Download Production and Cpi Day 2010

Business Cycle
[Real GDP per year]
Peak
Peak
Trough
One Cycle
Time
[Have averaged five years]
Expansion: an upturn - real GDP rises.
Peak: real GDP reaches its maximum.
Recession: real GDP declines 6 months.
Trough: real GDP reaches its minimum.
TOTAL SPENDING EFFECTS
BUSINESS CYCLE
• IF SPENDING DROPS BUSINESS PRODUCE
LESS AND THEREFORE NEED LESS
EMPLOYEES WHICH CAUSES A
DOWNTURN IN THE ECONOMY OR
BUSINESS CYCLE
• IF PEOPLE ARE SPENDING MORE
BUSINESSES PRODUCE MORE AND
THEREFORE NEED TO HIRE MORE PEOPLE
WHICH CAUSES THE CYCLE TO EXPAND
OR RECOVER.
Vocabulary You need to memorize
NET NATIONAL PRODUCT
• IS THE TOTAL INCOME
OF A NATIONS
Permanent RESIDENTS
MINUS LOSSES FROM
DEPRECIATION
• Depreciation is when
things become worth less
because of time or use. A
new car losses its value
as soon as you drive it off
the lot.
What is depreciation?
• Depreciation is when
things become worth
less because of time
or use. A new car
losses its value as
soon as you drive it
off the lot.
National Income
• Is the total income
earned by a nation’s
residents in the
production of goods
and services.
Personal Income
• Income that
households and
noncorporate
businesses receive.
Disposable Income
• Is money left over
after satisfying all
their obligations to the
government=Personal
income–personal
taxes.
Productivity
Why Productivity Is So Important
Productivity plays a key role in
determining living standards for
all nations in the world.
LAW OF Diseconomies of Scale
© 2007 Thomson South-Western
Productivity: Its Role and Determinants
– Productivity plays a key role in determining living
standards for all nations in the world.
– To understand the large differences in living
standards across countries, we must focus on the
production of goods and services.
© 2007 Thomson South-Western
ECONOMIC GROWTH AND
PUBLIC POLICY
• Government policies that raise productivity
and living standards
–
–
–
–
Encourage saving and investment.
Encourage investment from abroad.
Encourage education and training.
Establish secure property rights and maintain
political stability.
– Promote free trade.
– Promote research and development.
© 2007 Thomson South-Western
Improved Products - iceboxes to refrigerators
“Knee Buster” foot pedal
[step on it & the door opens]
Icebox – cooled by
“natural” ice
1927 GE Monitor Top
electric refrigerator-$300
From LPs to CDs
Added Leisure
[Workweek decreased
from 50 to 35 hours]
It takes $9.00 to buy what $1 did in 1948.
The Tucker Torpedo
would cost $22,050] today.
1948 Tucker[2,450]
10 inch image 12 inch image
$485
10 inch image
would cost
$4,325 in 2010
$695
12 inch image
would cost
$6,197 in 2010
20 inch image
$2,495
20 inch image
would cost
$22,249 in 2010
The 1st portable cell phone(1984) [Motorola’s “The Brick”]
took 10 years and $150 million to develop, and cost $3,995.
It weighed 2 pounds and offered just a half-hour of talk
time for every10 hr recharge. Consumers lined up in droves to
buy the world’s first cell phone. Service We want the “brick.”
Only $3,995, we want 2.”
was $150 a month.
It was called the Dyna TAC 800X. Motorola
says the wafer-thin RAZR represents the
tip of the iceberg of what phone designers
will be able to do. iPhone weighs about 5 oz.
Cell phones, like computers, have become
smaller, smarter, and cheaper. The $3,995
would be like $8,000 today, more expensive
than a large screen plasma TV.
The 2 pound “Brick”
ENIAC [Electronic Numerical Integrator And Computer]
First Computer built in 1946-$486,804.22
1st general purpose electronic digital computer,
being as big as a 3-bedroom house. It weighed 30
tons, was 80 ft long & had 17,468 vacuum
tubes. Price was $486,804.22.[the “beast”]
The first computer, at 30-tons, $486,804,
and with 17,468 vacuum tubes, could not
do as much as a microchip no bigger than
the mole on Cindy’s face.
*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
2010 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.
Factors that shift out the PPC also increase productivity.
Determinants of Productivity increase a country’s growth.
1. Stock of physical capital [tools & machinery increase productivity]
a. Try writing a term paper without a computer.
b. Try painting a fence without a brush.
c. Increasing the quantity of physical capital in an
economy can increase the quantity of more capital.
2. Human Capital [knowledge & skills makes labor more productive]
a. College courses and improved health increase productivity.
b. A nurse who studies to become a physician’s
assistant is increasing her human capital.
3. Natural Resources
a. A nation’s stocks of minerals, fertile soil, timber,
and navigable waterways contribute to productivity.
4. Technology [knowledge of how to produce goods in the best possible way]
[All of these productivity determinants require an investment, and
funds for investment come from saving. [Goal of supply-side economics]
4 Ways to Increase Productivity in
an economy
• Physical Capital or
Capital-These are the
tools to help with
production
How Productivity Is Determined
• Physical capital per worker is the stock of
equipment and structures that are used to
produce goods and services.
• Physical capital includes:
• Tools used to build or repair automobiles.
• Tools used to build furniture.
• Office buildings, schools, etc.
• Physical capital is a produced factor of
production.
• It is an input into the production process that in the past was
an output from the production process.
© 2007 Thomson South-Western
4 Ways to Increase Productivity in
an economy
• Human Capital-Production increases
when you have more education or
knowledge
How Productivity Is Determined
• Human capital per worker is the economist’s
term for the knowledge and skills that workers
acquire through education, training, and
experience.
• Like physical capital, human capital raises a
nation’s ability to produce goods and services.
© 2007 Thomson South-Western
4 Ways to Increase Productivity in
an economy
• Natural Resourcesland, rivers, and
mineral deposits.
How Productivity Is Determined
• Natural resources are inputs used in production
that are provided by nature, such as land, rivers,
and mineral deposits.
• Renewable resources include trees and forests.
• Nonrenewable resources include petroleum and
coal.
• Natural resources can be important but are not
necessary for an economy to be highly
productive in producing goods and services.
© 2007 Thomson South-Western
4 Ways to Increase Productivity in
an economy
Technological
Knowledge-society’s
understanding of the
best ways to produce
goods and services
How Productivity Is Determined
• Technological knowledge includes society’s
understanding of the best ways to produce
goods and services.
• Human capital includes the resources expended
transmitting this understanding to the labor
force.
© 2007 Thomson South-Western
Saving and Investment
• One way to raise future productivity is to invest
more current resources in the production of
capital.
© 2007 Thomson South-Western
Education
• An educated person might generate new ideas
about how best to produce goods and services,
which in turn, might enter society’s pool of
knowledge and provide an external benefit to
others.
• One problem facing some poor countries is the
brain drain — the emigration of many of the
most highly educated workers to rich countries.
© 2007 Thomson South-Western
• High Productivity Makes Products Cheaper.
The more productive your workers are the less
each product you produce costs. This brings the
price of goods down which means more people
in society can afford them.
• Therefore productivity helps society become
more wealthy.
© 2007 Thomson South-Western
Inflation
•
•
•
•
•
•
•
•
•
•
•
•
•
How is the CPI market basket determined?
The CPI market basket is developed from detailed expenditure information provided by
families and individuals on what they actually bought. For the current CPI, this information
was collected from the Consumer Expenditure Surveys for 2007 and 2008. In each of those
years, about 7,000 families from around the country provided information each quarter on
their spending habits in the interview survey. To collect information on frequently
purchased items, such as food and personal care products, another 7,000 families in each of
these years kept diaries listing everything they bought during a 2-week period.
Over the 2 year period, then, expenditure information came from approximately 28,000
weekly diaries and 60,000 quarterly interviews used to determine the importance, or weight,
of the more than 200 item categories in the CPI index structure.
What goods and services does the CPI cover?
The CPI represents all goods and services purchased for consumption by the reference
population (U or W) BLS has classified all expenditure items into more than 200 categories,
arranged into eight major groups. Major groups and examples of categories in each are as
follows:
FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, full service
meals, snacks)
HOUSING (rent of primary residence, owners' equivalent rent, fuel oil, bedroom furniture)
APPAREL (men's shirts and sweaters, women's dresses, jewelry)
TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance)
MEDICAL CARE (prescription drugs and medical supplies, physicians' services,
eyeglasses and eye care, hospital services)
RECREATION (televisions, toys, pets and pet products, sports equipment, admissions);
EDUCATION AND COMMUNICATION (college tuition, postage, telephone services,
computer software and accessories);
OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other
personal services, funeral expenses).
Does not include
• Core Consumer Price Index:
• Two measures of inflation are often reported: Core CPI, which does
not include food and energy cost, and non-core CPI, which includes
everything. Core CPI is important because this is what the Federal
Reserve looks at to decide whether or not to raise the Fed Funds rate.
The Fed uses the Core CPI because food and energy, specifically
gasoline, are so volatile and the Fed's tools are so slow-acting.
Therefore, inflation could be high if gas prices have increased
dramatically, but the Fed won't react until those increases trickle
through to the prices of other goods and services
• More important, the CPI does not include sales price of homes.
Instead, it calculates the monthly equivalent of owning a home, which
it derives from rents. This is very misleading, since rental prices are
likely to drop when there is high vacancy, usually when interest rates
are low and housing prices are rising. Conversely, when home prices
are dropping due to high interest rates, rents tend to increase.
Therefore, the CPI gives a false low reading when home prices are
high (and rents are low). This is why it did not warn of asset inflation
during the housing bubble of 2005.
• Calculator for different years.
• http://146.142.4.24/cgibin/cpicalc.pl?cost1=100.00&year1=1921&
year2=2011
• Top movie adjusted for inflation
• http://boxofficemojo.com/alltime/adjusted.h
tm
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February 7, 2012, 12:01 PM
Bernanke Tries to Keep Balance on Inflation, Jobs
Article
Comments (6)
REAL TIME ECONOMICS HOME PAGE »
By Jon Hilsenrath
Federal Reserve Chairman Ben Bernanke makes an interesting point at his
Senate Budget Committee hearing about how the Fed pursues its inflation
and employment mandates symmetrically.
•
– Published Credit: Associated Press
•
The law requires the Fed to pursue stable prices and maximum employment.
Mr. Bernanke has said before that if inflation were above the Fed’s 2%
target at a time of high unemployment, the Fed might not be very aggressive
about raising interest rates to bring inflation down quickly because it would
want to avoid making the job situation worse.
Inflation
• Inflation-is a rise in prices
• Does not mean all prices go up but on AVG
prices go up.
• During periods of inflation some prices
even go down
Future Value of Money and Present
Value of Money
• Money is worth less in the future because of
inflation.
• Half Gal. milk – .25 delivered fresh
• Loaf of bread – 8 cents
• Stamps – 3 cents
• Postcards – 1 cent
• Median cost of a house - $2,900
• Median monthly rent - $24
• Average 1940 car price - $650
• Coke – 3 cents
1962 Prices v. 2010 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 - $$12.1 trillion]
• Tuition at Harvard - $32,557
• Starting salary - $44,000
[college graduate]
• FICA of 7.65 of $106,800
[$8,170 maximum]
• Top marginal tax rate of 35%
of incomes over $357,700
• New median house price is
$242,000 [5.5 times the income of
today’s college grads]
• Coke - $1
• Movies - $10
• Gas, a gallon - $2.44
• 2010 Chevy Impala- $27,650
2010 Corvette Grand $60,000
62 Corvette $2,995
Http://objflicks.com/TakeMeBacktotheSixties.htm
Box Office Receipts
Movie
Receipts (mil.)
What was the most popular movie of all time?
[Mr. Index Goes To Hollywood]
1. Avatar
$750 Inflation-Adjusted Receipts
2. Titanic
601 Movie
Year Receipts(mil.)
3. Dark Knight
533 1. Gone With the Wind 1939 $1,485
1977
1,309
4. Star Wars (1977)
461 2. Star Wars
1965
1,048
5. Shrek
441 3. Sound of Music
4. ET
1982
1,043
6. ET (1982)
435 5. Ten Com.
1956
962
7. Star Wars[Pha. Men] 431 6. Titanic
1997
943
1975
850
8. Pirates of Caribbean 423 7. Jaws
1965
804
9. Spiderman
404 8. Dr. Zhivago
9. Avatar
2009
750
10.LOTR: Return King 377 10. The Jungle Book
1967
720
11.Spiderman II
373 11. Snow White
1937
706
12.Passion of Christ 370 What about “Gone With The Wind”
13.Jurassic Park
357 in 1939? #90 [$200 million]
14.Lord Rings(TT)
341 www.the-movie-times.com
15.Finding Nemo
340
16.Forrest Gump
330
Babe Ruth made $80,000 in 1931. That would
be equivalent to $1 million today. [Barry Bonds
got $18 million a year]
President Herbert Hoover’s salary in 1931
was $75,000. That would be equivalent to
$900,000 today. George Bush is being
paid $400,000 a year. President Kennedy
was paid $100,000 in 62 [$650,000 today] $80,000=$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 4 times that of Bill Gates.
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.
From 1860-1945, deflation occurred about as often as
inflation. It took $1.50 to buy what a dollar bought in
1860.
From 1960-1994, the average Argentine inflation was 127%
per year. Or, $1 billion in savings in 1960 gave you 1/13th
of a penny of purchasing power in 1994.
Hyperinflation in Brazil 1988-1994
If we had their same inflation for these six
years, blue jeans would have gone from $35
to $140 million per pair; gas from $2.75 per
gallon to $5 million per gallon; and $20 for
a pizza and a movie would now cost $90 mil.
Dinner for two cost $120 mil. [In $100 dollar
bills, this would weigh more than a ton.
• 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.
Consequences of Inflation
• Shrinking Incomes-People that don’t get raises at the same rate
as inflation are actually losing money each year. If inflation is
3% and their raise is 2% they are actually making less money the
next year because their dollar can’t buy as much as it could
before.
• Changes in Wealth-if inflation rise dramatically people that had
money in the bank find that their savings are not worth anything.
• Effect on Interest Rates-if inflation is happening interest rates go
up. If a bank loans out money and anticipates that inflation will
go up they know money will be worth less in the future so to
protect themselves they will raise interest rates. So they will get
more of the money back from the loan because they know it will
be worth less in the future.
Who wins/loses with 20% Unanticipated Inflation?
[Creditors, Debtors, Savers]
The debtor wins with 20% unanticipated inflation.
(some examples)
1. In 1914, total German mortgage debt was $10
billion
marks.
In 1923, $10 billion marks was worth 1 cent. All debt was wiped out.
2. Signed union contracts agreeing to 3% raises for next 3 years.
(A $30,000 salary would increase to $32,782 but it would
take $51,840 to buy what $30,000 would buy 3 years before)
3. Signed union contracts agreeing to COLAs for next 3 years.
(So a $30,000 salary of 3 years ago would now pay $51,840
which would buy what $30,000 would buy 3 years ago.
4. Your Econ teacher buys a $300,000 CD from the 1st Econ Bank
which pays him 5% interest for the next 3 years. [Saver]
Mr. Econ would earn $47,288 in interest at 5%, however at
20%, he could earn $218,400.] So the saver looses here.
Demand-Pull and Cost-Push
Inflation
• Demand pull-if consumers want more then producers can
produce that drives up prices. Think of an Auction. If there
is only one of something and more people then one want it
that will drive up the price of that good.
• Cost-Push-The cost of goods are going up because
production cost go up. If workers are not producing well
then cost for things go up. If a worker used to produce 10
cars an hour and now only can produce 5 the avg cost of
each car goes up.
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.
The Consumer Price Index
•
•
•
The consumer price
index (CPI) is a
measure of the
overall cost of the
goods and services
bought by a typical
consumer.
The Bureau of Labor
Statistics reports the
CPI each month.
It is used to monitor
changes in the cost of
living over time.
1
2
The Consumer Price Index
When the CPI rises, the typical
family has to spend more
dollars to maintain the same
standard of living.
The GDP Deflator versus the Consumer
Price Index
• Economists and policymakers monitor both the
GDP deflator and the consumer price index to
gauge how quickly prices are rising.
• There are two important differences between
the indexes that can cause them to diverge.
© 2007 Thomson South-Western
The GDP Deflator versus the Consumer
Price Index
• The GDP deflator reflects the prices of all
goods and services produced domestically,
whereas...
• …the consumer price index reflects the prices
of all goods and services bought by consumers.
© 2007 Thomson South-Western
The GDP Deflator versus the Consumer
Price Index
• The consumer price index compares the price of
a fixed basket of goods and services to the price
of the basket in the base year (only occasionally
does the BLS change the basket)...
• …whereas the GDP deflator compares the price
of currently produced goods and services to the
price of the same goods and services in the base
year.
© 2007 Thomson South-Western
GDP Deflator compared to the CPI
[CPI is normally higher.]
Percent
per Year
15
CPI
10
5
0
GDP deflator
1965
1970
1975
1980
1985
1990
1995
2000
Copyright©2004 South-Western
Clothing
Household 6.6% AlcoholHealth
4.5%
10.0%
4.3%
Recreation
10.4%
Shelter
27.9%
Food
18.0%
Transportation
18.3%
Inflation Song
• Song
•
•
Million Dollars link
If I had a 1,000,000 (If I had a 1,000,000)
I'd but you a house ( I would buy you a house)
If I had a 1,000,000 (If I had a 1,000,000)
I'd buy you furniture for your house ( maybe a nice chesterfield or an ottoman)
If I had a 1,000,000 (If I had a 1,000,000)
I'd but you a K-car ( a nice reliant automobile)
If I had a 1,000,000, I'd buy you love
If I had a 1,000,000
I'd build a treefort in our yard
If I had a 1,000,000
You could help it wouldn't be that hard
If I had a 1,000,000
Maybe we could put a refrigerator in there
Wouldn't that be fabulous!
If I had a 1,000,000 (If I had a 1,000,000)
I but you a fur coat( but not a real fur coat that's cruel)
If I had a 1,000,000 (If I had a 1,000,000)
I'd buy you an exotic pet(like a llama or an emu)
If I had a 1,000,000 (If I had a 1,000,000)
I'd but you John Merick's remains (All them crazy elephant bones)
If I had a 1,000,000 I'd buy your love
If I had a 1,000,000
We wouldn't have to walk to the store
If I had a 1,000,000
We'd take a limousine cause it costs more
If I had a 1,000,000 We wouldnt have to eat Kraft dinner
If I had a 1,000,000 (If I had a 1,000,000)
i'd but you a green dress ( but not a real green dress that's cruel)
If I had a 1,000,000 (If I had a 1,000,000)
I'd but you some art ( A Picasso or a Garfunkel)
If I had a 1,000,000 (If I had a 1,000,000)
I'd buy you a monkey (haven't you always wanted a monkey?)
If I had a 1,000,000 If I had a 1,000,000 If I had a 1,000,000
If I had a 1,000,000 I'd be RICH!
 cost of basket in current year 
CPI = 
  100
 cost of basket in base year 
 CPIYear 2 - CPIYear 1 
  100%
inflation rate = 
CPIYear 1


The Inflation Rate
The inflation rate is calculated as follows:
CPI in Year 2 - CPI in Year 1
Inflation Rate in Year2 
 100
CPI in Year 1
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Calculating the Consumer Price Index and
the Inflation Rate: An Example
Step 1:Survey Consumers to Determine a Fixed
Basket of Goods
4 hot dogs, 2 hamburgers
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Calculating the Consumer Price Index
and the Inflation Rate: An Example
Step 2: Find the Price of Each Good in Each Year
Fix the basket
4 hot dogs, 2 hamburgers
Year
Price of
Hot dogs
Price of
Hamburgers
2001
$1
$2
2002
$2
$3
2003
$3
$4
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Calculating the Consumer Price Index and
the Inflation Rate: An Example
Step 3: Compute the Cost of the Basket of Goods in
Each Year
2001
($1 per hot dog x 4 hot dogs) + ($2 per hamburger x 2 hamburgers) = $8
2002
($2 per hot dog x 4 hot dogs) + ($3 per hamburger x 2 hamburgers) = $14
2003
($3 per hot dog x 4 hot dogs) + ($4 per hamburger x 2 hamburgers) = $20
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Calculating the Consumer Price Index and the
Inflation Rate: An Example
Step 4: Choose One Year as the Base Year (2001) and
Compute the Consumer Price Index in Each Year
2001
($8/$8) x 100 = 100
2002
($14/$8) x 100 = 175
2003
($20/$8) x 100 = 250
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Calculating the Consumer Price Index and the
Inflation Rate: An Example
Step 5: Use the Consumer Price Index to Compute the
Inflation Rate from Previous Year
2002
(175-100)/100 x 100 = 75%
2003
(250-175)175 x 100 = 43%
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Calculating the Consumer Price Index and the
Inflation Rate: Another Example
 Base Year
is 1998.
 Basket of goods in 1998 costs $1,200.
 The same basket in 2000 costs $1,236.
 CPI = ($1,236/$1,200) X 100 = 103.
 Prices increased 3 percent between 1998
and 2000.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Table 1 Calculating the Consumer Price Index and the
Inflation Rate: An Example
© 2007 Thomson South-Western
Table 1 Calculating the Consumer Price Index and the
Inflation Rate: An Example
© 2007 Thomson South-Western
How the Consumer Price Index Is
Calculated
• Calculating the Consumer Price Index and the
Inflation Rate: Another Example
•
•
•
•
•
Base Year is 2002.
Basket of goods in 2002 costs $1,200.
The same basket in 2004 costs $1,236.
CPI = ($1,236/$1,200)  100 = 103.
Prices increased 3 percent between 2002 and 2004.
© 2007 Thomson South-Western
•
•
ALTERNATIVE CLASSROOM EXAMPLE:
Using the example from Chapter 22:
– .Fix the basket: 3 footballs and 4 basketballs.
– .Find the prices:
•
•
•
•
Year Price of Footballs
Year 1
$10
Year 2
12
Year 3
14
Price of Basketballs
$12
15
18
–
–
–
–
.Compute the Cost of the Basket:
Cost in Year 1 = (3 × $10) + (4 × $12) = $78
Cost in Year 2 = (3 × $12) + (4 × $15) = $96
Cost in Year 3 = (3 × $14) + (4 × $18) = $114
–
–
–
–
.Using Year 1 as the base year, compute the index:
CPI in Year 1 = ($78/$78) × 100 = 1 × 100 = 100
CPI in Year 2 = ($96/$78) × 100 = 1.2308 × 100 = 123.08
CPI in Year 3 = ($114/$78) × 100 = 1.4615 × 100 = 146.15
– .Compute the inflation rate:
– Inflation rate for Year 2 = [(123.08 – 100)/100] × 100% = 23.08%
– Inflation rate for Year 3 = [(146.15 – 123.08)/123.08] × 100% = 18.74%
Fixed basket of goods: 100 heads
of cauliflower, 50 bunches of
broccoli, 500 carrots
•
•
•
•
•
Year
Cauliflower
Broccoli Carrots
2001 $2
$1.50
$0.10
2002 $3
$1.50
$0.20
Compute CPI For 2001 and 2002
Use the CPI to compute the inflation rate
from the previous year
• Compute the cost of the basket of goods in each year:
• 2001: (100 x $2) + (50 x $1.50) + (500 x $.10) = $325
• 2002: (100 x $3) + (50 x $1.50) + (500 x $.20) = $475
• Choose one year as a base year (2001) and compute
the CPI in each year:
• 2001: $325/$325 x 100 = 100
• 2002: $475/$325 x 100 = 146
• Use the CPI to compute the inflation rate from the
previous year:
• 2002: (146-100)/100 x 100% = 46%
•
•
•
•
•
•
•
Baseballs
Price
Quantity
2001
10
50
2002
15
30
2003
20
20
Nominal GDP for 2001, 2002, 2003?
•
Real GDP for 2001, 2002, 2003
•
Deflator for 2001, 2002, 2003
•
Inflation rate according to Deflator 2001, 2002, 2003
•
If the Basket is 2 baseballs and three basketballs (assume 2001 is base
year)
•
What is CPI For 2001
•
What is CPI for 2002
•
What is CPI for 2003
•
Inflation Rate in 2001,2002, 2003?
Quiz 2
Basketballs
Price
Quantity
10
100
20
80
60
70
•
•
•
•
•
•
•
•
•
•
Baseballs
Price
Quantity
Price
2001
10
50
10
2002
15
30
20
2003
20
20
60
Nominal GDP for 2001, 2002, 2003?
2001=$1500 2002= $2050
2003=$4600
Real GDP for 2001, 2002, 2003
2001=$1500 2002=$1100
2003=$900
•
•
Deflator for 2001, 2002, 2003
2001=100 2002=186
2003=511
•
•
Inflation rate according to Deflator 2001, 2002, 2003
2001= 0% 2002= 86%
2003=174%
•
•
•
•
•
•
•
•
•
Quiz 2
Basketballs
Quantity
100
80
70
If the Basket is 2 baseballs and three basketballs(2001 is baseyear)
What is CPI For 2001
= 100
What is CPI for 2002
= 180
What is CPI for 2003
=440
Inflation Rate in 2001,2002, 2003?
2001= 0% 2002= 80% 2003= 144%
•
Baseballs
•
•
•
•
•
Basketballs
Price
Quantity
Price
2001
10
10
5
2002
12
20
7
2003
15
30
8
Nominal GDP for 2001, 2002, 2003?
•
Real GDP for 2001, 2002, 2003
•
Deflator for 2001, 2002, 2003
•
Inflation rate according to Deflator 2001, 2002, 2003
•
•
If the Basket is 2 baseballs and three basketballs(2001 is baseyear)
What is CPI For 2001
•
What is CPI for 2002
•
What is CPI for 2003
•
Inflation Rate in 2001,2002, 2003?
Quantity
5
10
24
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Baseballs
Basketballs
Price
Quantity
Price
Quantity
2001
10
10
5
5
2002
12
20
7
10
2003
15
30
8
24
Nominal GDP for 2001, 2002, 2003?
2001=125
2002=310 2003=642
Real GDP for 2001, 2002, 2003
2001=125 2002=250 2003=420
Deflator for 2001, 2002, 2003
2001=100
2002=124 2003=153
Inflation rate according to Deflator 2001, 2002, 2003
2001=0% 2002=24% 2003=22%
If the Basket is 2 baseballs and three basketballs(2001 is baseyear)
What is CPI For 2001
100
What is CPI for 2002
128.5
What is CPI for 2003
154.3
Inflation Rate in 2001,2002, 2003?
2001=0%
2002=28.5% 2003=20.3%
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
2001
$1
$2
2002
$2
$3
Step 3. Compute the market basket cost for each year.
2001 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4), so $8
2002 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6), so $14
Step 4. Choose one year as a base year (2001) and compute the CPI
2001 ($8/$8) x 100 = 100
2002 (14/$8) x 100 = 175
Step 5. Use the CPI to compute the inflation rate from previous year
2002 (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?
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%.
[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
x100 = 3.3%
130.7-124.0(6.7)
116-120(-4)
124.0 x 100 = ____
120 x 100 = ____
-3.3%
5.4%
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)%.
(42%) 18. Suppose that a consumer buys the following quantities of
these three commodities in 2000 and 2001.
Commodity
Quantity
2000 per Unit Price
Food
Clothing
Shelter
5 units
2 units
3 units
$6.00
$7.00
$12.00
2001 per Unit Price
$5.00
$9.00
$19.00
Which of the following can be concluded about the CPI for this individual
from 2000 to 2001?
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 [2000]: [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 2000)
Year 2 [2001]: [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 2001)
Change
Original =
$100-$80 [$20]
$80
x 100 = 25%;
so the CPI for this individual is 25%.
Dollar Figures from Different Times
• Do the following to convert dollar values from
year T into today’s dollars:
Amount in
 Amount in
today’s dollars
year T’s dollars
Price level today
Price level in year T
© 2007 Thomson South-Western
Dollar Figures from Different Times
• Do the following to convert (inflate) Babe
Ruth’s wages in 1931 to dollars in 2005:
Salary2005  Salary1931
Price level in 2005
Price level in 1931
195
 $80,000
15.2
 $ 1,026,316
© 2007 Thomson South-Western
Dollar Figures from Different Times
•
Do the following to convert (inflate) Babe
Ruth’s wages in 1931 to dollars in 1995:
Salary
1999
= Salary
1931
Price level in 1999

Price level in 1931
166
= $80,000 
15.2
= $873,684
• To change dollar values from one year to the
next, we can use this formula:
•
2. Example: Babe Ruth’s 1931 salary in 1999
dollars:
•
Salary in 1999 dollars = Salary in
1931 dollars × price level in 1999
• price level in 1931
•
• Salary in 1999 dollars = $80,000 × (166/15.2).
• Salary in 1999 dollars = $873,684.
• ALTERNATIVE CLASSROOM
EXAMPLE:
• Your father graduated from school and
took his first job in 1972, which paid a
salary of $7,000. What is this salary worth
in 1999 dollars?
• CPI in 1972 = 41.8
• CPI in 1999 = 166
• ALTERNATIVE CLASSROOM EXAMPLE:
• Your father graduated from school and took his first job
in 1972, which paid a salary of $7,000. What is this
salary worth in 1999 dollars?
• CPI in 1972 = 41.8
• CPI in 1999 = 166
• Value in 1999 dollars = 1972 salary × (CPI in 1999/CPI
in 1972)
• Value in 1999 dollars = $7,000 × (166/41.8) = $7,000 ×
3.97 = $27,790
• CPI 2010=339
• CPI 2000=300
• Salary of Michael Jordan was 3,500,000
what is that equivalent to today?
• Grant Smith was a doctor in 1944 and
earned $12,000 that year. His daughter,
Lisa Smith, is a doctor today and she
earned $210,000 in 2005. The price index
in 1944 was 17.6 and the price index in
2005 was 184.
• What was her father getting paid in 2005
dollars?
• What would she have gotten paid in 1944?
• Ingrid took a university teaching job as an
assistant professor in 1974 at a salary of
$10,000. By 2003, she had been promoted
to full professor, with a salary of $50,000.
If the price index in 1974 was 50 and the
price index in 2003 was 180, what is
Ingrid's 2003 salary in 1974
• ALTERNATIVE CLASSROOM
EXAMPLE:
• Your father graduated from school and
took his first job in 1972, which paid a
salary of $7,000. What is this salary worth
in 1999 dollars?
• CPI in 1972 = 41.8
• CPI in 1999 = 166
• ALTERNATIVE CLASSROOM EXAMPLE:
• Your father graduated from school and took his first job
in 1972, which paid a salary of $7,000. What is this
salary worth in 1999 dollars?
• CPI in 1972 = 41.8
• CPI in 1999 = 166
• Value in 1999 dollars = 1972 salary × (CPI in 1999/CPI
in 1972)
• Value in 1999 dollars = $7,000 × (166/41.8) = $7,000 ×
3.97 = $27,790
Inflation Summary
•
Causes and theories of inflation:
• 1. Demand-pull inflation: Spending increases faster than
production. (See Figure 8-7) Inflation will occur in range
2 and range 3 of this illustration. Bottlenecks occur in
some industries in range 2, and output cannot expand to
meet demand in these industries so producers raise prices;
in Range 3 full employment has been reached and resource
prices will rise with increasing demand, causing producers
to raise prices. Note: Chapter 7’s distinction between
nominal and real GDP is helpful here.
Inflation Summary
• 2. Cost-push or supply-side inflation: Prices rise
because of rise in per-unit production costs (Unit
cost = total input cost/units of output).
• a. Wage-push can occur as result of union
strength.
• b. Supply shocks may occur with unexpected
increases in the price of raw materials.
• Complexities: It is difficult to distinguish between
demand-pull and cost-push causes of inflation,
although cost-push will die out in a recession if
spending does not also rise.
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.
Interest Rates
• Nominal interest rates –Inflation or
expected inflation= Real interest rates
• Real Interest rate includes taking out of
inflation. So it is the real interest you
receive.
Interest Rates
• Nominal interest rate [5%]
– Measures interest in terms of the current
dollars paid [let’s say 5% on a 3-month T-bill]
– Appears on the borrowing agreement
– The rate quoted in the news media
• Real interest rate [3%]
– Equals the nominal rate of interest [5%] minus
the anticipated inflation rate [let’s say 2%]
– Expressed in dollars of constant purchasing
power [3%]
Interest Rates
• With no inflation, the nominal and real interest
rates would be identical [let’s say, 3%]
• With inflation [2%], the nominal interest rate [5%]
exceeds the real interest rate [3%]
– If the inflation rate is high enough [6%], the real interest
rate can actually be negative [ -1% or 5% - 6% = -1%]
– The nominal interest would not even offset the loss in
spending power because of inflation, so lenders would
lose purchasing power
– This is why lenders and borrowers are concerned
more about the real interest rate than the nominal
interest rate
Interest Rates
(percent
per year)
15
10
Nominal interest rate
5
0
Real interest rate [negative
–5
1965
1970
1975
1980
1985
1990
here]
1995
2000
Copyright©2004 South-Western
[Real I.R. + anticipated inflation = nominal I.R.]
+
6%
Real
Interest
Rate
=
8%
=
Nominal
Interest
Rate
Inflation
+ Premium
[Nominal I.R. – inflation rate = Real I.R.]
-
2%
8%
Nominal
Interest
Rate
-
Inflation
Premium
=
6%
=
Real
Interest
Rate
2 (c) Suppose that the nominal interest rate has been 6% with no expected inflation.
If inflation is now expected to be 2%, determine the value of each of the following.
(i) The new nominal interest rate
(ii) The new real interest rate
2(c)(i): The nominal interest rate is 8%.
[6% real + 2% expected inflation premium]
2(c)(ii): The new real interest rate would be 6%.
[8% new nominal in. rate – 2% anticipated inflation = 6% real I.R.]
6%
Real
Interest Rates
Real and Nominal Interest Rates
•
•
•
You borrowed $1,000 for one year.
Nominal interest rate was 15%.
During the year inflation was 10%.
Real interest rate = Nominal interest rate – Inflation
= 15% - 10% = 5%
Real and Nominal Interest Rates
• Interest represents a payment in the future for a
transfer of money in the past.
© 2007 Thomson South-Western
Real and Nominal Interest Rates
• The nominal interest rate is the interest rate
usually reported and not corrected for inflation.
• It is the interest rate that a bank pays.
• The real interest rate is the interest rate that is
corrected for the effects of inflation.
© 2007 Thomson South-Western
Real and Nominal Interest Rates
•
•
•
•
You borrowed $1,000 for one year.
Nominal interest rate was 15%.
During the year inflation was 10%.
Real interest rate = Nominal interest rate –
Inflation
• = 15% – 10% = 5%
© 2007 Thomson South-Western
[Nominal income – inflation rate = Real Income]
Nominal
Income
=
Inflation
Premium
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”
Figure 3 Real and Nominal Interest Rates
Interest Rates
(percent
per year)
15%
Nominal interest rate
10
5
0
Real interest rate
5
1965
1970
1975
1980
1985
1990
1995
2000
2005
© 2007 Thomson South-Western
“Thank you for
bringing me to
Timmy’s house and
not Michael Vick’s.”
The End