Download AP Macro Unit 2 Notes

AP/ Honors Unit 2 Notes: Measuring the Economy
1. 3 Goals of an Economy and the Major
Economic Measurements
A. Full Employment
1. Unemployment Rate- 4-6%
2. Employment Rate
3. Employment Population Ratio
B. Stable Prices- Low or No inflation
1. Consumer Price Index (CPI)- Retail; 2-3%
2. Producer Price Index (PPI)- Wholesale
3. GDP Price Deflator- Broadest measure
1. 3 Goals of an Economy and the Major
Economic measurements
C. Economic Growth
1. Gross Domestic Product (RGDP)- Nominal vs. Real
2. Real GDP Growth Rate- 3-5%
3. Real GDP per capita- widely used measure to compare
countries
4. Index of Leading Economic Indicators- predictive, 6
months out
1. 3 Goals of an Economy and the Major
Economic measurements
D. Misery Index- A blend of A and B
1. Inflation Rate (CPI) + Unemployment Rate
a. Last 10 years- 3% Inflation + 5% unemployment = Misery
Index of 8; not so miserable
b. Late 1970’s- 12% Inflation + 7% unemployment = Misery
Index of 19; very miserable!
c. Today- 1% Inflation + 9.6% unemployment = Misery Index of
10.6; more miserable and getting worse???
+
=
2. Gross Domestic Product (GDP)- total value($)
of final goods and services(G&S) produced
within a country in one year.
GDP= Consumer Spending (C) + Business Investment (I) +
Government Spending (G) + Net Exports (x - m or Nx)
C + I + G + Nx = GDP
The Paradox of Thrift
Just when the
government wants
people to be spending
the money they earn
from government
projects or from tax
cuts they actually cut
their spending. Why?
People are worried
about the economy and
begin saving more
instead.
3. Real vs. Nominal- Measurement in Nominal
terms does not take into account changes in
price while Real does. Real more accurately
reflects the growth of GDP, changes in
people's wages, or when measuring the value
of anything over a period of time.
Real rate = Nominal rate - inflation rate.
Nominal rate = Real rate + inflation rate.
Is the top film of all time REALLY Titanic?
No! Adjusting for Inflation, Gone with the Wind is
the top film.
3. Real vs. Nominal- Earning Interest
Nominal interest rate - inflation rate = Real interest rate
Real interest rate + inflation rate = Nominal interest rate
If you earn 1% in a bank savings account how
much do you make in real terms if the inflation
rate is 3%?
Nominal Interest Rate = 1%
Inflation Rate = 3%
1% - 3% = -2% real rate
Inflation
Anticipated Inflation
Nominal Interest Rate
Real Interest Rate
Inflation Premium
6%
11%
=
+
5%
Nominal
Interest
Rate
Real
Interest
Rate
Inflation
Premium
O 7.2
3. Real vs. Nominal- Wage increase
Nominal raise - inflation rate = Real raise
Real raise + inflation rate = Nominal raise
If you get a 3% raise how much do you
make in real terms if the inflation rate is
3%?
Nominal Raise = 3%
Inflation Rate = 3%
3% - 3% = 0% real ∆ wage
3. Real vs. Nominal- GDP Growth
Nominal GDP Growth rate - inflation rate = Real
GDP Growth rate
Real GDP Growth rate + inflation rate = Nominal
GDP Growth rate
If the GDP grows by 4% in 2008 how much
did it grow in real terms if the inflation rate
is 3%?
Nominal GDP Growth Rate = 4%
Inflation Rate = 3%
4% - 3% = 1% real GDP Growth
Nominal Versus Real GDP
• Nominal GDP
• Real GDP
• Price Index
• GDP Price Index
W 6.2
O 6.1
Price
Index
In Given
Year
Real
GDP
=
=
Price of Market Basket
In Specific Year
Price of Same Basket
In Base Year
x 100
Nominal GDP
Price Index (in hundredths)
Were gas prices during the
summer of 2008 really at record
highs of ≈ $4.00/gallon?
Yes. In the summer of 2008 they
were. Previous high was 1980
when they were $3.25 in current
dollars.
No, currently (2010) they are not.
Even though in nominal terms gasoline prices have
trended up, gasoline’s long term real trend has been
downward, but with dramatic short term increases.
Gasoline currently appears to be back to
“normal” in real terms.
Gasoline in real terms (2008 dollars) is near
it’s 15 year average of $2.00/ gallon.
4. Real GDP per capita- Economic output
per person; the best measure of
economic well being of the citizen’s of
one country compared with those of
another country.
5. Gross National Product (GNP)- total
value($) of final goods and services
(G&S) owned by the citizens of a
country in one year.
Real Gross Domestic Product 1940- January, 2009; bil. of 2000 dollars
Real Gross Domestic Product 1940- January 2009; % change from year ago
GDP per Capita (2005)
Japan has had a
long slow slide
Two ways to Count GDP
Expenditure Approach
Money is used to purchase/ buy goods and services in the
Product Market.
GDP= Consumer Spending (C) + Business Investment (I) +
Government Spending (G) + Net Exports (x - m or Nx)
C + I + G + Nx = GDP
Two ways to Count GDP
Income Approach
Productive resources are sold for money in the Resource Market.
Human Resources = Wages, Salaries, Tips, and Commissions
Capital Resources = Interest
Natural Resources = Rent
Entrepreneurship resources = Profit
W + I + R + P = National Income (NI)
plus Indirect Taxes (sales taxes) and Depreciation = GDP
Two Approaches to GDP
Expenditure
Approach
Income
Approach
Consumption by
Households
Wages
Investment by
Businesses
Interest
+
+
Government
Purchases
+
Expenditures
By Foreigners
G
= D=
P
+
+
+
+
Rents
Profits
Statistical
Adjustments
Expenditure Approach
Personal Consumption Expenditures C
• Durable Consumer Goods
• Nondurable Consumer Goods
• Consumer Expenditures for
Services
Gross Private Domestic Investment
Ig
• Machinery, Equipment, and Tools
• All Construction
• Changes in Inventories
• Noninvestment Transactions
Households as Spenders
Household Uses of Income-2005
Income Group (Households)
0
Household Income Expended (Percent)
10 20 30 40 50 60 70 80
Personal
Taxes
Personal
Saving
90
12%
0%
Personal
Consumption
88%
Consumption Divided Between…
Composition
of
Consumption
59%
29%
12%
Services
Nondurable
Goods
Durable
Goods
Source: Bureau of Economic Analysis
Expenditure Approach
Gross Investment
Depreciation
= Net Investment
-
Gross
Investment
Net
Investment
Depreciation
Increased
Stock of
Capital
Consumption
& Government
Spending
Stock of
Capital
January 1
Year’s GDP
December 31
Expenditure Approach
G
Government Purchases
• Expenditures for Goods and
Services
• Expenditures for Social Capital
Net Exports
Xn = Exports (X) – Imports (M) Xn
Putting It All Together:
GDP = C + I + G + Xn
GDP= $8,746 + 2,105 + 2,363 727 = $12,487 in 2005
GDP Approaches Compared
Accounting Statement for the U.S. Economy, 2005
in Billions
Receipts
Expenditures Approach
Allocations
Income Approach
Personal Consumption (C) $ 8746 Compensation
Gross Private Domestic
Rents
$ 7125
73
Investment (Ig)
2105 Interest
498
Government Purchases (G)
2363 Proprietor’s Income
939
Net Exports (Xn)
-727 Corporate Profits
Taxes on Production and
1352
917
Imports
National Income
Net Foreign Factor Income
Statistical Discrepancy
$10,904
-34
43
Consumption of Fixed
Capital
Gross Domestic Product $ 12,487 Gross Domestic Product
1574
$ 12,487
Comparative GDPs
GLOBAL PERSPECTIVE
Select Nations GDPs - 2005
GDP in Trillions of Dollars
0
United States
Japan
Germany
China
United Kingdom
France
Italy
Spain
Canada
Brazil
Korea, Rep.
India
Mexico
Russian Fed.
Australia
1
2
3
4
5
6
7
8
9
10
12
$12.4
$4.5
$2.8
$2.2
$2.2
$2.1
$1.7
$1.1
$1.1
$.79
$.79
$.78
$.77
$.76
$.70
Source: World Bank
The Income Approach
• Compensation of Employees
• Rents
• Interest
• Proprietor’s Income
• Corporate Profits
– Corporate Income Taxes
– Dividends
– Undistributed Corporate Profits
– Taxes on Production and Imports
The Income Approach
• From National Income to GDP
– Net Foreign Factor Income
– Statistical Discrepancy
– Consumption of Fixed Capital
• Other National Accounts
– Net Domestic Product (NDP)
– National Income (NI)
– Personal Income (PI)
– Disposable Income (DI)
– DI = C + S
W 6.1
The Income Approach
Income Relationships – United States, 2005
Gross Domestic Product (GDP)
Consumption of Fixed Capital
Net Domestic Profit (NDP)
Statistical Discrepancy
Net Foreign Factor Income
National Income (NI)
Taxes on Production and Imports
Social Security Contributions
Corporate Income Taxes
Undistributed Corporate Profits
Transfer Payments
Personal Income (PI)
Personal Taxes
Disposable Income (DI)
$ 12,487
-1,574
$ 10,913
-43
34
$ 10,904
-917
-871
-378
-460
+1,970
$ 10,248
-1,210
$ 9,038
Legal Forms of Business
•Sole Proprietorship
•Partnership
•Corporation
Domestic Output by Business Type
20%
Corporations
8%
Partnerships
Corporations
84%
Partnerships
11%
72% Sole Proprietorships
Sole Proprietorships
Percentage of Firms
5%
Percentage of Sales
Source: U. S. Census Bureau
HOUSEHOLDS AS INCOME RECEIVERS
FUNCTIONAL DISTRIBUTION
WAGES
$5,977 Billion
72%
PROPRIETOR’S 757 Billion
INCOME
9%
CORPORATE
PROFITS
787 Billion
9%
INTEREST
684 Billion
8%
RENTS
142 Billion
2%
2002 DATA
Households as Income Receivers
Functional Distribution of Income-2005
Income By Function Performed
0
National Income Received (Percent)
10
20
30
40
50
60
Wages &
Salaries
71%
Rents
1%
Interest
Proprietor’s
Income
Corporate
Profits
70
5%
9%
14%
Source: Bureau of Economic Analysis
Shortcomings of GDP
• Nonmarket Activities
• Leisure
• Improved Product Quality
• The Underground Economy
• GDP and the Environment
• Composition and
Distribution of the Output
• Noneconomic Sources of
Well-Being
Households as Income Receivers
Personal Distribution of Income-2004
Income Group (Households)
0
Lowest
20%
Second
20%
Middle
20%
Fourth
20%
Highest
20%
Personal Income Received (Percent)
10
20
30
40
50
60
3.4%
8.7%
14.7%
23.2%
50.1%
Source: Bureau of the Census
Shortcomings of GDP
GLOBAL PERSPECTIVE
Underground Economy as a Percentage
of GDP - Select Nations
Percentage of GDP
0
Greece
Italy
Spain
Portugal
Belgium
Sweden
Germany
France
Holland
United Kingdom
Japan
United States
Switzerland
5
10
15
20
25
30
Source: Journal of Economic Literature
Income Inequality
• Average Household Income $60,258 in
2004 - Among the Highest in the World
Distribution of U.S. Income by Households, 2004
(1)
Personal
Income Category
Under $10,000
$10,000 - $14,999
$15,000 - $24,999
$25,000 - $34,999
$35,000 - $49,999
$50,000 - $74,999
$75,000 - $99,999
$100,000 and Above
(2)
Percentage of All
Households in this Category
8.7
6.7
12.9
11.9
14.8
18.3
11.0
15.7
100.0
Source: Bureau of the Census
• Division Into 5 Equal Groups
Distribution by Quintiles, 2004
(1)
Quintile
(2)
Percentage of
Total Income
(3)
Upper
Income Limit
Lowest 20%
3.4
$18,500
Second 20%
8.7
34,738
Third 20%
14.7
55,331
Fourth 20%
22.2
88,029
Highest 20%
50.1
No Limit
Total
100.0
Source: Bureau of the Census
Income Mobility:
The Time Dimension
Causes of Income Inequality
Percentage of Total Income Received by the Top
One-Tenth of Income Receivers, Selected Nations
GLOBAL PERSPECTIVE
0
Guatemala
Brazil
South Africa
Mexico
United States
Italy
Sweden
Germany
10
20
30
40
50
48.3
46.9
44.7
43.1
29.9
26.8
22.2
22.1
Source: World Bank, World Development Indicators, 2005
What is Included in GDP
Money is exchanged for g and s.
Consumer Spending (C)- Spending by consumers on
goods and services
Business Investment (I)- Tools, Equipment and
Machinery; New Houses and Inventory too
Government Spending (G)- Purchase of g and s.
Net Exports (x - m or NX)- Exports ↑ NX ($ flows into
U.S.), Imports ↓NX ($ flows out of U.S.),
What is Excluded from GDP
Reason #1
Money is not exchanged
Non-Market Activities- G or S are produced but
no $ is exchanged. Unpaid work or labor;
housewife, volunteer, work you perform for
yourself;
What is Excluded from GDP
Reason #2
A Good or Service is not exchanged
Financial Transaction/ Transfer PaymentsMoney is exchanged but no G or S is produced.
Depositing or withdrawing money from a
bank, buying/ selling stock, receiving a loan,
Social Security, Food Stamps, student loans.
What is Excluded from GDP
Reason #3
To avoid counting something twice
Used Products – Not counted because they were counted
when they were new.
What is Excluded from GDP
Reason #3
To avoid counting something twice
Intermediate Goods- Parts or raw materials that are
produced to be used to produce another product.
Glass, Rubber, Steel, Aluminum, Plastic all used to make a
Car (the final product).
We do NOT want to count them twice, once when they
are first produced and then AGAIN when they are
added to the car. A value-added approach is used. We
only count the value they add to the final product, the
car.
No!
Intermediate Good
Yes!
Final Good
Value-added approach is used with intermediate goods to
avoid double counting
Economics
Unit 4 Notes and Terms
Taxes, Spending, and Economic Measurement
6. Business Cycle- A periodic change in the GDP; includes
recessions, expansions, peaks, troughs.
GDP Growth Rate (%)
Peak
Peak
Peak
Trough
Trough
Trough
Time in Quarters (3 months)
The Business Cycle
Phases of the Business Cycle
O 7.1
Peak
Level of Real Output
Peak
Peak
Trough
Trough
Time
Cyclical Impact:
Durables and Nondurables
Selected Growth Rates
GLOBAL PERSPECTIVE
Percentage Change (annual rate)
6
U.S.
4
2
0
France
Germany
U.K.
Italy
Japan
-2
-4
1997
1999
2001
2003
2005
Source: Economic Report of the President, 2006
7. Recession/ Contraction- A phase of the
business cycle where GDP declines.
8. Expansion/ Recovery- A phase of the
business cycle where GDP increases.
9. Trough- A turnaround point; economy
starts to grow again.
518 Days = 1
year and 5
months
10. Peak/ Prosperity/
Boom- A turnaround
point; economy may
be here for a long
time before the
economy starts to
shrink into recession.
11. Depression- A very
deep, long recession.
12. Index of Leading Economic Indicators- (TB
p.258-259) An economic measurement
which tries to predict what will occur to
economic growth 6-9 months in the future.
Consists of the following economic
measurements:
A.
B.
C.
D.
E.
F.
G.
H.
I.
Average Workweek
Initial Claims for Unemployment
New Orders for Consumer Goods
Vendor Performance- On-time delivery of inputs
New Orders of Capital Goods
Building Permits for New Houses
Stock Prices
Money Supply
Interest Rate Spread (High v. Low)
Dec. 2008
2009 Stimulus Package
by category- Link to
larger graphic
2009 Stimulus
Package by year
in which money
is spent- Link to
larger graphic.
Economic Statistics Rules of Thumb
aka “The Economic Sweet Spot”
Good  1-3% Inflation Bad
Bad  3-4% Growth (RGDP) Good
Good  4-6% Unemployment Bad
13. Net Domestic Product (NDP) - GDP minus
that part of output needed to replace the
capital goods worn out in producing the
output.
14. National Income (NI) - Total income earned
by resource (N, H, C, E) suppliers
(households) for their contribution to the
production of the GDP.
15. Personal Income (PI) - The income
available to resource owners (households)
before taxes.
16. Disposable Income (DI) - Personal income
minus taxes. The money you have
available to spend or save.
17. Unemployment- Over 16, being out of work,
and actively seeking a job.
18. Unemployment rate- # unemployed divided
by the total # of people in the labor force.
19. Employment Rate- # employed divided by
civilian population.
Civilian Unemployment Rate 1940- August 2010
Unemployment Rate
by County Since
January 2007
20. Labor force- # employed plus # unemployed
21. Labor force participation rate- the civilian
labor force divided by the total noninstitutionalized civilian population 16
years of age and over.
Unemployment
Labor Force, Employment, and Unemployment, 2005
Under 16
And/or
Institutionalized
(70.5 Million)
Not in
Labor Force
(76.8 Million)
Total
Population
(296.6 Million)
Employed
(141.7 Million)
Unemployed
(7.6 Million)
Labor
Force
(149.3 Million)
Unemployment
• Unequal Burdens
–Occupation
–Age
–Race and Ethnicity
–Gender
–Education
–Duration
• Noneconomic Costs
Unemployment Rate
for Someone Like Me
22. Types of Unemployment
1. Structural- Changes in the structure of the
economy caused by changing technology or
consumer demands throw segments of workers out
of work. Workers lack the right skills.
Examples:
Changing Consumer Tastes- Japanese v. American
Cars
Technology- iPods instead of CD’s
Mergers- Smitty’sSmith’sKroger (Fry’s)
Instead of
Instead of
22. Types of Unemployment
2. Cyclical- Caused by swings in the business
cycle.
Examples: Housing, Cars, Appliances,
Furniture, Sit-Down Restaurants all lay off
in a recession.
22. Types of Unemployment
3. Frictional- Caused by workers who are
"between jobs“ or are reentering the labor force.
Examples:
Quitting a job to look for a better one,
Homemakers, Students graduating, Leaving the
military
22. Types of Unemployment
4. Seasonal- Caused by changes in season
or weather.
Examples: Agriculture, Tourism, Sports
23. Natural Rate of Unemployment- The
unemployment rate when the economy is at
full employment, i.e. when the number of
people looking for jobs equals the job
vacancies.
Defined as being between 4-6% unemployment
because of frictional and structural
unemployment, the 2 types of unemployment
we will always have and can’t (and don’t
want to) completely eliminate.
24. Discouraged Workers- Workers who have
given up looking for work but would like to
work. They are not considered to be
unemployed because they are not actively
seeking employment.
25. Underemployment- Occurs when workers
are forced to take jobs that they are
overqualified for.
Example: Cleaning houses instead of managing an
office even though you have the education and
experience to manage the office.
Unemployment
GLOBAL PERSPECTIVE
Unemployment Rates in Five Industrial Nations, 1995-2005
Unemployment Rate (percent)
15
France
10
Italy
Germany
U.S.
5
Japan
0
1995
2000
2005
26. Inflation- An increase in the level
of prices. Ex: The CPI (see
below) last year increased at an
annual rate of 4%.
Inflation Rate (percent)
15
10
5
0
1960
1970
1980
1990
Annual Inflation Rates in the United States,1960-2005
2000
28. Deflation- A decrease in the level of prices. Ex: The
CPI decreased 2 % last year.
Deflation may sound great but the only time in the last
100 years that the U.S has had deflation was during the
Great Depression of the 1930’s.
Japan also had a bad recession in the late 1990’s and
experienced deflation.
If there is deflation why would people not wanted to buy
something today?
If they wait until tomorrow the price will be cheaper!
But…
Then that puts downward pressure on prices because
people are not buying things!
College
and
medical
care costs
are 2
categories
that have
gone up
much faster
than the
average
rate of
inflation.
27. Disinflation- A decrease in
the rate of inflation. The
CPI increased at only a
2% annual rate instead of
last year's 5% rate.
Example: Increased competition from China,
India, and illegal immigration has put
downward pressure on wages. Wages are a
large cost for business so this has helped keep
prices down.
1998-2008
Example: Technological change has helped push
the price of some products down which has
helped keep inflation relatively modest over the
last 20 years.
29. Stagflation- High unemployment and
high inflation at the same time. The worst
possible economic condition to
experience.
30. Misery Index = Inflation rate (CPI) +
Unemployment Rate. A good measure of
stagflation. A pretty good predictor of
Presidential Elections. If the Misery Index
increases in the year prior to the election
then the incumbent party usually loses.
Hyperinflation- When
inflation gets out of
control and increases at
very large rates.
Examples:
Hungary (post WWII)- 12,950,000,000,000,000 %
per year, with prices doubling every 15.6 hours.
Weimar Germany (1923)- 29,525% per month with
prices doubling every 3.7 days.
Zimbabwean inflation rates (official) since independence
Date
Rate
Date
Rate
Date
Rate
Date
Rate
Date
Rate
Date
Rate
1980
7%
1981
14%
1982
15%
1983
19%
1984
10%
1985
10%
1986
15%
1987
10%
1988
8%
1989
14%
1990
17%
1991
48%
1992
40%
1993
20%
1994
25%
1995
28%
1996
16%
1997
20%
1998
48%
1999
56%
2000
55%
2001
112%
2002
198%
2003
598%
2004
132%
2005
585%
2006
1,281%
2007
66,212%
2008
231,000,000%
(July)
Zimbabwe (2008)- Actual exchange rate: 516 quintillion %
per year (516 followed by 18 zeros). Zimbabwean prices
are currently doubling every 1.3 days.
Zimbabwe
$10,000,000
Bill
Zimbabwe Bills: $10 to $100,000,000,000
Hyperinflation- When inflation gets out of control
and increases at very large rates.
Sign in a Zimbabwe Toilet, 2008
31. Consumer Price Index (CPI ) -Most common measure of the
change in prices. Measured from some BASE year which
starts at 100. Economists check prices on a many different
products (a "market basket" of goods) and then check
those prices periodically and record the change in price.
Measures changes at the retail level.
32. Producer Price Index (PPI)- Measures the change in the price
of gods and services at the wholesale level.
33. GDP Price Deflator- Broadest price index because it
measures changes to prices across the economy.
Consumer Price Index 1940- August 2010; % change from 1 year ago
Consumer Price Index
Components
A different way to look at inflation
Inflation
GLOBAL PERSPECTIVE
Inflation Rates in Five Industrial Nations,
1995-2005
Inflation Rate (percent)
6
5
Italy
4
3
2
U.S.
France
1
0
Germany
Japan
-1
1995
2000
2005
Source: Bureau of Labor Statistics
Aggregate Demand and Aggregate Supply Graph
PL = Price Level
PL
RGDP = Real Gross
Domestic Product
AS
AD = Aggregate/
Total Demand
PL0
AD
0
Y0
AS = Aggregate/
Total Supply
RGDP=Y
35. Types or Causes of Inflation
1. Demand-Pull- Consumers and private
businesses increase their spending faster
than production(demand increases). This
pulls prices up.
PL
Aggregate/ Total Demand
(AD) ↑ from AD0 to AD1.
AS
PL ↑ from PL0 to PL1.
PL1
PL0
AD1
AD0
0
Y0
Y1
RGDP=Y
RGDP ↑ from Y0 to Y1.
U Rate ↓ because RGDP ↑.
34. Types or Causes of Inflation
2. Cost-Push- The cost of productive
resources (Natural, Human, Capital,
Entrepreneurship) increases and this forces
producers to push prices up.
AS1
PL
AS0
Aggregate/ Total Supply
(AS) ↓ from AS0 to AS1.
PL ↑ from PL0 to PL1.
PL1
RGDP ↓ from Y0 to Y1.
PL0
AD
0
Y1
Y0
RGDP=Y
U Rate ↑ because RGDP ↓.
34. Types or Causes of Inflation
3. Wage-Price Spiral- High prices cause workers to ask
for raises but this increases costs for producers who then
raise prices on the products they sell. These higher prices
then force workers to ask for..... (very similar to costpush inflation)
4. Excessive Monetary Growth- The supply of money
increases at a rate that is greater than the increase in the
production (supply) of G & S. People have more money
and pull prices up. TOO MANY DOLLARS CHASING
TOO FEW GOODS. Very closely related to demand-pull
inflation.
35. Who benefits and who is hurt by inflation
1. Borrowers- Helped; paying back loans in
dollars that are worth less than when they
were borrowed.
2. Lenders- Hurt; being paid in dollars that
are worth less than when they were loaned
out.
Real vs. Nominal and Inflation- Lending
Nominal raise - inflation rate = Real raise
Real raise + inflation rate = Nominal raise
If a bank loans money at 6% and the
inflation rate is 3% how much is the
bank making in real terms?
Nominal interest Rate = 6% Inflation Rate = 3%
6% - 3% = 3% real interest rate
The bank is making a 3% real profit.
Real vs. Nominal and Inflation- Lending
Nominal raise - inflation rate = Real raise
Real raise + inflation rate = Nominal raise
If a bank loans money at 6% and the
inflation rate increases to 8% how much
is the bank making in real terms?
Nominal interest Rate = 6%
Inflation Rate = 8%
6% - 8% = -2% real interest rate!
If this goes on for too long what is going to happen to the bank?
The bank will go bankrupt! This is what happened to the savings
and loans in the 1970’s and 1980’s.
35. Who benefits and who is hurt by inflation
3. Fixed income- Income stays the same
while everything gets more expensive.
Income decreases in real terms. Your
purchasing power decreases.
4. Individuals with Cost-of-Living
Adjustment (COLA) in wage contract.Helped or at least not affected. As inflation
increases so does your pay . Ex: If inflation
increases by 3% your hourly wage
automatically increases by 3%.
35. Who benefits and who is hurt by inflation
5. Employees- Hurt; get paychecks that are
worth less as inflation increases
6. Employers- Helped; give paychecks that
are worth less as inflation increases
Real vs. Nominal and Inflation- Wage increase
Nominal raise - inflation rate = Real raise
Real raise + inflation rate = Nominal raise
If you get a 3% raise how much do you
make in real terms if the inflation rate is
3%?
Nominal Raise = 3%
Inflation Rate = 3%
3% - 3% = 0% real ∆ wage
Who gains? Employers get to give ZERO real wage increase.
Who loses? Employees get a ZERO real wage increase.
Inflation
•Who is Hurt by Inflation?
–Employees/ Fixed-Income
Receivers
–Savers
–Creditors/ Lenders
W 7.4
Inflation
•Who is Unaffected or
Helped by Inflation?
–Flexible-Income
Receivers
•Cost-of-Living
Adjustments (COLAs)
–Debtors/ Borrowers
–Employers
W 7.4