Introduction to Economics 10.12.2013

7/27/2019 Introduction to Economics 10.12.2013

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Introduction to Economics

The subject matter of economics and somebasic economic concepts and analysis

U Ye Myint

Head of Department (Retired)Yangon University of Economics

12/11/2013 Introduction to Economics 1


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The Economy

The ECONOMYis the mechanism throughwhich resource use is organized to satisfy the

desires of people living together in a society.

The discipline of economicsis concerned with

the use of available resources to satisfyconflicting desires and demands.



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Two Key Concepts

Scarcity:The imbalance between our desiresand the meansof satisfying those desires.

Opportunity Cost: The sacrifice of the nextbest alternative useof resources when those

resources are used for an specific purpose.



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Scarcity

Economics is primarily concerned withscarcityhow well we satisfy our unlimited

wantsin a world of limited resources.

As long as human wants exceed available

resources, scarcity will exist.



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The scarce resources that are used in theproduction of goods and services can begrouped into four categories:

labor

land

capital

entrepreneurship


Factors of Production


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Laboris the total of both physical and mentaleffort expended by people in the productionof goods and services.

Landis the natural resources used in the

production of goods and services.

Capitalis the equipment and structures used

to produce goods and services. Officebuildings, tools, machines and factories are allconsidered capital goods.



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Capital also includes human capital, the

productive knowledge and skill people receivefrom education and on-the-job training.

Entrepreneurshipis the process ofcombining the labor, land and capital togetherto produce goods and services.

The entrepreneur is the one who makes thetough and risky decisions about what toproduce and how to produce.



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Entrepreneurs are always looking for new

ways to improve production techniques or tocreate new products. They are driven by thelure of positive incentivesprofits.

We are all entrepreneurs when we try newproducts or when we find better ways to

manage our households or our study time.



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Goodsare those items that we value or desire. They can be tangible goodsthat can be held,

heard, tasted or smelled or intangible goods

such as fairness for all, friendship, knowledge,security, and health.

Servicesare the intangible acts for whichpeople are willing to pay such as legal ormedical services.


Goods and Services


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The scarce goods that are created from scarceresources are called economic goods.

If there are not enough economic goods forall of us, we will have to compete for those

scarce goods.


Economic goods


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Because we assume that people want moregoods, it does not mean that economics alsopresumes that people are selfish and greedy.

People are willing to give up their money andtime for what they believe to be importantcauses, revealing that charitable endeavors are

desirable goods. Self-interestis not the same as selfishnessorgreed.


Self-interest versus selfishness


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We all face scarcity, because we cannot have

all of the goods and services that we desire. However, because we all have different wants

and desires, scarcity affects everyonedifferently.

Even the richest person must live withscarcity and must, at some point, choose one

want or desire over another. As we get more affluent, we learn of new

luxuries to provide us with satisfaction.



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Scarcity never has and never will beeradicated.

The same creativity that permits newmethods to produce goods and services in

greater quantities also reveals new wants.

It is very possible that our wants grow as fast,

if not faster, than our ability to meet thosewants, so we still feel scarcity as much ormore than we did before.



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Opportunity Cost

If we had unlimited resources, and thus an ability toproduce all of the goods and services anyone

wanted, we would not have to choose among thosewants.

We are all faced with the fact of scarcity, and as aconsequence, we must make choices.

Because none of us can afford to buy everything we

want, each time we do decide to buy one good orservice, we reduce our abilityto buy other things we

would also like to have.



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People must choose.

The cost of a choice is the values that must beforegone.

The highest or best foregone opportunityresulting from a decision is called the

opportunity cost.

To choose is to lose.

To get more of anything that is desirable, youmust accept less of something else that youalso value.



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The opportunity cost of going to college mustinclude the opportunity cost of your time.

The opportunity cost of rearing a childincludes the opportunity cost of the timespent in child rearing, time that could be usedpursuing a career or volunteering at a localmission.


OpportunityCost illustrations


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There's no such thing as a free lunch.

A lunch may be free to you, but it is not free

from society's perspective.

Some of society's scarce resources that could

have been used to produce something else ofvalue will have been used in the preparation ofthe lunch.


OpportunityCost illustrations


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Marginal Thinking

Most choices involve how much ofsomething to do rather than whether or notto do something.

Economists emphasize marginal thinkingbecause the focus is on additional, ormarginal, choices.

Marginal choices involve the effectsof adding or subtracting from the currentsituation.



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Watch out for the difference between average and

marginal costs.

Suppose an airline had 10 unoccupied seats on a

flight from YGN to MDY and the average costwas K10000per seat (K2,000,000/200). If thereare 10 people on standby each willing to pay

K8000, should the airline sell them the tickets?



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Another good example of marginal thinking is

auctions.

Prices are bid up marginally as the auctioneer

calls out one price after another. When abidder views the new price (the marginal cost)to be greater than the value she places on thegood (the marginal benefit) she withdrawsfrom further bidding.



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The rule of rational choiceis thatindividuals will only pursue an activity ifexpected marginal benefits are greater thanexpected marginal costs [orE(MB)>E(MC)].

Netbenefitsthe difference between theexpected marginal benefits and the expected

marginal costs



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We can use the concept of marginalthinking to evaluatepollutionlevels.

We have to weigh the expected marginalbenefits of a cleaner environment againstthe expected marginalcosts of a cleanerenvironment.

Zero pollution levels would be far too costlyin terms of what we would have to give up.



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Just as we can have optimal (or best) levels ofpollution that are greater than zero, the same

marginal thinking can be used to analyzecrime and safetyissues.

The result will not be either no crime or

perfectly safe products. The issue is not safe products versus unsafe

products but how muchsafety do we want. It is

not risk versus no risk but rather how muchriskdo we want.

Additional safety comes at a higher cost.



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Incentives Matter

In acting rationally, people are responding toincentives.

That is, they react to changes in expectedmarginal benefits and expected marginal costs.

In fact, much of human behavior can beexplained and predicted as a response toincentives.



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For most policy purposes, the primary

concern is what causes the level of someactivity to change.

If the benefits of some activity, like crime,rise and/or if the costs fall, economistsexpect the amount of that activity to rise.

Likewise, if the benefits of some activity fall

and/or if the costs rise, economists expectthe amount of that activity to fall.



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Positive incentivesare those that either

increase benefits or reduce costs and thusresult in an increased level of the relatedactivity or behavior.

Negative incentives, on the other hand,either reduce benefits or increase costs,resulting in a decreased level of the related

activity or behavior.



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Human behavior is influenced in predictableways by changes in economic incentives.

Economists use this information to predictwhat will happen when the benefits and costsof any choice are changed.



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Would birth rates fall if the income-taxdeduction for dependents was removed?

Would a death sentence for drug traffickersreduce drug trafficking?

Would stricter penalties deter cheating? Would stricter drunk driving laws reduce

drunk driving?


Incentives examples


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Specialization and Trade

People are specializingwhen theyconcentrate their energies on only one or afew activities.

This allows them to make the best use of(and thus gain the most benefit from) theirlimited resources.



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The primary advantages of specialization arethat employees acquire greater skill fromrepetition.

They avoid wasted time in shifting from onetask to another.

They do the types of work for which they arebest suited.


Advantages of Specialization


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If a person, a region, or a country canproduce a good or service at a loweropportunity cost than others, we say that theyhave a comparative advantagein theproduction of that good or service.

They can gain by specializing in the

production of the good in which they have acomparative advantage.


Comparative Advantage Theory


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We all specialize to some extent and rely onothers to produce most of the goods andservices we want.

The income earned for that work can then beused to buy goods and services from others

who specialize in the production of thosegoods and services.


Trade occurs because of specialization


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Trade, or voluntary trade, directly increaseswealth by making both parties better off (orthey wouldn't trade).

It is the prospect of wealthincreasingexchange that leads to productivespecialization.


Trade can make everyone bette-roff


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Trade increases wealth by allowinga person, a region, or a nation to specialize

in those products that it produces betterand to trade for the products that othersproduce better.

For example, the United States is better atproducing wheat while Brazil is better atproducing coffee.

The U.S. and Brazil trade these goods witheach other.



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Imagine Mg Mg had 10 pounds of tea and MaMa had 10 pounds of coffee. However, Mg

Mg preferred coffee to tea and Ma Mapreferred tea to coffee. Could both parties bemade better off through trade?

If Mg Mg traded his tea to Ma Ma for coffee,both parties would be better off. Trade simplyreallocates goods and the voluntary exchange

increases wealth by making both parties betteroff.



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Market Prices Coordinate

Economic Activity

In a market economy, private individuals andfirms own most of the resources.

Property rightsare the rules of oureconomic game. If well defined, property

rights give individuals the incentive to usetheir property efficiently.


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The basis of a market economy is voluntaryexchange and the price system that guidespeople's choices and produces solutions tothe questions of what goods to produceand how to produce those goods and

distribute them.

The market systemprovides a way forsuppliers and consumers to allocate scarceresources through their actions andinactions in the marketplace.



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Buyers and sellers indicate their wants throughtheir actions and inactions in the marketplace, and

it is this collective voice that determines howresources are allocated.

Market prices serve as the language of the market

system and communicate crucial information toboth consumers and suppliers.

These prices communicate information about therelative availability of products to consumers, and

they provide suppliers with critical informationabout the relative value that consumers place onthose products.



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Three Basic Economic Questions

WHATwill be produced?Given scarce resources, decisions must be made about

how much of each good and service to be produced.

HOWwill goods be produced?Alternative mixtures of productive resources (capital,

labor, and land) are possible.

ToWHOMwill goods be distributed?Particular goods and services should go to those whovalue them the most. That is why we do not allconsume the same items.



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Economics Has Two Main Branches: MICROECONOMICS: Analyzes choices made

by individual participants in an economy with

special emphasis on how prices are determinedand how prices influence decisions.

MACROECONOMICS:Analyzes the overall

performances of an economy - its totalproduction, price level, rate of inflation,unemployment, trade balance, and rate of growth.



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Micro- and Macro-economics

Microeconomicsfocuses on the individualparts of the economy.

How households and firms make decisions

and how they interact in specific markets Macroeconomicslooks at the economy as a

whole.

Economy-wide phenomena, includinginflation, unemployment, and economicgrowth



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THE ECONOMIST AS POLICY ADVISOR

When economists are trying to explain the world,they are scientists.

When economists are trying to change the world,they arepolicy advisor.

When economists are trying to solve thepractical problems of the world, they areengineers.



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Positive vs. Normative Analysis

Positive analysisattempts to describe the economy inobjective terms.

Positive statementsare statements that attempt to describethe world as it is. Called descriptive analysis

Normative analysisjudges the desirability of alternativecourses of actions or systems of behavior.

Normative statementsare statements about how the world

should be. Calledprescriptive analysisMost economists concern themselves with both.



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POSITIVE VERSUS NORMATIVE ANALYSIS

Positive or Normative Statements?

An increase in the minimum wage will cause adecrease in employment among the least-skilled.

POSITIVE

Higher federal budget deficits will cause interest

rates to increase.POSITIVE


?

?

?


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POSITIVE VERSUS NORMATIVE ANALYSIS

Positive or Normative Statements?

The income gains from a higher minimum wageare worth more than any slight reductions in

employment.NORMATIVE

State governments should be allowed to collect

from tobacco companies the costs of treatingsmoking-related illnesses among the poor.

NORMATIVE


?

?

?


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TEN PRINCIPLES OF ECONOMICS

How people make decisions.

1. People face tradeoffs.

2. The cost of something is what you give up to get it

3. Rational people think at the margin.

4. People respond to incentives.



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How people interact with each other.

5. Trade can make everyone better off.

6. Markets are usually a good way to organize

economic activity.

7. Governments can sometimes improve economicoutcomes.



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The forces and trends that affect how theeconomy as a whole works.

8. The standard of living depends on a countrys

production.9. Prices rise when the government prints too much

money.

10. Society faces a short-run tradeoff betweeninflation and unemployment.



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Principle #1: People Face Tradeoffs.

To get one thing, we usually have to give up another thing.

_ Guns v. butter _ Food v. clothing

_ Leisure time v. work _ Efficiency v. equity

Efficiency v. Equity

Efficiencymeans society gets the most that it canfrom its scarce resources.

Equitymeans the benefits of those resources aredistributed fairly among the members of society.


Making decisions requires trading

off one goal against another.


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Principle #2: The Cost of Something Is What YouGive Up to Get It.

Decisions require comparing costs and benefitsof alternatives.

Whether to go to college or to work?

Whether to study or go out on a date?

Whether to go to class or sleep in?

The opportunity costof an item is what you giveup to obtain that item.



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Principle #3: Rational People Think at the Margin.

Marginal changesare small, incrementaladjustments to an existing plan of action.


People make decisions by comparing costs

and benefits at the margin.


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Principle #4: People Respond to Incentives.

Marginal changes in costs or benefits motivatepeople to respond.

The decision to choose one alternative overanother occurs when that alternatives marginal

benefits exceed its marginal costs!



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Principle #5: Trade Can Make Everyone BetterOff.

People gain from their ability to trade with oneanother.

Competition results in gains from trading.

Trade allows people to specialize in what they dobest.



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Principle #6: Markets Are Usually a Good Way toOrganize Economic Activity.

A market economyis an economy that allocates resourcesthrough the decentralized decisions of many firms andhouseholds as they interact in markets for goods and

services.

Adam Smith made the observation that households andfirms interacting in markets act as if guided by an

invisible hand. Prices guide decision makers to reach outcomes that

tend to maximize the welfare of society as a whole.



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Principle #7: Governments Can SometimesImprove Market Outcomes.

Market failureoccurs when the market fails toallocate resources efficiently.

When the market fails (breaks down)

government can intervene to promote efficiencyand equity.

externality

public goods

market power


#


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Principle #8: The Standard of Living Dependson a Countrys Production.

Almost all variations in living standards are explainedby differences in countries productivities.

Productivityis the amount of goods and services

produced from each hour of a workers time.

Standard of living may be measured in different ways:

By comparing personal incomes.

By comparing the total market value of a nations production.


l # h h


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Principle #9: Prices Rise When the GovernmentPrints Too Much Money.

Inflation is an increase in the overall level ofprices in the economy.

One cause of inflation is the growth in thequantity of money.

When the government creates large quantities ofmoney, the value of the money falls.



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Principle #10: Society Faces a Short-runTradeoff Between Inflation and

Unemployment.

The Phillips Curve illustrates the tradeoffbetween inflation and unemployment:

Inflation Unemployment

Its a short-run tradeoff!



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THE ECONOMIST AS A SCIENTIST

The economic way of thinking . . . Involves thinking analytically and objectively.

Makes use of the scientific method.

The Scientific Method: Observation,Theory, and More Observation

Uses abstract models to help explain how a complex,real world operates.

Develops theories, collects, and analyzes data toevaluate the theories.



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The Role of Assumptions

Economists make assumptions in order to makethe world easier to understand.

The art in scientific thinking is deciding which

assumptions to make.

Economists use different assumptions toanswer different questions.



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Economic Models

Economists use models to simplify reality inorder to improve our understanding of theworld

Trade off between simplicity & reality

Two of the most basic economic modelsinclude:

1. The Circular Flow Diagram

2. The Production Possibilities Frontier



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Our First Model: The Circular-Flow Diagram

The circular-flow diagramis a visual model of theeconomy that shows how money and goodsflow through markets among households andfirms.

Two economic units1. Firms

2. Households

Two markets1. Product market

2. Factor market12/11/2013 Introduction to Economics 62


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SpendingGoods andservicesbought

RevenueGoodsand servicessold

Labor, land,and capital

= Flow of inputs

and outputs= Flow of dollars

Factors of

productionWages, rent,and profit

FIRMSProduce and sellgoods and services

Hire and use factorsof production

Buy and consumegoods and services

Own and sell factorsof production

HOUSEHOLDS

Households sellFirms buy

MARKETSFORFACTORS OF PRODUCTION

Firms sellHouseholds buy

MARKETSFOR

GOODS AND SERVICES

Simple Model of Circular low of Income

O S d M d l Th P d i P ibili i


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Our Second Model: The Production PossibilitiesFrontier

Theproduction possibilities frontieris a graph that showsthe combinations of output that the economy canpossibly produce given the available factors ofproduction and the available production technology.

Concepts Illustrated by the Production PossibilitiesFrontier

Efficiency

Tradeoffs

Opportunity Cost

Economic Growth


Figure 2 The Production Possibilities Frontier


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g

12/11/2013 Introduction to Economics 65Copyright2003 Southwestern/Thomson Learning

Productionpossibilitiesfrontier

A

B

C

Quantity ofCars Produced

2,200

600

1,000

3000 700

2,000

3,000

1,000

Quantity ofComputers

Produced

DUnattainable

point

Under-employed

and/or Inefficient

point

Figure 3 A Shift in the Production Possibilities Frontier(Economic growth)


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(Economic growth)

12/11/2013 Introduction to Economics 66Copyright 2004 South-Western

E

Quantity ofCars Produced

2,000

700

2,100

7500

4,000

3,000

1,000

Quantity ofComputers

Produced

A


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WHY ECONOMISTS DISAGREE

They may disagree about the validity ofalternative positive theories about how the worldworks.

They may have different values and, therefore,different normative views about what policy

should try to accomplish.



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Appendix: Working with Graphs

Graphs are an important economic tool. They: allow economists to better understand the

workings of the economy, and

enhance the understanding of importanteconomic relationships.

The most useful graph for our purposes is onethat merely connects a vertical line (the Y-axis)with a horizontal line (the X-axis).


E hibit 1 Pl tti G h


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Exhibit 1: Plotting a Graph


Y

X-50 -40 -30 -20 -10 10 20 30 5040

-10-20

-30-40-50

5040302010

G h b d h h l i hi


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Graphs can be used to show the relationshipbetween two variables.

A variableis something that is measured by anumberlike your height.

Relationships between two variables can beexpressed in a simple two-dimensional graph.

Three common types of graphs are:

(a) pie charts

(b) bar graphs

(c)time series graphs



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Exhibit 2:



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E

xh

i

bi

t

2



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Exhibit 2:



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When two variables move in the same directions,there is apositive relationshipbetween the two

variables. (upward sloping) That is, an increase in one variable (practice time) is

accompanied by an increase in another variable(overall score).

When two variables move in different directions,there is anegative relationshipbetween the two

variables. (downward sloping) When one variable rises, the other variable falls.



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Exhibit 3: A Positive Relationship

The graphshows anexample of apositive

relationship. The skaters

who practicedthe most

scored thehighest.


ScoresatZ

Games

109876543

21

100 20 30 40 Practice Time per Week

(10, 4)

(20, 6)

(30, 8)

(40, 10)

A

B

C

D


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A downward-sloping line, the demand curve,

shows the different combinations of priceand quantity purchased.

The higher you go up on the vertical (price)axis, the smaller the quantity purchased onthe horizontal axis, and the lower you go

down along the vertical (price) axis, thegreater the quantity purchased.


Exhibit 4: Emilys Demand Curve


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Exhibit 4: Emily s Demand CurveA Negative Relationship

The downwardslope of the curvemeans that price andquantity are inversely,

or negatively related.

As price falls,quantity purchasedincreases and vice

versa.


(1, $25)

(2, $20)

(3, $15)

(4, $10)

(5, $5)

Priceof

CDs

$25

20

15

10

5

0 21 3 4 5 6 Quantity of CDs Purchased

Demand Curve

A

B

C

D

E


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Even when only two variables are shown on theaxes, graphs can be used to show the relationshipbetween three variables.

For example, a rise in income may increase thequantity of CDs purchased at each possible price.

This would shift the whole demand curve for CDsoutward to a new position.



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Exhibit 5: Shifting a Curve


Priceof

CDs

Priceof

CDs

(with higher income)

D

Quantity of CDs Purchased

D

0

(with lower income)

D


D

0


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It is important to remember the difference

between a movement up and down along acurve and a shift in the whole curve.

A change in one of the variables on the

graph, like price or quantity purchased, willcause a movement along the curve.

A change in one of the variables not shown,

like income in our example, will cause thewhole curve to shift.



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Exhibit 6: Shifts vs. Movements


Priceof

CDs

D0


D1

0

Going fromPoint A to Bindicates

movementalong ademand curve.

Going from D0to D1is a shift.

A

B


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The slope, or steepness, of curves can

be either positive (upward sloping) ornegative (downward sloping).

A curve that is downward sloping

represents an inverse, or negative,relationship between the two variables.

A curve that is upward sloping

represents a direct, or positiverelationship between the two variables.


Exhibit 7: Downward-Sloping


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Exhibit 7: Downward SlopingLinear Curves

A downward-sloping curverepresents a

negativerelationshipbetween twovariables.


25

20

15

10

5

5 10 15 20 25

Downwardsloping

0

Exhibit 7: Upward-Sloping


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p p gLinear Curves

An upward-sloping curverepresents a

positiverelationshipbetween two

variables.


25

20

15

10

5

5 10 15 20 250

Upward

sloping


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The slope of a linear curve between twopoints measures the relative rates of changeof two variables.

The slope of a linear curve can be defined asthe ratio of the change in the Yvalue to thechange in theXvalue, or the ratio of the rise

to the run.


Exhibit 8: Slopes of Positive


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Exhibit 8: Slopes of Positiveand Negative Linear Curves


Y-axis

X-axis

10987654321

1 2 3 4 5 60

A B

2 Run1 Rise

Positiveslope+1/2

Y-axis

X-axis

10987654321

1 2 3 4 5 60

A

B+2 Run

Negativeslope-4-8Rise


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Along a nonlinear curve, the slope variesfrom point to point.

However, we can find the slope of such a

curve at any point by finding the slope of thetangent to that curve at that point.


Exhibit 9: The Slope of a


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Exhibit 9: The Slope of a

Nonlinear Curve


Y-axis

X-axis

5

4

3

2

1

1 2 3 4 5 760

AC

Slope=0B

3 MAJOR STATS IN MACROECONOMICS


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I. Measuring the aggregate outputof the economy

(GDP)(GDPis the market value of all final goods andservices produced within an economy in a givenperiod of time)

II. Measuring the aggregate price level (CPI)

(CPI measures the cost of living, inflation)

III. Measuring aggregate employment level, i.e.,joblessness (Unemployment Rate)

(The unemployment rate tells us the fraction ofworkers who are unemployed.

Fundamental of economics 89

3 MAJOR STATS IN MACROECONOMICS

Three ways of Computing GDP


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1. totalvalue of final goods and servicesproduced within the

country in a given period of time2. total incomefrom the production of goods & services, which

equals the sum of wages and profitsthe top half of thecircular flow of dollars

3. total expenditureon purchases of goods & services, whichequals the sum of consumption and investmentexpenditures

the bottom half of the circular flow of dollars

These three waysof computing GDP must be equal because theexpenditureof buyers on products is , by the rules ofaccounting, income to the sellers of those products, which inturn is equal to the value of final products.

Three ways of Computing GDP

Some Notes on Computing GDP


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1) Used goodsare not includedin the calculation of GDP.

2) Inventoriesare treated depending on-

-if the goods are stored, their value is included in GDP

-if they spoil, GDP remains unchanged

-when the goods are finally sold out of inventory, they are

considered used goods (and are not counted).3) Intermediate goodsare not countedin GDP to avoid double

counting. Value added=value of output - value of raws.

4) Non-marketable goods are put into GDP using their imputed

value. For example, imputed rent for home ownership, salary ofgovernment servants such as firefighter, police officer, senator.Rents on cars, lawn mowers, jewelry and other durable goodsowned by households are left out of GDP. Meals cooked athome are the same.


REAL versus NOMINAL GDP


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Nominal GDP (Y) is the GDP at current prices.Real GDP (y) is the GDP at constant prices.

This distinction between real and nominal can also be applied toother monetary values, like wages.

nominal wage, W = P x wreal wage, w = W/P

This conversion from nominal to real units allows us to eliminatethe problems created by having a measuring stick (dollar value) thatessentially changes length over time, as the price level changes.

Nominal GDP,Y =y x P Real GDP,y=Y/P



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The GDP deflator, also called the implicit price deflator for GDP,measures the price of output relative to its price in the base year. Itreflects whats happening to the overall level of prices in the

economy.

=Nominal GDP

Real GDP

GDP Deflator

GDP DEFLATOR


COMPONENTS OF GDP


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Governmentpurchases of goods

and services

Y = C + I + G + NX

Total demandfor domesticoutput (GDP)

is composedof

Consumptionspending byhouseholds

Investmentspending bybusinesses and

households Net exportsor net foreign

demand

This is called the national income accounts identity.

COMPONENTS OF GDP


OTHER MEASURES OF INCOME


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1. Gross national product (GNP)

GNP = GDP+Factor Payments from Abroad -FactorPayments to Abroad

Whereas GDP measures the total income produceddomestically, GNP measures the total income earned bynationals(residents of a nation).

2. Net national product (NNP)

NNP = GNPDepreciation

(the amount of the economys stock of plants, equipment, and

residential structures that wears out during the year)


II. COMPUTING CPI


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The most commonly used measure of the level of prices is theCPI. In Myanmar, it is computed and published by the CentralStatistical Organization (CSO).

Another measure of general price level is the GDP deflator, theimplicit price deflator for GDP.

The Consumer Price Index (CPI)turns the prices of manygoods and services into a single index measuring the overall levelof prices.


II. COMPUTING CPI

CPI =(Quantity Current Price)

(Quantity Base-year Price)100

CPI versus GDP DEFLATOR


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1. GDP deflator measures the prices of all goods produced

CPI measures prices of only the goods and services boughtby consumers

Thus, an increase in the price of goods bought by firms or thegovernment will show up in the GDP deflator but not in theCPI.

2. GDP deflator includes only those goods and servicesproduced domestically. Imported goods are not a part ofGDP and therefore dont show up in the GDP deflator.

3. CPI assigns fixed weights to the prices of different goodsGDP deflator assigns changing weights.



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labor force= the sum of the employed and unemployedunemployment rate= the percentage of the labor force that isunemployedlabor force participation rate= the percentage of the adult

population who are in the labor force.

Number of UnemployedLabor Force

100Unemployment Rate =

Labor ForceAdult Population

100Labor Force Participation Rate =

III. MEASURING UNEMPLOYMENT


OKUNS LAW


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The negative relationship between unemployment and GDP is

calledOkuns

Law, after Arthur Okun, the economist who firststudied it. In short,% Change in Real GDP = 3% - 2 % Change in Unemployment

Rate

If the unemployment rate remains the same, real GDP grows byabout 3 percent. For every percentage point the unemployment

raterises, real GDP growth typically falls by 2 percent. Hence, if the

unemployment rate rises from 6 to 8 percent, then real GDPgrowth

would be: Percentage Change in Real GDP = 3% - 2 (8% - 6%) = - 1%



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THE END

Introduction to Economics 10.12.2013

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