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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