo

$12026

PI is what we can spend save

or pay in taxes

ldquoIncome received by

householdswhether earned orunearnedrdquo

$10924

DIis what we can

SPENDor

SAVE

Y receivednot earned

Y earnednot received

GDPGross Domestic Product

$14256

NDPNational Domestic Product

$12392

NINational Income

$12288

PIPersonal income

$12026

DIDisposable Income

$10924

Gross PrivateDomestic Investment

$1 628GovernmentPurchases

$2931

Xn(X-M) -$392

-Depreciation[Replacement Cap]

$1864

$12288

ldquoIncome earnedby US resourcesrdquoplus taxes on pro-duction amp imports

-Statistical Discrep

$209[to make the income approach match the

expenditure approach]

+NFFI$105

+$2528 Trans Pay

-$418 Undis Cor Pro-$315 Corp Inc Tax -$967Soc Sec Con

-1090 Taxes on proamp M

ROW[$264]

US [$159]

NFFI = $105

ldquoU Can See The ToiletPaperrdquo

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

bull Gross Domestic ProductGDP= C +I+G+Xn = Consumption + Investment +Government

Spending+ Net Exports [(all exports) X-M (all imports)]bull Net Domestic Product (your value-what you could sell if ya

had to)

NDP= GDP- Depreciation (the loss of value over time- replacement cost)

bull National IncomeNI= NDP +NFFIEUS-Statistical Discrepancy Net Foreign Factor Income earned in USbull Personal Income (what you can pay in taxes spend or save)

PI= NI- Undistributed Corporate ProfitsndashCorporate Income Taxes -Social Security-Taxes on production amp iMports +Transfer Payments

bull Disposable Income (what you can spend or save)

DI= PI- personal income taxes

National Income Accounting

U Can See The Toilet Paper

NDP NI PIDIG

DP

>

- Personnel Taxes-$1102

$10 089[ldquoCrdquo]

Consumption[66]

$12392

[births-deaths]

ldquoAvailablefor salerdquo

$12026

PI is what we can spend save

or pay in taxes

ldquoIncome received by

householdswhether earned orunearnedrdquo

$10924

DIis what we can

SPENDor

SAVE

Y receivednot earned

Y earnednot received

GDPGross Domestic Product

$14256

NDPNational Domestic Product

$12392

NINational Income

$12288

PIPersonal income

$12026

DIDisposable Income

$10924

Gross PrivateDomestic Investment

$1 628GovernmentPurchases

$2931

Xn(X-M) -$392

-Depreciation[Replacement Cap]

$1864

$12288

ldquoIncome earnedby US resourcesrdquoplus taxes on pro-duction amp imports

-Statistical Discrep

$209[to make the income approach match the

expenditure approach]

+NFFI$105

+$2528 Trans Pay

-$418 Undis Cor Pro-$315 Corp Inc Tax -$967Soc Sec Con

-1090 Taxes on proamp M

ROW[$264]

US [$159]

NFFI = $105

ldquoU Can See The ToiletPaperrdquo

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

NDP NI PIDIG

DP

>

- Personnel Taxes-$1102

$10 089[ldquoCrdquo]

Consumption[66]

$12392

[births-deaths]

ldquoAvailablefor salerdquo

$12026

PI is what we can spend save

or pay in taxes

ldquoIncome received by

householdswhether earned orunearnedrdquo

$10924

DIis what we can

SPENDor

SAVE

Y receivednot earned

Y earnednot received

GDPGross Domestic Product

$14256

NDPNational Domestic Product

$12392

NINational Income

$12288

PIPersonal income

$12026

DIDisposable Income

$10924

Gross PrivateDomestic Investment

$1 628GovernmentPurchases

$2931

Xn(X-M) -$392

-Depreciation[Replacement Cap]

$1864

$12288

ldquoIncome earnedby US resourcesrdquoplus taxes on pro-duction amp imports

-Statistical Discrep

$209[to make the income approach match the

expenditure approach]

+NFFI$105

+$2528 Trans Pay

-$418 Undis Cor Pro-$315 Corp Inc Tax -$967Soc Sec Con

-1090 Taxes on proamp M

ROW[$264]

US [$159]

NFFI = $105

ldquoU Can See The ToiletPaperrdquo

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

- Personnel Taxes-$1102

$10 089[ldquoCrdquo]

Consumption[66]

$12392

[births-deaths]

ldquoAvailablefor salerdquo

$12026

PI is what we can spend save

or pay in taxes

ldquoIncome received by

householdswhether earned orunearnedrdquo

$10924

DIis what we can

SPENDor

SAVE

Y receivednot earned

Y earnednot received

GDPGross Domestic Product

$14256

NDPNational Domestic Product

$12392

NINational Income

$12288

PIPersonal income

$12026

DIDisposable Income

$10924

Gross PrivateDomestic Investment

$1 628GovernmentPurchases

$2931

Xn(X-M) -$392

-Depreciation[Replacement Cap]

$1864

$12288

ldquoIncome earnedby US resourcesrdquoplus taxes on pro-duction amp imports

-Statistical Discrep

$209[to make the income approach match the

expenditure approach]

+NFFI$105

+$2528 Trans Pay

-$418 Undis Cor Pro-$315 Corp Inc Tax -$967Soc Sec Con

-1090 Taxes on proamp M

ROW[$264]

US [$159]

NFFI = $105

ldquoU Can See The ToiletPaperrdquo

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

NFFI = $10 billion

[USA Profits Overseas]

Rest of World

$220 billion

Foreign Profits in USA

$210 billion

If US profits in the ROW [$220] are greater than foreign profits in the US [$210] add the difference

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

C = $_______ Ig = $_______ G = $_______ Xn = $_______

Gross Domestic Product (GDP) -Consumption of fixed capital

Net Domestic Product (NDP) +Net For Factor Inc Earn US -Statistical Discrepancy

National Income (NI) -Undistributed Corporate Profits -Corporate income taxes -Social Security Contributions

-Taxes on prod amp imports +Transfer payments

Personal Income (PI) -Personal Taxes

Disposable Income (DI)

[18th Edition] NIA Practice ndash ldquoHow To Do Itrdquo Personal taxes 403 -Undistributed corp profits 46 Imports 362 -Social Security contrib 169 +Transfer payments 283 Personal consumption 2316 -Corporate Income Taxes 88 Gross private domes invest 503 -Taxes on prod amp imports 231 Government purchases 673 Exports 465 Depreciation [Capital consumption] 307Statistical Discrepancy 10 NFFIE in the US -12

$112

NFFI = -$12

2316503673

+1033595-307

3288-12

-231

3266-46-88

-169

+283

-534

3015-403

2612

ROW$100

English CAccounting CAmerican History DEconomics F

-10

Irsquom going through an academic recession

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Business CyclePEAK

Level of

bu

sin

ess a

cti

vit

y

Time

Trough

TROUGH

Expa

nsio

n

GROWTH TRENDExpansi

on

PEAK

InflationldquoToo much moneyrdquo

Contraction

Unemployment

Contraction

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

We ONLY have Economic Growth when we expand the size of the productive capacity of the economy - the

ability to produce MORE goods and services

Real Capital

Real Capital

Real Capital

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

bull Size of employed labor forcebull Quantity of real capitalbull Discovery of new raw materials

bull Average hours of work

Increase in inputs [such as land labor and capital]

[33]

bull Technological advancebull Education and trainingbull Use resources in the least costly

way [Productive efficiency]

bull Allocate resources among production techniques that produce goodsservices that maximize societyrsquos well-being

Increase productivity

of these inputs [66]

RealGDP

There are two main ways in which RGDP can grow 1 Increase in inputs [land labor or capital] 33

2 Increase in productivity of these inputs 66

x=

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

1 Real GDP2 Unemployment3 Core Inflation [taking out food and energy]

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Nominal GDP

[prices of output in the current year][measures ldquooutput and pricesrdquo]

and

Real GDP

[base year prices of the year being measured][measures ldquoonly outputrdquo]

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Importance of Real GDP in Determining a Recession

Apple GDP ExampleA country produces 10 apples in base year x $1 Nominal [current] amp Real [constant]GDP both=$10

Year 2 A country produces 10 apples x $125Nominal GDP=$1250 (no recession but worse off)[Real GDP would = $10 (10 apples x $1)]

Or Year 2 A country produces 9 apples x $125Nominal GDP=$1125 but real is $9 (9 apples x $1)

(recession although nominal GDP is up)

Real GDP measures current output at base-year prices

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Nominal [ ] GDP v Real GDP

Nominal [Current) GDPv

Real (constant) GDP

Price of Market Basket(2001) [nominal GDP] $64

GDP Price Index = Price of same Market Basket(1998)x100 [Real GDP] $50x100=128[GDP Deflator] in the base year (1998) [$64128 x 100 = $50]

Base year[$50$50=1x100=100] $46$50x100=92 [deflation of 8]

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$1384711998 x 100=$11541]

Real GDP[amp Nominal GDP]

$9847

Real GDP$11541

GDP Deflator [11998]

+ $1694 trillion

Nominal GDP[$13847]

Inflationcomponent

20002006

Base Year

[not $4 trillion]

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Depreciation1933

$76 billion[in current dollars]

Depreciation Investment amp Disinvestment

Positive Net InvestmentIg exceeds Depreciation

Negative Net InvestmentDepreciation exceeds Ig

Ig$16 billion

Disinvestment

of $6 billionDeclining

productive capacity

Ig($16) - D($76) = (Disinv of $6)(Disinvest of $6) + D($76)=($16)

Ig($16)ndashDisinv($6)=(Depr of $76)

Ig($2105) - D($1574) = (In of $531)In($531) + D($1574) = (Ig of $2105)

Ig($2105)-In($531)=(Depr of $1574)

Depreciation2005

$1574 Trillion

Ig

$2105 TrillionInInvestment

of $531 bilExpanding productive

capacity

>

>

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

ExpandingStaticDeclining Productive Capacity

Maintainingour production

possibilities

Expanding Productive Capacity

Static Productive Capacity

Declining Productive Capacity

increased

decreased

No change

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Non-market Transactions donrsquot countEarthquakes divorces etc increase GDPLeisure isnrsquot factored inImproved Product QualityThe Underground EconomyGDPrsquos impact on the EnvironmentPer Capita OutputCountries with low GDP per capita have more infants with low birth weight higher rates of infant mortality higher rates of maternal mortality higher rates of child malnutrition and less common access to safe drinking water Also fewer go to school and they have fewer teachers They have fewer TVs and telephones fewer paved roads They also win fewer Olympic medals

SHORTCOMINGS OF GDP

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100

Market Basket cost $5000 in base yearBase Year $5000$5000 x 100 = 100Later year letrsquos say the basket cost $7500$7500$5000 x 100 = 150 or 50

inflationLater year Letrsquos say the basket cost $2500$2500$5000 x 100 = 50 or 50

deflation

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Practice Formulas

$6737[1994]1261[1987($4540)]x100 = $5343 [+$803]ldquoReal GDP deflates nominal GDP to actual valuerdquo[takes the air out of the nominal balloon]

Base year[$50$50=1x100=100] $46$50x100=92[deflation of 8]

Nominal GDP(2001) [nominal GDP] $64GDP Price Index = Real GDP(1998) x 100 [Real GDP] $50 x 100 = 128[GDP Deflator] [The base year is 1998] [$64128 x 100 = $50]

Unemployment 5655000Labor Force x 100 = unemployment rate 140863000 x 100 = 4[Employed + unemployed] [135208000+5655000] [2000]

Okunrsquos Law or GDP gap)=Unemployment Rate over 6 x 2 75 so 15x2 = 3 Or $3 billion GDP Gap[$100 billion nominal GDP x 03 = $3 billion]

(2000-later year) (1999-earlier year) [Changeoriginal x 100] Current yearrsquos index ndash last yearrsquos index 1722-1666(56)CPI = Last yearrsquos index(1999-earlier year) x 100 1666 x100 = 34

_________________________ ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

70

>

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Real GDP takes the ldquoairrdquo out of the nominal GDP ldquoballoonrdquo

The effects of inflation have been eliminated so the remaining changes are ldquorealrdquo changes

Nominal GDP ndash measured in terms of money[Current output measured in current prices]Real GDP ndash measured in terms of goodsservices

[Current output measured in base-year prices]

[$67371261 x 100=$5343]

Real GDP[amp Nominal GDP]

$4540

Real GDP$5343

GDP Deflator [1261]

+ $803 billion

Nominal GDP[$6737]

Inflationcomponent

19871994

Base Year

[not $2197 trillion]

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Real GDP Nominal GDP

REAL GDP= Index x 100

ExUsing the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261

$6947 x 100 =5509 trillion 1261

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Real GDP = Nominal GDPIndex X 100

$92992[1999]10477[1996] x 100 = $88758 [So +$10626]ldquoReal GDP deflates nominal GDP to actual valuerdquo [takes the air out of the nominal balloon]

$52508 $37747 $567181085 x 100=$_____ 1081 x 100=$_____ 1170 x100=$_____4839 3492 4848

NS 12 and 1312 Using the above formula what is the real GDP for 1994 if nominal GDP was $6947 trillion and the GDP deflator was1261 ($6611$5610$5509) trillion

13 For 1996 what would real GDP be if nominal GDP were $7636 trillion and the GDP deflator were 1102($6929$9628$6928)

[$69471261 x 100 = $5509 trillion

[$7636 trillion1102 x 100 = $6929 trillion]

ldquoNominalrdquo

ldquoRealrdquo

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

UNEMPLOYMENT Unemployed

Unemployment Rate= Labor Force x 100

ExIf the total population is 280 million and the civilian labor force

includes 129558000 with jobs and 6739000 unemployed but looking for jobs what is the unemployment rate

6739000 x 100 =49 129558000 + 6739000

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Unemployment 15100000Unemployment Rate = Labor Force x 100 98 = 154082000 x 100 [Employed + unemployed] [138982000+15100000]

In Forney 42 are unemployed amp 658 are employed The unemployment rate is __

One mil are unemployed amp 19 mil are employed The unemploy rate is __65

NS 4141 If the total population is 280 million and the civilian labor force includes 129558000 with jobs and 6739000 unemployed but looking for jobs then the unemployment rate would be ____ 49

[6739000136297000 x 100 = 49]

(Sept of 2009)

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

The unemployment rate in June of 2010 was 97The next month 125000 jobs were lostldquoDid the unemployment rate go up in July 2010rdquoNo because 652000 more workers became discouraged [bringing the total to 26 million] and quit looking the July unemployment rate actually improved to 95 But the economy was obviously worse off

Jan 2008 - June 2010

95The ldquodiscouraged workersrdquo had looked in the last year but not in the last month

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

GDP GAPOkunrsquos Law

Okunrsquos Law= 6- current unemployment rate x 2 = ___x GDP = ___

Ex The Actual unemployment rate is 73 The GDP is 300 Billion What is the GDP Gap

6 - 73 (13) 13x2+ 26 26 x 300 Billion = 780 million

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Unemployment [Letrsquos say that Nominal GDP is $100 billion][And if it were $300 billion] Rate1 7 real unempl is __ gap is ___ output forgone is ___ B ___ B 2 8 real unempl is __ gap is ___ output forgone is ___ B ___ B3 13 real unempl is __ gap is ___ output forgone is ___ B ___ B4 14 real unempl is __ gap is ___ output forgone is ___ B ___ B

6 YFYPYA

$10 tr

[Frictional+Structural]

3

AD1 AS

Arthur Okun[GDP Gap = unemployment rate above 6 x 2]

E2 Recessionary Gap(YR)Potential output ($10) exceeds actual output($9)Actual unemployment rate(11) exceeds Potential unemp rate(6)

11YRYA

$9 Tr

1

AD2

5 Cyclical(ldquorealrdquo) Unempl10[5x2=10] Negative Gap

[Okunrsquos Law]

1 2 22 4 47 14 148 16 16

FE GDP ldquoBullrsquos Eyerdquo

$100 B $300 B

6124248

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Okunrsquos LawGDP Gap = Unemployment Rate over 6 x 275 unemployment so 15 x 2 = 3[$3 bil GDP Gap($100 Bil nominal GDPx3 or $100 B x 03 =$3 B)

on Practice Formulas1 Unemployment is 7 Nominal GDP is $200 billion Real unemp is __ The gap is __ Y being forgone is $__ B

2 Unemployment is 8 Nominal GDP is $500 billion Real unemp is __ The gap is __ Y being forgone is $__ B

3 Unemployment is 10 Nominal GDP is $100 billion Real unemp is __ The gap is __ Y being forgone is $__ B

Unemployment Rate over 6 x 2

2 4

4 20

8 8

1

2

4 NS 43 amp 4443Unemployment is 17 Nominal GDP is $200 billion What is the GDP gap __ What output is forgone $___44 Unemployment is 16 Nominal GDP is $300 billion What is the GDP gap __ What output is forgone $___

22 44

20 60

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Sometimes the economy is turbocharged and we are cranking out more than can be sustained

During a recession actual Y falls below potential Y

Usually potential amp actual

output track pretty closely

Although output is rising [2] there is still a $900 billion output gap so how long will it take to eliminate the output gap amp put 7 million back to work It all depends on the pace of the growth

POTENTIAL Y$141 Trillion

Actual Y$132 Trillion

At 6 growth the unemployment rate would reach its potential 5 unemployment in 2012

At 3 the unemployment rate would reach 5 in 2020

At 2 the unemployment rate would rise reaching119 in 2020

Herersquos what would happen to the unemploymentrate [89 now] under three growth scenarios

Even when the economy is functioning at its potential about 5 of the labor force is unemployed

PROJECTED

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

CPI INFLATION Current yearrsquos index ndash last yearrsquos index

CPI = Last yearrsquos index x 100

ExThe CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was

1722-1666 x 100 =49 1666

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

NS 50 51 amp 5250The CPI was 1666 in 1999 and 1722 in 2000 Therefore the rate of inflation for 2000 was (273442) 51 If the CPI falls from 160 to 149 in a particular year the economy has experienced (inflationdeflation) of (54969)52 If CPI rises from 1605 to 1630 in a particular year the rate of inflation for that year is (162040)

[-11160 x 100 = -69]

(2006-later year) (2005-earlier year) Current yearrsquos index ndash last yearrsquos index 1991 ndash 1927 [67]CPI = Last yearrsquos index(2006-earlier year) x 100 1927 x 100 = 33

1307-1240(67) 116-120(-4) 333-300(33) 1240 x 100 = ____ 120 x 100 = ____ 300 x 100 = ____

[ChangeOriginal X 100 = inflation]

54 -33 11

[561666 x 100 = 34]

So 33 increase in SocialSecurity benefits for 2007

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

A consumer in this economy buys only 2 goodsndashhot dogs amp hamburgersStep 1 Fix the market basket What percent of income is spent on each

The consumer in this economy buys a basket of

4 hot dogs and 2 hamburgers

Step 2 Find the prices of each good in each year Year Price of Hot Dogs Price of Hamburgers 2009 $1 $2 2010 $2 $3

Step 3 Compute the basket cost for each year 2009 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4) so $8 2010 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6) so $14

Step 4 Choose one year as a base year (2009) and compute the CPI 2009 ($8$8) x 100 = 100 2010 (14$8) x 100 = 175Step 5 Use the CPI to compute the inflation rate from previous year 2010 (175100 x 100 = 175) or to get actual (175-100)100 x 100 =75Or Change $14-$8 ($6) Original $8 x 100 = 75

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

(42) 18 Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008

Commodity Quantity 2007 per Unit Price 2008 per Unit PriceFood 5 units $600 $500Clothing 2 units $700 $900Shelter 3 units $1200 $1900

Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] a It remained unchanged c it decreased by 20 b It decreased by 25 d It increased by 20 e It increased by 25(Answer) Year 1 [2007] [5 food x $6 = $30 2 clothing x $7 = $14 3 shelters x $12 = $36

for dollar value [or basket cost] of $80 CPI = 100 ($80$80 x 100 = 100 for 2007)

Year 2 [2008] [5 food x $5 = $25 2 clothing x $9 = $18 3 shelters x $19 = $57

for dollar value [basket cost ]of $100 CPI =125 ($100$80 X 100 = 125) or (125100 x 100 = 125 for 2008)

Change $100-$80 [$20]Original = $80 x 100 = 25 so the CPI for this individual is 25

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Year CPI Inflat1913 991914 100 101915 101 101916 109 791917 128 1741918 151 1801919 173 1461920 200 1561921 179 1051922 168 -611923 171 181924 171 001925 175 231926 177 111927 174 -171928 171 -171929 171 001930 167 -231931 152 -901932 137 -991933 130 -511934 134 311935 137 221936 139 151937 144 361938 141 211939 139 14

Year CPI Inflat1940 163 109 1941 147 501942 163 1091943 173 611944 176 171945 180 231946 195 831947 223 1441948 241 811949 238 -121950 241 131951 260 791952 265 191953 267 081954 269 071955 268 -041956 272 151957 281 331958 289 281959 291 071960 296 171961 299 101962 302 101963 306 131964 310 131965 315 161966 324 29

Year CPI Inflat1967 334 311968 348 421969 367 551970 388 571971 405 341972 418 321973 444 621974 493 1101975 538 911976 569 581977 606 651978 652 761979 726 1131980 824 1351981 909 1031982 965 621983 996 321984 1039 431985 1076 361986 1096 191987 1136 361988 1183 411989 1240 481990 1307 541991 1362 421992 1403 301993 1445 30

Year CPI Inflat1994 1482 261995 1524 281996 1569 301997 1605 231998 1630 161999 1666 222000 1722 342001 1771 282002 1799 162003 1840 232004 1889 272005 1953 342006 2016 322007 2074 282008 2153 382009 2145 -042010 2180 16

ftpftpblsgovpubspecialrequestscpicpiaitxt

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Rule of 70

_______70___________ldquoRule of 70rdquo = annual rate of increase

Ex The GDP is growing at 16 At this rate the standard of living will double in __ years 70 = 44 years (4375 years)

16

Ex Inflation is growing at 5 At this rate prices will double in __ years 70 = 14 years 5

Ex Interest rates are currently at 3 At this rate investments will double in __ years 70 = 23 years (23333 years)

3

[

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

__________________________ldquoRule of 70rdquo = annual rate of increase (3) = 23 years

[Inflation (prices to double)] 70 70 70 [Investments to double] 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years

70

70

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Real Income Value

nominal income ndashinflation rate= real income

Ex The inflation rate rose by 3 but the income level rose by 5 what happened to the real income

5-3=2

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

NominalIncome

RealIncome

InflationPremium

-16

10

6

[Nominal income ndash inflation rate = Real Income]

=

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

ldquoReal Incomerdquo measures the amount of goodsservices nominal income will buy[ change in real income = change in nominal income - change in PL] 5 10 5

Nominal income rose by 10 PL increased by 4 - then real income rose by ___Nominal income rose by 20 PL increased by 5 - then real income rose by ___

615

ldquoYou will get a 10 raiserdquo

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

Answer to 3 (a) 400x$6=$2400 1000x$2=$2000 and 800x$2 = $1600 for a Nominal GDP of $6000

Answer to 3 (b) (i) ChangeOriginal x 100 therefore 50100 x 100 = 50 inflation rate

Answer to 3 (b) (ii) Nominal GDPGDP deflator x 100 = Real GDP $6000150 X 100 = Real GDP of $4000

Answer to 3 (c) Inflation between these years has increased 50 wages have increased only 20 therefore workers real wages or real purchasing power has decreased

Answer to 3 (d) The borrower has borrowed ldquodearrdquo money but is paying back ldquocheaperrdquo money He is better off because he is paying back money that isnrsquot worth what it was when he took out the loan

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

3 Gala Land produces 3 final goods bread water and fruit The table [right] shows this yearrsquos output and price for each good (a) Calculate this yearrsquos nominal GDP

(b) Assume that in Gala Land the GDP deflator [GDP price index) is 100 in the base year and 150 this year Calculate the following (i) The inflation rate expressed as a percent between the base year amp this year

(ii) This yearrsquos real GDP

(c) Since the base year workers have received a 20 increase in their nominal wages If workers face the same inflation that you calculated in part (b)(i) what has happened to their real wages Explain

(d) If the GDP deflator [inflation] in Gala Land increases unexpectedly would a borrower with a fixed-interest-rate loan be better off or worse off Explain

This Yearrsquos Output This Yearrsquos Price400 loaves of bread $6 per loaf1000 gallons of water $2 per gallon800 pieces of fruit $2 per piece

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

15 The business cycle is defined as the _______ and _______ in business activity

A EXPANSION B PEAK C CONTRACTION D TROUGH

___ 16 High point of expansion___ 17 Period of growth (GDP increases)___ 18 ldquoBottoming outrdquo of business activity___ 19 Laid off workers are called back___ 20 Near or at full employment (4-6)___ 21 Have averaged 11 months since WWII

NS 15-21

upturns downturns

B

DABC

A

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

22 During a recession jobs relating to (durablenondurable) goods are affected the most because they are

postponable and have monopoly power (few sellers)

23 (LeadingCoincidentLagging) indicators ndash statistics that illustrate the direction the economy is heading in 6-9 months

24 (LeadingCoincidentLagging) indicators ndash snapshot of the economy ldquoat this timerdquo

25 (LeadingCoincidentLagging) indicators ndash statistics that tell where the economy has been

26 Full employment occurs when we have ______ unemployment The current unemployment rate is ____

27 (Discouraged workersTemporary unemployed workers) are those who have given up looking for a job

28 The presence of discouraged workers amp counting part-time workers as fully employed results in the official rate being (understatedoverstated)

29 If 2 million out of 8 million unemployed workers become ldquodiscouragedrdquo

amp quit looking for work the official rate would (incrdecrbe unchanged)

30 If 3 million part time workers switch to full time work the official rate will (fallriseremain unchanged)

NS 22-30

4-673

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

NS 31-49 31 (FrictionalStructuralCyclical) is ldquotemporaryrdquo ldquoshort-termrdquo unemployment32 (FrictionalStructuralCyclical) is technological ldquolong-termrdquo unemployment33 (FrictionalStructuralCyclical) is unemployment resulting from recessions

A FRICTIONAL B STRUCTURAL C CYCLICAL

___ 34 Michael lost his job due to the recession [business cycle downturn]___ 35 College graduate is searching for his first job___ 36 Amanda is quitting Wendyrsquos to work at McDonaldrsquos___ 37 There are job losses at Ford due to a decrease in AD___ 38 Lifeguards in the winter and Santarsquos during the spring___ 39 The auto replaces carriage makers___ 40 ATM machines replace bank tellers

45 The cost of unemployment can be measured by the amount by which (potentialactual) GDP exceeds (potentialactual) GDP46 If the unemployment rate is 8 we can infer that the (potentialactual) GDP is in excess of (potentialactual) GDP47 (InflationDisinflationDeflation) is a general increase in prices48 (InflationDisinflationDeflation) is a decline in prices49 (InflationDisinflationDeflation) is a decrease in the rate of inflation

CAACABB

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

54 (Demand-pullCost-push) inflation results from an increase in aggregate demand [AD]55 (Demand-pullCost-push) inflation results from an increase in production costs [wages or input cost]56 The only group that benefits from inflation are (creditorsdebtorsfixed income pensioners) 59 The misery index is equal to the _______________________ plus the ________________60 The current misery index is ______ [changes every month]

NS 54-60

unemployment rate [73]

inflation rate [15] (These 2 figures chg each month)88

This changes every month

Highest ever- June 1980- 2198Lowest ever July 1953- 297Invented in 1970rsquos- post-dated back to the 50rsquoshellip

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

47 Inflation ndash overall increase in prices 48 Deflation ndash decrease in prices (1955) 49 Disinflation ndash decrease in inflation(1980-83)

Up in 2007 Legal Svc 52Col Tuition 58Tech Svc 17Hospitals 54Col Fees 58Comp Train53Med Serv 54

Down in 2007 Gasoline 431TVs 194Homes 182Toys 68Girls clothing 36New cars 32Boys clothing 11Furniture 01

Take some money out of circulation to make it more valuable

Above about 20-25 inflation is considered too much[39 in 2008 -04 in 2009 and 16 in 2010]

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

AD1

AD2

Demand-Pull Inflation[ldquoGood Newsrdquo ndash more jobs ldquoBad Newsrdquo ndash higher prices]

AS

PL1

PL2

Y YI

ldquoGood Newsrdquo - more jobs

ldquoBad Newsrdquo-higher prices E1

E2

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

AD2AD1

Disinflationary Recessions[ldquoGood Newsrdquondashlower prices ldquoBad Newsrdquondashjob losses]

AS

PL1

PL2

YR Y

ldquoGood newsrdquo-lower prices

ldquoBad newsrdquo- job losses

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Adverse Supply Shocks[ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash inflation]

AD AS1

PL1

YYR 10

AS2

$225

This economy is stagnating

but inflating

Stagflation

PL2[10]

Stagnating

Inflating

This created cognitive dissonance among many

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo]will not work with Stagflation

AD1

4

Y

10

10

AS2

Stagflation

AD2

15

15

AD3

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

[ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]

AD AS1

PL1

Y

PL2

Y2

$150

AS2

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

1 PPI ndash (Production Price Index) wholesale prices [what retailers are buying]

2 CPI ndash (Consumer Price Index) retail prices [what consumers are buying]

3 GDP Deflator ndash production prices

[what consumers businesses government and foreigners are buying that we produced]

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Consumer Price Index (CPI)

[CPI measures cost of living relative to a base year[100]The CPI is a market basket of 364 items at 23000establishments in 87 cities that the typical householder buys It does not include exports because we do not buy exports but does include imports About 55 of the CPI is services

Food amp energy make up 23 of the CPI Core inflation makes sense only for people who ldquodonrsquot eat or driverdquo

Core

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Health43

Transportation183

Shelter279

Household100

Clothing66 Alcohol

45Recreation

104

Food180

>

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

1 Substitutes not counted2 Quality not considered (airbags)

3 No discount stores (ldquooutlet biasrdquo)4 New items not counted a 1st VCR the Phillips 1500 the worldrsquos 1st VCR for home use sold for $1295 but $50 today They fell in price 70 before entering the CPI

b First solar powered calculators appeared in 1972 for $120 but didnrsquot make the CPI until 1978 c In 2000 a 20-inch LCD TV cost $5000 today under $300 d Cell phones[The ldquoBrickrdquo]were introduced in 1984 at $3995 e The camcorder cost $1500 in 1987 now under $150 f 50 inch Flat Screen TV in 1999 cost $12000 now $650

1969 Sharp QT-8D Calculator for $475 [4 functions][First battery-powered electronic calculator]

If orange goesfrom $100 to

$200amp

Tomato juice goes from $1

to 80

>

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

These could execute 330000computations per sec(2 billion now)These had 5 MB disk drives TodayDell makes computers with 500GB70000 times larger Stores were selling them for $3300 after buyingthem for $2000

M Dell ndash 2nd richest TXHe bought parts fromBYTE Magazine for$600 and sold themfor $1500-$2000

1981 IBM PC477MHz

160 KB floppy drives

$3300

1991 Compaq 48633 MHz

120 MB hard drive$2300

2011 Dell Optiplex 160

2 GB320 GB hard drive

$700

>

>

Who is the Richest American Ever John D Rockefellerrsquos [1839-1937] wealth would be worth $200 billion in todayrsquos money or 2 12 times that of Bill Gates ($72 Billion)

Babe Ruth made $80000 in 1931 That would be equivalent to $11 mil today [Barry Bonds got $18 million for his last year]

President Herbert Hooverrsquos salary in 1931 was $75000 That would be equivalent to $1075657 today Pres Obama is being paid $400000 a year President Kennedy was paid $100000 in 62 [$730000 today]

Although Rockefeller was worth $200 billion he could notwatch TV play video games surf the internet or send email to his grandkids For most of his life he could not use AC travel by car or plane use a telephone to call friends or take advantage of antibiotics to prolong amp enhance life

Perhaps the average American today is richer than the richest American a century ago

$80000=$11 M

>

Presidential pay history

Date established Salary Salary in 2011 Dollars

September 24 1789 $25000 $631000 (1789)

March 3 1873 $50000 $860000 (1873)

March 4 1909 $75000 $1837078 (1909)

January 19 1949 $100000 $915966 (1949)

January 20 1969 $200000 $1188010 (1969)

January 20 2001 $400000 $492000 (2011) Obama would have to make $492000 to buy what Bush could buy for $400000 in 2001

[$400000 x 21801771 = $492000]

CPI

238

367

1771

89

CPI was 2180 for 2010

1962 Prices v 2011 Prices [National Debt - $286 billion] [National Debt - $$316722162 so each citizens share of this debt is $5285490]bull Tuition at Harvard - $900bull Starting salary - $6000

[college graduate]bull FICA of 3125 of $4800

[$150 maximum]bull Top marginal tax rate of 91

of incomes over $200000bull New house for $10-15000

[25 times the income of a new college graduate]

bull Coke - 5 centsbull Movies - 50 bull Gas a gallon - $29bull 1962 Chevy Impala- $1500

bull Tuition at Harvard - $38891bull Median Starting salary - $45400

[college graduate]bull FICA of 62 of $113700

[$7049 maximum]bull Top marginal tax rate of 35

of incomes over $388350bull New median house price is

$242000 [55 times the income of todayrsquos college grads]

bull Coke - $1 bull Movies - $10bull Gas a gallon - $350bull 2011 Chevy Impala- $25860

62 Corvette $2995 2013 Corvette Grand $59600

HttpobjflickscomTakeMeBacktotheSixtieshtm

Presidential pay history

Date established Salary Salary in 2011 Dollars

September 24 1789 $25000 $631000 (1789)

March 3 1873 $50000 $860000 (1873)

March 4 1909 $75000 $1837078 (1909)

January 19 1949 $100000 $915966 (1949)

January 20 1969 $200000 $1188010 (1969)

January 20 2001 $400000 $492000 (2011) Obama would have to make $492000 to buy what Bush could buy for $400000 in 2001

[$400000 x 21801771 = $492000]

CPI

238

367

1771

89

CPI was 2180 for 2010

1962 Prices v 2011 Prices [National Debt - $286 billion] [National Debt - $$316722162 so each citizens share of this debt is $5285490]bull Tuition at Harvard - $900bull Starting salary - $6000

[college graduate]bull FICA of 3125 of $4800

[$150 maximum]bull Top marginal tax rate of 91

of incomes over $200000bull New house for $10-15000

[25 times the income of a new college graduate]

bull Coke - 5 centsbull Movies - 50 bull Gas a gallon - $29bull 1962 Chevy Impala- $1500

bull Tuition at Harvard - $38891bull Median Starting salary - $45400

[college graduate]bull FICA of 62 of $113700

[$7049 maximum]bull Top marginal tax rate of 35

of incomes over $388350bull New median house price is

$242000 [55 times the income of todayrsquos college grads]

bull Coke - $1 bull Movies - $10bull Gas a gallon - $350bull 2011 Chevy Impala- $25860

62 Corvette $2995 2013 Corvette Grand $59600

HttpobjflickscomTakeMeBacktotheSixtieshtm

1962 Prices v 2011 Prices [National Debt - $286 billion] [National Debt - $$316722162 so each citizens share of this debt is $5285490]bull Tuition at Harvard - $900bull Starting salary - $6000

[college graduate]bull FICA of 3125 of $4800

[$150 maximum]bull Top marginal tax rate of 91

of incomes over $200000bull New house for $10-15000

[25 times the income of a new college graduate]

bull Coke - 5 centsbull Movies - 50 bull Gas a gallon - $29bull 1962 Chevy Impala- $1500

bull Tuition at Harvard - $38891bull Median Starting salary - $45400

[college graduate]bull FICA of 62 of $113700

[$7049 maximum]bull Top marginal tax rate of 35

of incomes over $388350bull New median house price is

$242000 [55 times the income of todayrsquos college grads]

bull Coke - $1 bull Movies - $10bull Gas a gallon - $350bull 2011 Chevy Impala- $25860

62 Corvette $2995 2013 Corvette Grand $59600

HttpobjflickscomTakeMeBacktotheSixtieshtm

Cost-Push Inflation ndash 3 things maycause ldquocost-pushrdquo inflation1 Wage-push ndash strong labor unions2 Profit-push ndash companies increase prices when their costs increase3 Supply-side cost shocks ndash unanticipated increase in raw materials such as oil

ldquoDemand-pullrdquo

ldquoCost-pushrdquo

Demand-Pull Inflation ndash increase in AD[ldquoToo many dollars chasing too few goodsrdquo] Originates from ldquobuyers side of the marketrdquo

D1 D2

P2

ldquoWage-pricerdquoSpiral

S1S2D

PL2

PL1

S

P1

>

Stagflation Periods[1974-75 and 1981-82]

Although the economy was stagnating it was inflating instead of disinflating

bull Who is Hurt by InflationndashFixed-Income ReceiversndashSaversndashCreditors

bull Who is Unaffected by InflationndashFlexible-Income Receivers

bull Cost-of-Living Adjustments (COLAs)ndashDebtorsndashGovernment (as a big debtor)

benefits big time

• GDP ndash measures legal production in the U
• Slide 2
• Slide 3
• Slide 4
• Slide 5
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• Slide 11
• Slide 12
• Slide 13
• Slide 14
• National Income Accounting
• Slide 16
• Slide 17
• Depreciation Investment amp Disinvestment
• Slide 19
• Slide 20
• Slide 21
• Slide 22
• Slide 23
• Slide 24
• Slide 25
• 1 Real GDP 2 Unemployment 3 Core Inflation [taking o
• Slide 27
• Importance of Real GDP in Determining a Recession
• Slide 29
• Slide 30
• Depreciation Investment amp Disinvestment (2)
• ExpandingStaticDeclining Productive Capacity
• SHORTCOMINGS OF GDP
• GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100
• Slide 35
• Practice Formulas
• Slide 37
• Real GDP
• Slide 39
• UNEMPLOYMENT
• Slide 41
• Slide 42
• GDP GAPOkunrsquos Law
• Slide 44
• Unemployment Rate over 6 x 2
• Slide 46
• CPI INFLATION
• [ChangeOriginal X 100 = inflation]
• Slide 49
• Slide 50
• Slide 51
• Rule of 70
• Slide 53
• Real Income Value
• Slide 55
• Slide 56
• Slide 57
• Slide 58
• Slide 59
• NS 15-21
• NS 22-30
• Slide 62
• Slide 63
• Slide 64
• Slide 65
• Slide 66
• Slide 67
• Adverse Supply Shocks [ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash in
• Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo] will not work with Sta
• [ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]
• Slide 71
• Consumer Price Index (CPI)
• Slide 73
• Slide 74
• Slide 75
• Slide 76
• Slide 77
• 1962 Prices v 2011 Prices
• Slide 79
• Stagflation Periods [1974-75 and 1981-82]
• Slide 81

Stagflation Periods[1974-75 and 1981-82]

Although the economy was stagnating it was inflating instead of disinflating

bull Who is Hurt by InflationndashFixed-Income ReceiversndashSaversndashCreditors

bull Who is Unaffected by InflationndashFlexible-Income Receivers

bull Cost-of-Living Adjustments (COLAs)ndashDebtorsndashGovernment (as a big debtor)

benefits big time

• GDP ndash measures legal production in the U
• Slide 2
• Slide 3
• Slide 4
• Slide 5
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• Slide 11
• Slide 12
• Slide 13
• Slide 14
• National Income Accounting
• Slide 16
• Slide 17
• Depreciation Investment amp Disinvestment
• Slide 19
• Slide 20
• Slide 21
• Slide 22
• Slide 23
• Slide 24
• Slide 25
• 1 Real GDP 2 Unemployment 3 Core Inflation [taking o
• Slide 27
• Importance of Real GDP in Determining a Recession
• Slide 29
• Slide 30
• Depreciation Investment amp Disinvestment (2)
• ExpandingStaticDeclining Productive Capacity
• SHORTCOMINGS OF GDP
• GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100
• Slide 35
• Practice Formulas
• Slide 37
• Real GDP
• Slide 39
• UNEMPLOYMENT
• Slide 41
• Slide 42
• GDP GAPOkunrsquos Law
• Slide 44
• Unemployment Rate over 6 x 2
• Slide 46
• CPI INFLATION
• [ChangeOriginal X 100 = inflation]
• Slide 49
• Slide 50
• Slide 51
• Rule of 70
• Slide 53
• Real Income Value
• Slide 55
• Slide 56
• Slide 57
• Slide 58
• Slide 59
• NS 15-21
• NS 22-30
• Slide 62
• Slide 63
• Slide 64
• Slide 65
• Slide 66
• Slide 67
• Adverse Supply Shocks [ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash in
• Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo] will not work with Sta
• [ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]
• Slide 71
• Consumer Price Index (CPI)
• Slide 73
• Slide 74
• Slide 75
• Slide 76
• Slide 77
• 1962 Prices v 2011 Prices
• Slide 79
• Stagflation Periods [1974-75 and 1981-82]
• Slide 81

bull Who is Hurt by InflationndashFixed-Income ReceiversndashSaversndashCreditors

bull Who is Unaffected by InflationndashFlexible-Income Receivers

bull Cost-of-Living Adjustments (COLAs)ndashDebtorsndashGovernment (as a big debtor)

benefits big time

• GDP ndash measures legal production in the U
• Slide 2
• Slide 3
• Slide 4
• Slide 5
• Slide 6
• Slide 7
• Slide 8
• Slide 9
• Slide 10
• Slide 11
• Slide 12
• Slide 13
• Slide 14
• National Income Accounting
• Slide 16
• Slide 17
• Depreciation Investment amp Disinvestment
• Slide 19
• Slide 20
• Slide 21
• Slide 22
• Slide 23
• Slide 24
• Slide 25
• 1 Real GDP 2 Unemployment 3 Core Inflation [taking o
• Slide 27
• Importance of Real GDP in Determining a Recession
• Slide 29
• Slide 30
• Depreciation Investment amp Disinvestment (2)
• ExpandingStaticDeclining Productive Capacity
• SHORTCOMINGS OF GDP
• GDP Deflator[GDP Price Index] = Later CPIBase CPI x 100
• Slide 35
• Practice Formulas
• Slide 37
• Real GDP
• Slide 39
• UNEMPLOYMENT
• Slide 41
• Slide 42
• GDP GAPOkunrsquos Law
• Slide 44
• Unemployment Rate over 6 x 2
• Slide 46
• CPI INFLATION
• [ChangeOriginal X 100 = inflation]
• Slide 49
• Slide 50
• Slide 51
• Rule of 70
• Slide 53
• Real Income Value
• Slide 55
• Slide 56
• Slide 57
• Slide 58
• Slide 59
• NS 15-21
• NS 22-30
• Slide 62
• Slide 63
• Slide 64
• Slide 65
• Slide 66
• Slide 67
• Adverse Supply Shocks [ldquobad newsrdquo ndash job losses ldquobad newsrdquo ndash in
• Traditional Fiscal Policy [ldquoGrdquo amp ldquoTrdquo] will not work with Sta
• [ldquogood newsrdquondashjob gains ldquogood newsrdquondashdisinflation]
• Slide 71
• Consumer Price Index (CPI)
• Slide 73
• Slide 74
• Slide 75
• Slide 76
• Slide 77
• 1962 Prices v 2011 Prices
• Slide 79
• Stagflation Periods [1974-75 and 1981-82]
• Slide 81