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GDP – measures legal production in the
U.S. in one year.
GDP measures all final goods/services
produced by workers and capital located
in the U.S., regardless of ownership.
[Domestically located resources]
Final goods are goods ready for consumption.
1. Second Hand Sales[no production]
2. Public/Private Transfer Payments
3. Purely Financial Transactions
4. Intermediate Goods
5. U.S. Corporations producing overseas
6. Non-market transactions
[household or volunteer work]
Underground Economy
7. Illegal business activity
8. Unreported legal business activity
Intermediate Goods – components of the final good.
A. Ford buys batteries or tires for its cars.
B. KFC buys chickens to eventually sell to customers.
2nd Hand Sales
– no current production.
A. 1957 Chevy bought in 2010
This falls under the rule of “Do
Not Double Count”.
57 Chevy
Salesman
[It has not been produced again in 2010 & would not count.]
The salesman is doing productive work. His commission would count.
B. Boots produced in 1980 are bought in a Thrift Store in 2011.
They also have not been produced again.
Salesman’s commission would count.
You are buying his services.
Shoe salesman
Purely Financial Transactions – stocks, bonds, CDs.
There is no current production.
Ex: If 100 shares of Dell stock is bought
Buying stock is not buying a product but buying
ownership of the firm. Buying bonds is making a loan.
I’m not buying a Dell computer
but part ownership of Dell.
Exchanging one financial asset for another.
This represents transfer of ownership from
one shareholder to another.
[swapping bits of paper].
A. Public Transfer Payments–welfare, unemployment, social
security. [There is no contribution to final production]
“Now that I’ve gotten my
welfare check, I can get a
white iPad 2”
B. Private Transfer Payments, like your
parents giving you $250 cash for Christmas,
or - $100 for making an “A” in economics.
[Just transferring funds from one private
individual to another private individual]
Unreported “legal” business activity does not count.
This is two-thirds of the “underground economy.”
Before LASIK Surgery
Then he has LASIK but the
surgeon doesn’t report
$500 of his $3,400 bill?
And what if this
waitress doesn’t
report all tips?
And what if the
dentist doesn’t
report $400 for
teeth whitening?
Illegal business activity, because it goes unreported, also
does not count. Making up 1/3 of the “underground economy,”
also called the [“black market”]. It includes murder for hire,
gambling, drugs, prostitution, and money laundering.
And, what is money laundering?
Money Laundering
Making money illegally (drug money)
and making it look like it was legally
earned (like buying a laundry mat
or car wash that deal in cash) and
report it as legally earned.
“Ida Ho”
“Give me the money in
your purse. At least it
will not count in GDP!”
Legal
Illegal
$300 B
$600 B
Wages and
Salaries $185
doesn’t get reported
What gets reported is
the “Above Ground”
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, don’t marry your maid, yardman,
or fitness instructor, or you will hurt GDP.
GM in
France
Nike in
Indonesia
If U. S. corporations produce goods overseas,
it does not count in GDP, but would count in GNP.
Remember, we are measuring production inside
the U.S. Imports represent production outside of
the U.S.
On the next slide, read each sentence and determine,
“To Be or Not To Be Counted?” That is the question.
If “Yes”, put “Y” and tell if it is “C”, “Ig”, “G”, or “X”.
If “No”, put “N” and give the number from below on
why it is not counted in GDP.
GDP DOES NOT INCLUDE
1. Second hand sales [no current production] [but the salesman’s commission counts]
2. Public/Private transfer payments [no current production]
3. Purely financial transactions [no current production] [broker’s fees do count]
4. Intermediate goods [component of final good]
5. U.S. corporations producing overseas.
6. 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 [“off the books”]
Example:
___
C ___
Y 1. New Toyota Tundra truck manufactured in San Antonio and
sold to your economics teacher the year it was produced.
___
1 ___
N 2. You buy a new Wii at GameStop in 2009. Does it
count if you resell it on eBay in March of 2010?
CY
6N
6N
3N
6N
1N
CY
6N
8N
7N
6N
6N
CY
GY
4N
5N
CY
Ig Y
GY
IgY
6N
Ig Y
XY
6N
5N
___ ___ 1. You buy a purple “Tinky Winky”, [produced in TX] from Wal-Mart.
___ ___ 2. You and your family paint your house. [labor involved]
___ ___ 3. You marry your housemaid. [“working-for-love”] [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 $1,000 worth of dental work but reports only $500 of it.
Does the $500 the dentist keeps and doesn’t 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 [& not having much success].
___ ___ 12. Your dad bakes you a home-baked loaf of bread. [his labor]
1. 2nd Hd
___ ___ 13. You buy a loaf of bread from Kroger’s Grocery Store.
sales
___ ___ 14. The U.S. government purchases 5 B-2 Bombers for $2 B each.
2. Transfers
___ ___ 15. Ford buys a ton of sheet metal used in making car doors.
3. Financial
___ ___ 16. You buy a new “iPad 2” [produced in China] from the Apple store.
4.
___ ___ 17. You send in a $90 check to your dentist for cleaning your teeth.
Intermediate
___ ___ 18. Your family buys a new house next to the mansion of Bill Gates.
5. Overseas
___ ___ 19. 100 additional teachers are hired by the Frisco ISD.
6. Non-market
___ ___ 20. GM invest in $500 million worth of robots to assemble their cars.
7. Illegal
___ ___ 21. You volunteer 10 hours a week of your time to work for senior citizens.
8. Unreported
___ ___ 22. Ford produces 25,000 F150s in Denver which are not sold by the end of the year.
___ ___ 23. Russia buys 3,000 Dell computers, produced in NY, as they become Rusky Dell Dudes.
___ ___ 24. A man’s wife does all his cooking and sewing, working for him 16 hours per day.
___ ___ 25. Nike produces $10 million worth of Nike Air Jordan’s in Vietnam.
National Income Accounting
• Gross Domestic Product
GDP= C +I+G+Xn = Consumption + Investment +Government
Spending+ Net Exports [(all exports) X-M (all imports)]
• Net Domestic Product (your value-what you could sell if ya had to!)
NDP= GDP- Depreciation
• National Income
(the loss of value over time- replacement cost)
NI= NDP +NFFIEUS-Statistical Discrepancy
Net Foreign Factor Income earned in US
• Personal Income (what you can pay in taxes, spend or save!)
PI= NI- Undistributed Corporate Profits–Corporate
Income Taxes -Social Security-Taxes on
production & iMports +Transfer Payments
U
• Disposable Income (what you can spend or save!)
Ca
DI= PI- personal income taxes
n
G
D
P
NDP
NI
PI
DI
$10, 089
[“C”]
“U
Can
See
The
ToiletPap
onsumption
-$418 Undis Cor Pro
[Replacement Cap.]
$12,026
-$315 Corp Inc Tax
+N.F.F.I. -$967Soc Sec Con Y earned/not received
$1,864
[66%]
Ta
$105 -1090
-Statistical Discrep. +$2,528 Trans Pay Y received/not earned
-Depreciation
xes on pro.& M
$12,392
ross Private
Domestic
Investment
$1, 628
Government
Purchases
$2,931
Xn(X-M)
-$392
GDP
PI
is
what
we
$12,288
can spend, save,
ROW[$264]
or
$10,924
pay in taxes.
U.S. [$159]
DI
is what we can
“Income
NFFI = $105
[births-deaths] “Income earned received by
SPEND
U.S. resources”
or
“Available by
plus taxes on prohouseholds, SAVE.
for sale”
duction & imports
DI
NI
PI
whether
NDP
$12,026
or $10,924
$12,392 $12,288 earned
Gross Domestic Product
National Domestic Product
$14,256
-Personnel
Taxes
-$1,102
$209
[to make the income
approach match the
expenditure approach]
National Income
Personal income
Disposable Income
Depreciation, Investment & Disinvestment
Negative Net Investment
Depreciation exceeds Ig
Disinvestment
of $6 billion
Depreciation
1933
$7.6 billion
[in current dollars]
Declining
productive
capacity
Positive Net Investment
Ig exceeds Depreciation
Ig
In
$2,105 Trillion
Investment
Depreciation
of $531 bil.
Expanding
productive
$1,574 Trillion
capacity
2005
Ig
$1.6 billion
Ig($1.6) - D($7.6) = (Disinv. of $6) Ig($2,105) - D($1,574) = (In of $531)
(Disinvest. of $6) + D($7.6)=($1.6) In($531) + D($1,574) = (Ig of $2,105)
Ig($1.6)–Disinv.($6)=(Depr. of Ig($2,105)-In($531)=(
$7.6)
Depr.
of $1,574
[U.S.A. Profits
Overseas]
Rest of World
$220 billion
Foreign Profits in U.S.A.
$210 billion
N.F.F.I. = $10 billion
If U.S. profits in the ROW [$220] are greater than
foreign profits in the U.S. [$210], add the difference.
[18th Edition]
NIA Practice – “How To Do It”
Personal taxes
403
Imports
362
+Transfer payments
283
-Corporate Income Taxes 88
-Taxes on prod. & imports 231
Exports
465
Statistical Discrepancy
10
I’m going through an
academic recession.
English
C
Accounting
C
American History
D
Economics
F
-Undistributed corp. profits 46
-Social Security contrib.
169
Personal consumption
2,316
Gross private domes invest.
503
Government purchases
673
Depreciation [Capital consumption] 307
N.F.F.I.E. in the U.S.
-12
C=
Ig =
G=
Xn =
$_______
2,316
$_______
503
$_______
673
$_______
+103
Gross Domestic Product (GDP)
-Consumption of fixed capital
Net Domestic Product (NDP)
+Net For. Factor Inc. Earn. U.S.
-Statistical Discrepancy
National Income (NI)
-Undistributed Corporate Profits
-Corporate income taxes
-Social Security Contributions
-Taxes on prod. & imports
+Transfer payments
Personal Income (PI)
-Personal Taxes
Disposable Income (DI)
3,595
-307
3,288
-12
-10
ROW
$100
$112
3,266
-46
-88 -534
-169
NFFI
-231
+283
3,015
-403
2,612
= -$12
PEAK
Business Cycle
Inflation
PEAK
Level of business activity
“Too much money”
TROUGH
Trough
Unemployment
Time
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
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%}
• Size of employed labor force
• Quantity of real capital
• Discovery of new raw materials
• Average hours of work
• Technological advance
• Education and training
• Use resources in the least costly
way [Productive efficiency]
• Allocate resources among
production techniques that
produce goods/services that
maximize society’s well-being.
Increase in
inputs [such
as land, labor
and capital]
[33%]
x
Increase
productivity
of these
inputs
[66%]
=
Real
GDP
1. Real GDP
2. Unemployment
3. Core Inflation
[taking out food and energy]
Nominal GDP
[prices of output in the current year]
[measures “output and prices”]
and
Real GDP
[base year prices of the year being measured]
[measures “only output”]
Importance of Real GDP in Determining a Recession
Real GDP measures current output at base-year prices.
Apple GDP Example
A country produces 10 apples in base year x $1;
Nominal [current] & Real [constant]GDP both=$10
Year 2: A country produces 10 apples x $1.25;
Nominal GDP=$12.50
(no recession but worse off)
[Real GDP would = $10 (10 apples x $1)]
Or Year 2: A country produces 9 apples x $1.25;
Nominal GDP=$11.25 but real is $9 (9 apples x $1)
(recession although nominal GDP is up)
Nominal [
]
GDP v. Real
GDP
Base year[$50/$50=1x100=100] $46/$50x100=92 [deflation of 8%]
Price of Market Basket(2001)
[nominal GDP]
$64
= Price of same Market Basket(1998)x100; [
[GDP Deflator]
in the base year (1998)
GDP Price Index
Nominal [Current) GDP
v.
Real (constant) GDP
[$13,847/119.98 x 100=$11,541]
Inflation
Nominal GDP
[$13,847]
GDP Deflator [119.98]
component
Base Year
Real GDP
Real GDP
$11,541
[& Nominal GDP]
$9,847
+ $1,694 trillion
2000 [not $4 trillion]
2006
Nominal GDP – measured in terms of money.
Real GDP takes the “air” out of the nominal GDP “balloon”.
[Current output measured in current prices]
The effects of inflation have been eliminated, so the
Real GDP – measured in terms of goods/services.
remaining changes are “real” changes.
[Current output measured in base-year prices]
Depreciation, Investment & Disinvestment
Negative Net Investment
Depreciation exceeds Ig
Disinvestment
of $6 billion
Depreciation
1933
$7.6 billion
[in current dollars]
Declining
productive
capacity
Positive Net Investment
Ig exceeds Depreciation
Ig
In
$2,105 Trillion
Investment
Depreciation
of $531 bil.
Expanding
productive
$1,574 Trillion
capacity
2005
Ig
$1.6 billion
Ig($1.6) - D($7.6) = (Disinv. of $6) Ig($2,105) - D($1,574) = (In of $531)
(Disinvest. of $6) + D($7.6)=($1.6) In($531) + D($1,574) = (Ig of $2,105)
Ig($1.6)–Disinv.($6)=(Depr. ofIg($2,105)-In($531)=(
$7.6)
Depr.
of $1,574
Expanding/Static/Declining Productive Capacity
increased
Expanding Productive Capacity
Maintaining
No change
our production
possibilities
Static Productive Capacity
decreased
Declining Productive Capacity
SHORTCOMINGS OF GDP
Non-market Transactions don’t count
Earthquakes, divorces, etc. increase GDP
Leisure isn’t factored in
Improved Product Quality
The Underground Economy
GDP’s impact on the Environment
Per Capita Output
Countries 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.
GDP Deflator[GDP Price Index]
Later CPI/Base CPI x 100
=
Market Basket cost $50.00 in base year.
Base Year $50.00/$50.00 x 100 = 100
Later year, let’s say the basket cost $75.00.
$75.00/$50.00 x 100 = 150 or 50% inflation
Later year, Let’s say the basket cost $25.00.
$25.00/$50.00 x 100 = 50 or 50% deflation.
Base year[$50/$50=1x100=100] Practice Formulas $46/$50x100=92[deflation of 8%]
Nominal GDP(2001)
GDP Price Index = Real GDP(1998) x 100;
[GDP Deflator]
[nominal GDP] $64
[Real GDP] $50 x 100 = 128
[The base year is 1998]
[$64/128 x 100 = $50]
$6,737[1994]/126.1[1987($4,540)]x100 = $5,343 [+$803.]
“Real GDP deflates nominal GDP to actual value”[takes the air out of the nominal balloon]
Unemployment
Labor Force x 100 =
[Employed + unemployed]
unemployment rate;
5,655,000
140,863,000 x 100 = 4%
[135,208,000+5,655,000]
[2000]
Okun’s Law or GDP gap)=Unemployment Rate over 6% x 2; 7.5%, so 1.5%x2 = 3%.
Or, $3 billion GDP Gap[$100 billion nominal GDP x .03% = $3 billion].
(2000-later year)
(1999-earlier year)
[*Change/original x 100]
Current year’s index – last year’s index
172.2-166.6(5.6)
C.P.I. = Last year’s index(1999-earlier year) x 100; 166.6
x100 = 3.4%
_________________________
70
“Rule of 70” = % annual rate of increase (3%) = 23 years
“Real Income” measures the amount of goods/services nominal income will buy.
[% change in real income = % change in nominal income - % change in PL.]
5%
10%
5%
[$6,737/126.1 x 100=$5,343]
Nominal GDP
[$6,737]
Inflation
GDP Deflator [126.1]
component
Base Year
Real GDP
Real GDP
$5,343
[& Nominal GDP]
$4,540
+ $803 billion
1987 [not $2,197 trillion]
1994
Nominal GDP – measured in terms of money.
Real GDP takes the “air” out of the nominal GDP “balloon”.
[Current output measured in current prices]
The effects of inflation have been eliminated, so the
Real GDP – measured in terms of goods/services.
remaining changes are “real” changes.
[Current output measured in base-year prices]
Real GDP
Nominal GDP
REAL GDP=
Index
x 100
Ex:Using the above formula, what is the real GDP for 1994
if nominal GDP was $6,947 trillion and the GDP deflator was
126.1?
$6,947
126.1
x 100
=5,509 trillion
“Nominal”
Real GDP = Nominal GDP/Index X 100
“Real”
$9,299.2[1999]/104.77[1996] x 100 = $8,875.8 [So, +$1,062.6]
“Real GDP deflates nominal GDP to actual value” [takes the air out of the nominal balloon]
$5,250.8
$3,774.7
$5,671.8
4,848
3,492 117.0 x100=$_____
4,839 108.1 x 100=$_____
108.5 x 100=$_____
NS 12 and 13
12. Using the above formula, what is the real GDP for 1994
if nominal GDP was $6,947 trillion and the GDP deflator was
126.1? ($6,611/$5,610/$5,509) trillion.
[$6,947/126.1 x 100 = $5,509 trillion
13. For 1996, what would real GDP be if nominal GDP were
$7,636 trillion and the GDP deflator were 110.2?
($6,929/$9,628/$6,928).
[$7,636 trillion/110.2 x 100 = $6,929 trillion]
UNEMPLOYMENT
#Unemployed
Unemployment Rate= Labor Force x 100
Ex:If the total population is 280 million, and the civilian labor force
includes 129,558,000 with jobs and 6,739,000 unemployed but
looking for jobs what is the unemployment rate?
6,739,000
129,558,000 + 6,739,000
x 100
=4.9%
Unemployment
15,100,000
Unemployment Rate = Labor Force x 100; 9.8% = 154,082,000 x 100
[Employed + unemployed]
[138,982,000+15,100,000]
(Sept. of 2009)
In Forney, 42 are unemployed & 658 are employed. The unemployment rate is __
6 %.
One mil. are unemployed & 19 mil. are employed. The unemploy. rate is __%.
5
NS 41
41. If the total population is 280 million, and the civilian labor force
includes 129,558,000 with jobs and 6,739,000 unemployed but
looking for jobs, then the unemployment rate would be 4.9
____%.
[6,739,000/136,297,000 x 100 = 4.9%]
The unemployment rate in June of 2010 was 9.7%.
The next month, 125,000 jobs were lost.
“Did the unemployment rate go up in July, 2010?”
No, because 652,000 more workers became
discouraged [bringing the total to 2.6 million]
and quit looking, the July unemployment rate
actually improved to 9.5%. But, the economy
was obviously worse off.
Jan, 2008 - June, 2010
The “discouraged workers” had
looked in the last year but not in
the last month.
9.5%
GDP GAP/Okun’s Law
Okun’s Law= 6%- current unemployment
rate x 2 = ___x GDP = ___
Ex: The Actual unemployment rate is 7.3%. The GDP is 300 Billion.
What is the GDP Gap?
6% - 7.3% (1.3) 1.3x2+ 2.6%
2.6% x 300 Billion = 780 million
AD1
AD2
3%
AS
FE GDP “Bull’s Eye”
1%
5% Cyclical(“real”) Unempl.11% 6% [Frictional+Structural]
10%[5%x2=10%] Negative Gap
Y*F
YR
[Okun’s Law]
Arthur Okun
YP
YA YA [GDP Gap = unemployment rate above 6% x 2]
$9 Tr. $10 tr.
E2 Recessionary Gap(YR)
Potential output ($10) exceeds actual output($9).
Actual unemployment rate(11%) exceeds Potential unemp. rate(6%).
Unemployment [Let’s say that Nominal GDP is $100 billion.][And if it were $300 billion?]
1.
2.
3.
4.
$100 B
$300 B
Rate
1
2 B ___
2 %; output forgone is ___
7%; real unempl. is __%;
% gap is ___
6 B
2
4 %; output forgone is ___
4 B ___
8%; real unempl. is __%;
% gap is ___
12 B
7
13%; real unempl. is __%;
% gap is 14
___ %; output forgone is14
___ B ___
42 B
8
16 B ___
14%; real unempl. is __%;
% gap is 16
___ %; output forgone is ___
48 B
Unemployment Rate over 6% x 2
Okun’s Law
GDP Gap = Unemployment Rate over 6% x 2
7.5% unemployment, so 1.5% x 2 = 3%.
[$3 bil. GDP Gap($100 Bil. nominal GDPx3%; or $100 B x .03 =$3 B.)
on Practice Formulas
1. Unemployment is 7%; Nominal GDP is $200 billion.
4 B.
2
Real unemp. is __%.
The % gap is __%.
Y being forgone is $__
1
2. Unemployment is 8%; Nominal GDP is $500 billion.
20 B.
4
Real unemp. is __%.
The % gap is __%.
Y being forgone is $__
2
3. Unemployment is 10%; Nominal GDP is $100 billion.
4
8
8 B.
Real unemp. is __%.
The % gap is __%.
Y being forgone is $__
NS 43 & 44
43.Unemployment is 17%. Nominal GDP is $200 billion.
44
What % is the GDP gap? 22
__% What output is forgone? $___
44. Unemployment is 16%. Nominal GDP is $300 billion.
60
What % is the GDP gap? 20
__% What output is forgone? $___
Although output is rising [2%], there is still a $900 billion output gap, so how long will it take to
eliminate the output gap & put 7 million back to work. It all depends on the pace of the growth.
Here’s what would happen to the unemployment
rate [8.9 now] under three growth scenarios:
At 3% the unemployment
rate would reach 5% in 2020.
At 6% growth, the unemployment
rate would reach its potential, 5%
unemployment in 2012.
Sometimes the economy is
turbocharged and we are cranking
out more than can be sustained.
POTENTIAL Y
$14.1 Trillion
At 2%, the unemployment
rate would rise, reaching
11.9% in 2020.
Actual Y
$13.2 Trillion
Even when the economy is functioning at its potential,
about 5% of the labor force is unemployed.
During a recession, actual
Y falls below potential Y.
PROJECTED
CPI / INFLATION
Current year’s index – last year’s index
C.P.I. =
Last year’s index
x 100
Ex:The CPI was 166.6 in 1999 and 172.2 in 2000. Therefore, the
rate of inflation for 2000 was?
172.2-166.6
166.6
x 100
=4.9%
[Change/Original X 100 = inflation]
So, 3.3% increase in Social
Security benefits for 2007
(2006-later year)
(2005-earlier year)
Current year’s index – last year’s index
199.1 – 192.7 [6.7]
C.P.I. = Last year’s index(2006-earlier year) x 100; 192.7 x 100 = 3.3%
130.7-124.0(6.7)
116-120(-4)
124.0 x 100 = 5.4
____
120 x 100 = -3.3
____
%
%
333-300(33)
11%
300 x 100 = ____
NS 50, 51, & 52
50.The CPI was 166.6 in 1999 and 172.2 in 2000.
Therefore, the rate of inflation for 2000 was
(2.7/3.4/4.2)% [5.6/166.6 x 100 = 3.4%]
51. If the CPI falls from 160 to 149 in a particular
year, the economy has experienced (inflation/deflation)
of (5/4.9/6.9)%. [-11/160 x 100 = -6.9%]
52. If CPI rises from 160.5 to 163.0 in a particular year,
the rate of inflation for that year is (1.6/2.0/4.0)%.
A consumer in this economy buys only 2 goods–hot dogs & hamburgers.
Step 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 = 175
Step 5. Use the CPI to compute the inflation rate from previous year
2010 (175/100 x 100 = 175%) or to get actual % (175-100)/100 x 100 =75%
Or, 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
Food
Clothing
Shelter
5 units
2 units
3 units
$6.00
$7.00
$12.00
2008 per Unit Price
$5.00
$9.00
$19.00
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 (125/100 x 100 = 125 for 2008)
Change
Original =
$100-$80 [$20]
$80
x 100 = 25%;
so the CPI for this individual is 25%.
Year
1913
1914
1915
1916
1917
1918
1919
1920
1921
1922
1923
1924
1925
1926
1927
1928
1929
1930
1931
1932
1933
1934
1935
1936
1937
1938
1939
CPI
9.9
10.0
10.1
10.9
12.8
15.1
17.3
20.0
17.9
16.8
17.1
17.1
17.5
17.7
17.4
17.1
17.1
16.7
15.2
13.7
13.0
13.4
13.7
13.9
14.4
14.1
13.9
Inflat. Year
1940
1.0
1941
1.0
1942
7.9
1943
17.4
1944
18.0
1945
14.6
1946
15.6
1947
10.5
1948
-6.1
1949
1.8
1950
0.0
1951
2.3
1952
1.1
1953
-1.7
1954
-1.7
1955
0.0
1956
-2.3
1957
-9.0
1958
-9.9
1959
-5.1
1960
3.1
1961
2.2
1962
1.5
1963
3.6
1964
2.1
1965
1.4
1966
CPI
16.3
14.7
16.3
17.3
17.6
18.0
19.5
22.3
24.1
23.8
24.1
26.0
26.5
26.7
26.9
26.8
27.2
28.1
28.9
29.1
29.6
29.9
30.2
30.6
31.0
31.5
32.4
Inflat.
10.9
5.0
10.9
6.1
1.7
2.3
8.3
14.4
8.1
-1.2
1.3
7.9
1.9
0.8
0.7
-0.4
1.5
3.3
2.8
0.7
1.7
1.0
1.0
1.3
1.3
1.6
2.9
Year
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
CPI
Inflat.
33.4
3.1
34.8
4.2
36.7
5.5
38.8
5.7
40.5
3.4
41.8
3.2
44.4
6.2
49.3 11.0
53.8
9.1
56.9
5.8
60.6
6.5
65.2
7.6
72.6 11.3
82.4 13.5
90.9 10.3
96.5
6.2
99.6
3.2
103.9
4.3
107.6
3.6
109.6
1.9
113.6
3.6
118.3
4.1
124.0
4.8
130.7
5.4
136.2
4.2
140.3
3.0
144.5
3.0
Year
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
CPI
Inflat.
148.2
2.6
152.4
2.8
156.9
3.0
160.5
2.3
163.0
1.6
166.6 2.2
172.2 3.4
177.1 2.8
179.9 1.6
184.0 2.3
188.9 2.7
195.3 3.4
201.6 3.2
207.4 2.8
215.3 3.8
214.5 -0.4
218.0 1.6
ftp://ftp.bls.gov/pub/
special.requests/cpi/
cpiai.txt
Rule of 70
_______70___________
“Rule of 70” =
% annual rate of increase
Ex: The GDP is growing at 1.6%. At this rate the standard of living
will double in __ years?
70
= 44 years (43.75 years)
1.6%
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 (23.333 years)
3%
[
70
__________________________
“Rule of 70” = % annual rate of increase (3%) = 23 years
[Inflation (prices to double)]
70
70
70
[Investments to double]
years 9 = 8
7 years
10 = ________12
=6
_____
_______
years [GDP (standard of living) to double]
70
Real Income Value
nominal income –inflation 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%
[Nominal income – inflation rate = Real Income]
16%
Nominal
Income
6%
Inflation
Premium
=
10%
Real
Income
“Real Income” measures the amount of goods/services 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 ___%.
6
15
Nominal income rose by 20%, PL increased by 5% - then real income rose by ___%.
“You will get a 10% raise”
3. Gala Land produces 3 final goods: bread,
water, and fruit. The table [right] shows this
year’s output and price for each good.
(a) Calculate this year’s nominal GDP.
Answer to 3. (a): 400x$6=$2,400; 1,000x$2=$2,000;
and 800x$2 = $1,600 for a Nominal GDP of $6,000.
This Year’s Output
400 loaves of bread
1,000 gallons of water
800 pieces of fruit
This Year’s Price
$6 per loaf
$2 per gallon
$2 per piece
(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 & this year.
Answer to 3. (b) (i):
Change/Original x 100; therefore 50/100 x 100 = 50% inflation rate.
(ii) This year’s real GDP
Answer to 3. (b) (ii):
Nominal GDP/GDP deflator x 100 = Real GDP; $6,000/150 X 100 = Real GDP of $4,000.
(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.
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.
(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. (d): The borrower has borrowed “dear” money but is paying back
“cheaper” money. He is better off because he is paying back money that isn’t worth
what it was when he took out the loan.
3. Gala Land produces 3 final goods: bread,
water, and fruit. The table [right] shows this
year’s output and price for each good.
(a) Calculate this year’s nominal GDP.
This Year’s Output
400 loaves of bread
1,000 gallons of water
800 pieces of fruit
This Year’s Price
$6 per loaf
$2 per gallon
$2 per piece
(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 & this year.
(ii) This year’s 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.
NS 15-21
15. The business cycle is defined as the
upturns and downturns
_______
_______ in business activity.
A. EXPANSION
B
___
A
___
___
D
A
___
B
___
___
C
16.
17.
18.
19.
20.
21.
B. PEAK
C. CONTRACTION
D. TROUGH
High point of expansion
Period of growth (GDP increases)
“Bottoming out” of business activity
Laid off workers are called back.
Near or at full employment (4-6%)
Have averaged 11 months since W.W.II.
22. During a recession, jobs relating to
NS 22-30
(durable/nondurable) goods are affected the most because they are
postponable and have monopoly power (few sellers).
23. (Leading/Coincident/Lagging) indicators – statistics that illustrate the
direction the economy is heading in 6-9 months.
24. (Leading/Coincident/Lagging) indicators – snapshot of the economy
“at this time.”
25. (Leading/Coincident/Lagging) indicators – statistics that tell where
the economy has been.
26. Full employment occurs when we have ______%
4-6 unemployment. The
current unemployment rate is ____%.
7.3
27. (Discouraged workers/Temporary unemployed workers) are those
who have given up looking for a job.
28. The presence of discouraged workers & counting part-time workers as
fully employed results in the official rate being (understated/overstated).
29. If 2 million out of 8 million unemployed workers become “discouraged”
& quit looking for work, the official rate would (incr/decr/be unchanged).
30. If 3 million part time workers switch to full time work, the official rate
will (fall/rise/remain unchanged).
NS 31-49
31. (Frictional/Structural/Cyclical) is “temporary”, “short-term” unemployment.
32. (Frictional/Structural/Cyclical) is technological, “long-term” unemployment.
33. (Frictional/Structural/Cyclical) is unemployment resulting from recessions.
A. FRICTIONAL
B. STRUCTURAL
C. CYCLICAL
___
C 34. Michael lost his job due to the recession [business cycle downturn].
___
A 35. College graduate is searching for his first job.
___
A 36. Amanda is quitting Wendy’s to work at McDonald’s.
___
C 37. There are job losses at Ford due to a decrease in AD.
___
A 38. Lifeguards in the winter and Santa’s during the spring.
___
B 39. The auto replaces carriage makers.
___
B 40. ATM machines replace bank tellers.
45. The cost of unemployment can be measured by the amount by which
(potential/actual) GDP exceeds (potential/actual) GDP.
46. If the unemployment rate is 8%, we can infer that the (potential/actual) GDP
is in excess of (potential/actual) GDP.
47. (Inflation/Disinflation/Deflation) is a general increase in prices.
48. (Inflation/Disinflation/Deflation) is a decline in prices.
49. (Inflation/Disinflation/Deflation) is a decrease in the rate of inflation.
NS 54-60
54. (Demand-pull/Cost-push) inflation results from an increase in
aggregate demand [AD].
55. (Demand-pull/Cost-push) inflation results from an increase in
production costs [wages or input cost].
56. The only group that benefits from inflation are
(creditors/debtors/fixed income pensioners).
unemployment rate [7.3%]
59. The misery index is equal to the _______________________
plus the ________________
inflation rate [1.5%] (These 2 figures chg each month)
8.8% [changes every month]
60. The current misery index is ______.
This changes every month.
Highest ever- June 1980- 21.98%
Lowest ever July 1953- 2.97%
Invented in 1970’s- post-dated back to the 50’s…
Above about 2.0-2.5% inflation is considered too much.
[3.9% in 2008; -0.4% in 2009; and 1.6% in 2010]
Up in 2007 %
Legal Svc 5.2
Col. Tuition 5.8
Tech. Svc. 1.7
Hospitals 5.4
Col. Fees
5.8
Comp. Train5.3
Med. Serv. 5.4
Take some money
out of circulation
to make it more
valuable.
Down in 2007 %
Gasoline
43.1
TVs
19.4
Homes
18.2
Toys
6.8
Girls clothing 3.6
New cars
3.2
Boys clothing 1.1
Furniture
0.1
47. Inflation – overall increase in prices
48. Deflation – decrease in prices (1955)
49. Disinflation – decrease in inflation(1980-83)
Demand-Pull Inflation
[“Good News” – more jobs; “Bad News” – higher prices]
AD2
AS
AD1
E2
PL2
“Bad News”
-higher prices
PL1
E1
“Good News”
- more jobs
Y*
YI
Disinflationary Recessions
[“Good News”–lower prices; “Bad News”–job losses]
AD2
AS
AD1
PL1
PL2
“Good news”
-lower prices
YR
“Bad news”
- job losses
Y*
Adverse Supply Shocks
[“bad news” – job losses; “bad news” – inflation]
AS2
AD
PL2[10%]
AS1
This economy is
Inflating
but
PL1
inflating.
Stagflation
$2.25
Stagnating
This created cognitive
dissonance among many.
stagnating
YR Y*
10%
Traditional Fiscal Policy [“G” & “T”]
will not work with Stagflation
AD1 AD2 AS2
15%
10%
4%
15% 10%
AD3
Y* Stagflation
[“good news”–job gains; “good news”–disinflation]
AD
AS1
AS2
$1.50
PL1
PL2
Y*
Y2
1. PPI – (Production Price Index) wholesale
prices [what retailers are buying]
2. CPI – (Consumer Price Index) retail prices
[what consumers are buying]
3. GDP Deflator – production prices
[what consumers, businesses,
government, and foreigners
are buying that we produced.]
Consumer Price Index (CPI)
Core
Food & energy make up 23% of the CPI. Core inflation
makes sense only for people who “don’t eat or drive.”
[CPI measures cost of living relative to a base year[100]
The CPI is a market basket of 364 items at 23,000
establishments 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.
Clothing
Household 6.6% AlcoholHealth
4.5%
10.0%
4.3%
Recreation
10.4%
Shelter
27.9%
Food
18.0%
Transportation
18.3%
1.
2.
3.
4.
If orange goes
from $1.00 to
$2.00
Substitutes not counted
&
Quality not considered (airbags)
Tomato juice
goes from $1
No discount stores (“outlet bias”)
to .80
New items not counted
a. 1st VCR, the Phillips 1500, the world’s
1st VCR for home use sold for $1,295
but $50 today. They fell in price 70%
before entering the CPI.
1969 Sharp QT-8D Calculator for $475 [4 functions]
[First battery-powered electronic calculator]
b. First solar powered calculators appeared in 1972 for
$120 but didn’t make the CPI until 1978.
c. In 2000, a 20-inch LCD TV cost $5,000, today under $300.
d. Cell phones[The “Brick”]were introduced in 1984 at $3,995.
e. The camcorder cost $1,500 in 1987, now under $150.
f. 50 inch Flat Screen TV in 1999 cost $12,000, now $650.
*These could execute 330,000
1981 IBM PC
4.77MHz
160 KB floppy drives
$3,300
computations per sec(2 billion now).
These had 5 MB disk drives. Today
Dell makes computers with 500GB,
70,000 times larger. Stores were
selling them for $3,300 after buying
them for $2,000.
1991 Compaq 486
33 MHz
120 MB hard drive
$2,300
2011 Dell Optiplex 160
2 GB
320 GB hard drive
$700
M. Dell – 2nd richest TX
He bought parts from
BYTE Magazine for
$600 and sold them
for $1,500-$2,000.
Babe Ruth made $80,000 in 1931. That would
be equivalent to $1.1 mil. today. [Barry Bonds
got $18 million for his last year]
President Herbert Hoover’s salary in 1931
was $75,000. That would be equivalent to
$1,075,657 today. Pres. Obama is being
paid $400,000 a year. President Kennedy
was paid $100,000 in 62 [$730,000 today]
$80,000=$1.1 M
Who is the Richest American Ever?
John D. Rockefeller’s [1839-1937] wealth would be worth
$200 billion in today’s money, or 2 1/2 times that of Bill Gat
($72 Billion).
Although Rockefeller was worth $200 billion, he could not
watch 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 & enhance life.
Perhaps the average American today is richer
than the richest American a century ago.
Presidential pay history *CPI was 218.0 for 2010
Date established
Salary
Salary in 2011 Dollars
CPI
September 24, 1789
$25,000
$631,000 (1789)
March 3, 1873
$50,000
$860,000 (1873)
8.9
$75,000
$1,837,078 (1909)
January 19, 1949
23.8
$100,000
$915,966 (1949)
January 20, 1969
36.7
$200,000
$1,188,010 (1969)
January 20, 2001
177.1
$400,000
$492,000 (2011)
March 4, 1909
Obama would have to make $492,000 to buy what Bush could buy for $400,000 in 2001.
[$400,000 x 218.0/177.1 = $492,000]
1962 Prices v. 2011 Prices
[National Debt - $286 billion]
• Tuition at Harvard - $900
• Starting salary - $6,000
[college graduate]
• FICA of 3.125 of $4,800
[$150 maximum]
• Top marginal tax rate of 91%
of incomes over $200,000.
• New house for $10-15,000
[2.5 times the income of a
new college graduate]
• Coke - .5 cents
• Movies - .50
• Gas, a gallon - $.29
• 1962 Chevy Impala- $1,500
[National Debt - $$316,722,162 so each citizen's
share of this debt is $52,854.90.]
• Tuition at Harvard - $38,891
• Median Starting salary - $45,400
[college graduate]
• FICA of 6.2 of $113,700
[$7,049 maximum]
• Top marginal tax rate of 35%
of incomes over $388,350
• New median house price is
$242,000 [5.5 times the income of
today’s college grads]
• Coke - $1
• Movies - $10
• Gas, a gallon - $3.50
• 2011 Chevy Impala- $25,860
2013 Corvette Grand $59,600
62 Corvette $2,995
Http://objflicks.com/TakeMeBacktotheSixties.htm
Demand-Pull Inflation – increase in AD.
[“Too many dollars chasing too few goods”]
Originates from “buyers side of the market”.
D1 D2 S
P2
P1
“Demand-pull”
D S2
PL2
PL1
S1
Cost-Push Inflation – 3 things may
cause “cost-push” inflation.
“Cost-push”
1. Wage-push – strong labor unions
2. Profit-push – companies increase prices
when their costs increase.
3. Supply-side cost shocks – unanticipated “Wage-price”
Spiral
increase in raw materials such as oil.
Stagflation Periods
[1974-75 and 1981-82]
Although the economy was stagnating, it was inflating, instead of disinflating.
• Who is Hurt by Inflation?
–Fixed-Income Receivers
–Savers
–Creditors
• Who is Unaffected by Inflation?
–Flexible-Income Receivers
• Cost-of-Living Adjustments (COLAs)
–Debtors
–Government (as a big debtor)
benefits big time