Download Fall 2014 Economic Rulers

Economic Rulers
GDP, Deflator, CPI, Unemployment Rate
Simple (Closed)
Circular-Flow Diagram
The Expanded
Circular-Flow Diagram
What is GDP?
• The total value of all final goods and
services produced within a country in
a given period of time
GDP formula
GDP =
C + I + G + (X – M)
Income (Y) =
C + I + G + (X – M)
AD (Aggregate
Demand) =
C + I + G + (X – M)
Components of GDP
What’s included in GDP
• End Module 10
Nominal, Real, & per
capita GDP
Nominal GDP (nGDP) uses current year
prices. There are 2 reasons it could
increase
-- more goods & services are produced by
the economy
-- there is an increase in the price level
(a.k.a. inflation)
-- ex: GDP is currently raising in the US,
some economists think this is due to rise
in price of oil.
Nominal, Real, & per
capita GDP
Real GDP (rGDP) uses base year prices.
This means that one year (e.g. 2000) is
randomly picked and the prices for that
year are used when totaling the RGDP for
all the other years too. There is only 1
reason it could increase
-- more goods & services are produced by
the economy
Nominal, Real, & per
capita GDP
Per capita GDP:
GDP divided by the size of the population;
it is equivalent to the average GDP per
person
-- the greater inequality that exists in income
distribution, the less likely that per capita GDP
will correspond to the “typical” person’s share of
GDP (still standard and best measurement of
standard of living within a nation)
Important:
• Real GDP = Nominal
GDP – inflation
• Real interest rates =
Nominal interest rates
– inflation
• In Econ, NOMINAL
stuff = REAL stuff but
with inflation added!
This graph shows that while output at constant prices rose about four-fold,
at current prices it rose about nineteen-fold or over four times as much.
Still important:
The green line is inflation
calculated from the quarterly
GDP deflator numbers (%
change from 4 quarters
earlier).
The purple line is calculated
from the monthly CPI-U index
(% change from 12 months
earlier).
• The GDP Deflator is an instrument that measures
the change in the price level of products but not
changes in production (broadest price index)
FORMULAS
(you know you love them)
Deflator =
Nominal GDP x
Real GDP
100
Real GDP = Nominal GDP x
GDP Deflator
100
PRACTICE
Assume the following:
Consumer Expenditures
$600
Business Expenditures
$150
Government Expenditures
$200
Imports
$75
Exports
$65
Transfer Payments
$50
Depreciation
$25
1. Calculate the GDP for this economy.
C + I + G + (X - M)
$940
PRACTICE
2. The GDP figure that you calculated above is for Year 1
& is comprised of:
90 econ texts @ $10 each
40 econ workbooks @ $1 each
In Year 2 this same economy produced:
90 econ texts @ $15 each
40 econ worksheets @ $2 each
Calculate Nominal GDP for Years 1 & 2.
(90 x $10) + (40 x $1)
Year 1 GDP $940
(90 x $15) + (40 x $2)
Year 2 GDP $1430
PRACTICE
3. Calculate the GDP deflator for this economy from
Year 1 to Year 2 using the figures provided.
Nominal GDP/Real GDP x 100
$1430/$940 x 100 = 152.13
4. Calculate the real GDP for Year 2 for this economy.
Nominal GDP/Deflator x 100
$1430/152.13 x 100 = $940.00
5. Calculate real GDP if in 2002 nominal GDP is $1000
and the deflator is 200.
Nominal GDP/Deflator x 100
$1000/200 x 100 = 500
2B Friday 9.19
Breaking News…
GDP changes
Sometimes it goes up
Sometimes it goes down
This is called the business cycle
Parts of the Cycle
Peak – top of the cycle, prelude to recession
Recession – 2 consecutive quarters of negative growth
Trough – bottom of the cycle (prob not a depression)
Recovery – growth below the trend line (~3%)
Expansion – growth above the trend line
Boom – an unusually sharp period of growth; steep slope
EXTREME Cycling:
Hyperinflation
• Extreme, rapid, pervasive
inflation
• Leads to the breakdown
of the economic system
• Spend, don’t lend
• Encourages speculation,
hoarding, and investment
in nonproductive wealth
• Inflation arbitrarily
redistributes income
e.g. Argentina’s coupon
barter system
e.g. African entrepreneur’s
refrigerator wealth
EXTREME Cycling:
Hyperinflation
EXTREME Cycling:
Depression
• A severe and
prolonged recession
• Not seen in the U.S.
since the 1930s
• Unlikely to recur due
to automatic
stabilizers and more
activist fiscal and
monetary policies
EXTREME Cycling:
Depression
• Unemployment
wastes resources &
drains the economy
• Long-term
unemployment has
been associated with
increased homicides,
suicides, heart
disease, and mental
illness
Extremes are Yucky!
Employment Act of 1946 has stated it is the
“responsibility of the U.S. government to
promote full employment and production.” (i.e.
stable growth and full employment)
Stable growth: increasing GDP without ruinous
inflation; growth achieved either through an
increase in inputs or an increase in productivity
*productivity is the best key to long term growth
Full Employment
• Everyone able and
willing to work has a
job
OR
• No cyclical
unemployment
• 3 – 6%
• a.k.a. “the natural
rate of
unemployment”
Limitations of GDP as
an Economic Indicator
• Doesn’t count illegal activity
• Doesn’t count legal activity which goes unreported
to evade taxes
• Doesn’t count production outside of the market
economy
Limitations of GDP as
an Economic Indicator
• Doesn’t indicate income distribution
• Doesn’t count environmental effects
Limitations of GDP as
an Economic Indicator
• Doesn’t count the value of leisure
• Doesn’t count improved product quality
The Economic
Supervillian:
Inflation and
Unemployment
Inflation Bc
• Inflation is a sustained &
widespread rise in prices
• Measured by a change in
some price level index
• All indexes express the
cost of a market basket of
goods relative to its cost
in some base year
• Base year = 100
The Consumer Price Index
• The Consumer Price Index (CPI) is the most
popularly used measure of inflation
• The CPI measures the overall cost of goods and
services bought by the “typical” consumer
• The CPI is a weighted index
The Consumer Price Index
“A tsk-it, a tas-kit: the CPI (weighted) basket”
Housing (includes rent,
insurance, maintenance,
utilities, etc.)
41%
Food & Beverages
17%
Transportation
17%
The Consumer Price Index
“A tsk-it, a tas-kit: the CPI (weighted) basket”
Medical Expenses
7%
Clothing
6%
Entertainment
4%
“Other”
7%
Calculate Inflation
with the CPI by…
1. Fixing the basket (fixed items, fixed
quantity
2. Identifying prices at various points in
time
3. Totaling the basket’s cost
4. Choosing a base year & computing the
index
Calculate Inflation
with the CPI by…
4b. CPI Formula:
Current basket amount
Base basket amount
X 100
=
CPI
5. Computing the Inflation Rate
CPI Yr 2 – CPI Yr 1
CPI Yr 1
X 100 = inflation rate
Practice
The only things Logan
citizens ever consume
are bananas and laffy
taffy. Each year
consumers purchase 3
laffy taffy and 2
bananas.
LT
Bananas
2002
$6.00
$1.00
2003
$6.50
$1.25
2004
$6.75
$1.40
2005
$7.15
$1.50
Practice
LT
Bananas
2002 $6.00
$1.00
2003 $6.50
$1.25
2004 $6.75
$1.40
2005 $7.15
$1.50
1. Calculate the total cost of
what a typical consumer
purchases in Logan in each
of the years listed.
2002 ($6 x 3) + ($1 x 2) = $18
+ $2 = $20
2003 ($6.50 x 3) + ($1.25 x 2)
= $19.50 + $2.50 = $22
2004 ($6.75 x 3) + ($1.40 x 2)
= $20.25 + $2.80 = $23.05
2005 ($7.15 x 3) + ($1.50 x 2)
= $21.45 + $3 = $24.45
Practice
2. Using 2003 as the base year,
calculate the consumer
price index for each year.
2002 $20/$22 x 100
90.9
2003 $22/$22 x 100
100
2004 $23.05/$22 x 100
104.8
2005 $24.45/$22 x 100
111.1
2002
2003
2004
2005
LT Bananas
$6.00 $1.00
$6.50 $1.25
$6.75 $1.40
$7.15 $1.50
Practice
2002
2003
2004
2005
LT
Bananas
$6.00
$1.00
$6.50
$1.25
$6.75
$1.40
$7.15
$1.50
3. Use the consumer price index
figures from question 2 to
calculate the rate of inflation from
2002 to 2003, 2003 to 2004, and
2004 to 2005.
2002-2003 (100 – 90.9) / 90.9 x
100
= 10%
2003-2004 (104.8 – 100) / 100
x 100
= 4.8%
2004-2005 (111.1 – 104.8) /
104.8 x 100
= 6.01%
Application: Real
Wage Example
Knowing the inflation rate with the CPI allows
economists to compare the prices of things
across time (e.g. P of labor)
1970
1980
1990
2000
Average
Hourly
Wage
$3.23
$6.66
$10.01
$13.75
CPI
38.8
82.4
130.7
172.2
Application: Real
Wage Example
1970
1980
1990
2000
Average
Hourly
Wage
$3.23
$6.66
$10.01
$13.75
CPI
38.8
82.4
130.7
172.2
Find the decade with the highest real wage using
the following formula:
Real Wage Yr X = Nominal Wage Yr X x 100
CPI Yr X
Application: Real
Wage Example
Average
Hourly
Wage
CPI
1970
$3.23
1980
$6.66
1990
$10.01
2000
$13.75
38.8
82.4
130.7
172.2
Real Wage
$8.32
$8.08
$7.66
$7.99
Answer: $3.23 / 38.8 =
Base Year 1983 ($8.02); 2001 Av. Nom. Hrly
Wage is $14.33 (CPI 177.1) By what % did real
wages change ’83 to ’01?
*less than 1% increase in real wages
The Other Indexes
Producer Price Index (PPI)
-- broader index than the
CPI and measures the cost
of goods (intermediate /
capital) and services
(intermediate) bought by
firms
Useful as a leading economic
indicator – predicts changes
in CPI 6 to 9 months prior to
the occurance
The Other Indexes
GDP Deflator
-- broadest price index
-- NOT weighted
-- measures price level changes of the same
quantity of GDP across time
Why Evil? Inflation’s WMD
Because money is earned and
purchases are made through time,
inflation has the potential to
redistribute income.
Inflation decreases the purchasing
power of dollars
-- 1/price level = purchasing power
Lenders seek a “fair” return for the loan
of their money:
Nominal i rate – real i rate = anticipated
rate of inflation
Inflation
Redistributes
Income (Y)
• Net Debtors
– amount borrowed > the amount saved / lent; GAINS
with unanticipated inflation because borrows dollars
with a higher purchasing power than the dollars used
to repay debt
• Net Creditors
– amount saved / lent > the amount borrowed (e.g.
retirees); HURT with unanticipated inflation because
the value of their assets decreases due to cheaper
dollars (less purchasing power)
Inflation Redistributes
Income (Y)
• Employers
– GAIN if output prices rise
faster than wages (most
common type of inflation);
HURT if wages outpace
output prices
• Employees
– HURT if real wages are
decreased due to faster
rising prices (usual case);
GAIN if reverse is true
(and do not lose job)
Inflation Redistributes
Income (Y)
• Producers
– GAIN if output
prices rise faster
than costs (wages,
machinery, inputs)
• Consumers
– likely HURT
because of eroding
real income (less
purchasing power)
Inflation’s WMD
• Adds uncertainty to the
economy (new ventures may be
tabled due to the uncertain rate
of return)
• Inflation distorts the economy by
encouraging people to buy
more (before the price goes up)
• Deflation – people buy less
while waiting for further price
decreases
Two Types of Inflation
• Cost-Push Inflation
– Costs of production
increase forcing an
increase in the price level
• Demand-Pull Inflation
– Aggregate demand equals
total spending; “too many
dollars chasing too few
goods” bids up the price for
goods and services
‘lation Review
• Inflation
– General increases in all prices across the country
(rule of thumb: keep under 3%)
• Disinflation
– Inflation occurring but at a decreasing rate (lower rate
of inflation than before)
• Deflation
– General decrease in prices across the country (Japan
in 1990s; U.S. in 1930s)
• Hyperinflation
– Collapse of the monetary system due to government
overprinting of money
• Stagflation
– Supply shocks; both unemployment & inflation
increase at the same time
Confessions: Index #
Problem
• There is no perfect
cost of living index
because no two
families buy the exact
same bundle of
goods (retirees v.
teenagers)
• Substitution bias:
prices change
unevenly; consumers
substitute toward less
expensive goods
Confessions: Index # Problem
• Introduction of new
goods: there is a time
lag before new products
are added to the basket
• Unmeasured quality
changes: computers
may cost slightly more
but are more powerful,
etc.
CPI
Specialized (C only)
production)
v.
GDP
Deflator
broader (all
Includes imports (M)
solely domestic production
Fixed basket (weighted)
varied basket (unweighted)
Varied prices
fixed dollars (prices)
*GDP Deflator tends to show slightly higher inflation
compared to the CPI
UNEMPLOYMENT
Unemployment Rate:
# of unemployed people
expressed as a % of the
labor force
Unemployment Rate
=
# unemployed
Total Civilian Labor Force
X 100
Calculating
Unemployment Rate
Solutions
The following formulas should be used to answer the questions in this
problem set:
Labor Force = # of employed + # of unemployed
Unemployment Rate = [(# of unemployed/labor force) x 100] %
Labor Force Participation Rate = [(Labor force/adult population) x 100] %
Adult population200 million
Employed
125 million
Unemployed
8 million
Not in labor force
67 million
1. Calculate the size of the labor force.
Calculating Unemployment Rate
Solutions
1. Calculate the size of the labor force.
# employed + # of unemployed =
(125 million + 8 million) =
133 million in labor force
2. Calculate the unemployment rate.
# of unemployed / labor force x 100 =
8 million / 133 million x 100 =
6%
3. Calculate the labor-force participation rate.
Labor Force / Adult Population x 100 =
133 million / 200 million x 100 =
66.5%
Unemployment
• When actual GDP
grows more slowly
than potential GDP
then unemployment
rises
• When actual GDP
grows faster than
potential GDP then
unemployment falls
Who Counts?
U.S. population
Potential Labor Force
Labor Force
Civilian Labor Force
Labor Force
Participation Rate
280m
(everyone in U.S.)
-70m
(children & institutionalized)
210m (out of labor force: retired, unpaid
-70m rich, students, discouraged)
140m
-2m
(military)
138 million
=
labor force
x 100
adult population
Who Counts?
*approximately 1/3 of adults are not in the labor
force
Employment Definitions
Employed:
anyone with a job –
even part-time or
over qualified
Unemployed:
temporarily laid off or
have actively looked
for work in the past 4
weeks
Types of Unemployment
Frictional Unemployment
voluntarily left to improve
job, short time off, or
improve skills
Structural Unemployment
needs of the economy
have shifted; no further
demand for these workers;
workers tend to be older,
difficult to retrain, unable to
find work near previous
salary; fairly intractable
problem
Types of Unemployment
Seasonal
Unemployment:
temporary & due to
the time of year; selfcorrecting
Cyclical
Unemployment:
due to the business
cycle (recession,
etc.); focus of
government policy
Tape Measure
Problems: the
unemployment rate
• Does not indicate underemployed workers
• Doesn’t count discouraged workers (no longer
looking for a job)
Tape Measure Problems: the
unemployment rate
• Does not indicate length of unemployment
• Doesn’t count disguised unemployment
(involuntarily part-time work, loss of overtime,
shortened hours, etc.)
The Axis of Evil: the
connection
• Generally there is a
negative correlation
between inflation &
unemployment
• Phillips Curve: a
curve that shows the
tradeoff between
inflation and
unemployment
The Axis of Evil: the
connection
• Phillips Curve is
downward
sloping
• Higher inflation
rates are
associated with
lower
unemployment
rates
Effects
• High unemployment wastes resources (lost
output)
• “full” employment varies (3 – 6% unemployment)
2 Solutions
Governments seek to
mitigate the effect of
the business cycle
(inflation &
unemployment) in
pursuit of growth,
price stability, and
full employment by
using two
strategies…
Solutions
2
Fiscal Policy –
manipulation of
government money
flows (spending &
taxation)
Monetary Policy –
manipulation of the
money supply (&
interest rates) by the
Federal Reserve