Download Topic 2: Macroeconomics

Topic 2: Macroeconomics
GDP
Unemployment
Inflation
1
What are signs of a healthy
economy?
 High output, high income
 Low unemployment
 Stability (output, prices, etc.)
2
Measures of output
 Gross Domestic Product (GDP): market value of all final
goods & services produced within an economy in a given
time period.
 Gross National Product (GNP): market value of all final
goods & services produced by a nation’s citizens in a given
time period.
 National Income (Y): total income earned in an economy in a
given time period. Equivalent to GDP in equilibrium.
 Net Domestic Product (NDP): GDP minus depreciation
3
GDP
GDP and GNP
4
noncitizens
inside
nation
citizens
inside
nation
GDP Only
GDP & GNP
GNP
citizens
outside
nation
GNP Only
What we care about, what we observe
 Most policy makers are more concerned with National
Income (Y) or NDP, rather than GDP
 GDP is easier to measure
 We will refer to any these items as “output”, and treat them
as approximate equals
5
How do we use GDP numbers?
 Provides a means of comparing standards of living between
countries and overtime
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7
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 Does the map imply that people in India and eastern China
have a higher standard of living than people in Utah or most
of Australia?
 What’s missing?
 Population Size / Population Density
 A better measure of well being is GDP Per Capita
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GDP per capita
 A better measure since
 Adjusts for differences in population
 Otherwise a big country can have higher GDP than a small
country even if the small country has a higher standard of living
 Which country has the highest GDP per capita?
 Which country has the lowest GDP per capita?
 LINK
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Comments on GDP
 GDP does not account for income inequality. Counties with
high GDP might have high income inequality. That is, a few
very rich people may pull up the GDP for an otherwise poor
country.
 Can be difficult to measure accurately, especially in
developing countries and countries that do not collect or
release data.
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Economic Growth
 Economic Growth = Sustained rise in real GDP per capita
 Causes:
 Increased workforce participation
 Increase output per worker hour
 Better quality (education & skills) of the work force
 More capital
 Better capital (improved technology)
 Declining share in agriculture (can work year round)
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14
Link
US economic growth
US GDP per capita over time
15
Economic Recession
 Recession = Negative economic growth
 The US government defines a recession as a period of two or
more consecutive quarters of negative growth (declines to
real GDP)
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17
US economic growth
US GDP per capita over time
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GDP Changes During Recessions
UK:
US:
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Economic Growth
 Representing economic growth on the PPF
 Macroeconomic policy is concerned with
 Increasing economic growth
 Limiting the duration and severity of recessions and periods of
slow growth
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Calculating GDP
21
Gross Domestic Product (GDP)
GDP is the
 market value
 considering monetary value allows us to add apples to oranges
 of FINAL goods and services
 if we count the value of the car, we shouldn’t add to it the value
of the steering wheel.
 produced IN an economy
 by citizens and non-citizens within the boarders of a county
 in a given time period.
 usually annually or quarterly
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Guidelines for calculating GDP
It must go through the market place. Otherwise, ignore it.
2. Should involve the 3 factors of production that year. Ignore
payments towards future production, or things produced last
year.
3. Don’t include transfers in ownership without production, or
pure paper money transfers.
4. Nothing illegal.
1.
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Would the following transactions
be counted by this year’s US GDP?
 Hire neighbor teenager to babysit or cut your grass
 No–doesn’t go through the market place. Under-the-table
payments.
 Buy a pizza from the local pizza joint owned by an Italian
citizen
 Yes
 Do your own laundry when you would be willing to pay $10
for someone else to do it for you
 No—no transaction takes place
 Pay a laundry service to wash your dirty clothes
 Yes
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Would the following transactions
be counted by this year’s US GDP?
 Hire a limo driver to take you out for a night on a town
 Yes
 Hire a get-a-way driver for your weekend bank heist
 No—illegal transaction
 Buy a bottle of French wine from the local wine store
 Mostly No—the wine production would not count, but the
value added by the wine shop and US importers would count
 Use a stock broker to buy 100 shares of Google stock
 Mostly No—buying stock does not involve production so it
doesn’t count, but the services provided by the broker do count
25
Would the following transactions
be counted by this year’s US GDP?
 Boeing builds a plane in Kansas which it sells to the US
government
 Yes
 Grow weed to sell to one’s roommate
 No—illegal transaction & doesn’t go through market
 Go skiing at a Utah resort
 Yes
 Buy a 2007 Ford Mustang from someone on Craig’s List
 No—production didn’t take place this year
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Would the following transactions
be counted by this year’s US GDP?
 Firestone produces tires which it sells to Ford for use on new
trucks
 Indirectly—The production contributes to GDP by adding to
the value of the Ford trucks. But, they shouldn’t be double
counted if we are already counting the trucks.
 Ford builds a Mustang this year that sits on a dealer’s lot
before being sold next January
 Yes—All of the production (except some dealer services) took
place this year. That’s what counts.
 Brazilian citizen attends UM as a student, paying tuition
 Yes—education is a service
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Calculating GDP: big picture
 Expenditure approach
 Add together how much households, the government, and
investors spend on all final goods and services, adjust for net
exports (i.e., exports minus imports)
 Income approach
 Add together total compensation, interest payments, rental
income, owner income, and profits in the economy
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Calculating GDP
 The Income and Expenditure approaches are equivalent
 GDP = Y = C + I + G + (X – M)
 Y = Income, C = Consumption, I = Investment,
G = Government Spending, X = Exports, M = Imports
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Circular Flow Diagram
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Expenditure Approach, example
Numbers in billions for US, year 2008
 C = $10,003
 I = $2,056
 G = $2,796
 X-M = -$706 (i.e., trade deficit)
 GDP = Y = $14,151
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Practical Tools for Calculating GDP
 Expenditure Approach: Count only final sales. (Works if all
transactions happen in the same year.)
 Income Approach: Count value added (VA) for each stage of
production.
VA = final sales - intermediate goods
GDP = ΣVA
 DON’T double count. Avoid counting Value Added and Final
Sales.
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GDP Example
 In an economy, there are three producers: a grape farm, a
winery, and a liquor store. All production goes towards the
production of wine. What’s their Value Added?
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Buys input at
Sells output at
Vineyard
0
$75k
Winery
$75k
$200k
Liquor store
$200k
$300k
VA
GDP Example
 In an economy, there are three producers: a grape farm, a
winery, and a liquor store. All production goes towards the
production of wine.
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Buys input at
Sells output at
VA
Vineyard
0
$75k
$75k
Winery
$75k
$200k
$225k
Liquor store
$200k
$300k
$100k
Total:
$300k
GDP Example
 GDP = Total VA = Value of Final Goods
Buys input at
Sells output at
VA
Vineyard
0
$75k
$75k
Winery
$75k
$200k
$225k
Liquor store
$200k
$300k
$100k
Total VA:
$300k
Value of Final Goods
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Total Value Added
Liquor Store Value Added
 The liquor store bought inputs for $200K, sold outputs for
$300K, and added value of $100K.
 What did the liquor store produce?
 A retail service, which counts towards GDP just like production
itself
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GDP Example
 The liquor store sells some of the wine during their annual
closeout sale, and total sales fall to $250k…
 The vineyard is located in a different country…
 If the vineyard produced the grapes and sold them to the
winery last year, but the winery and liquor store didn’t do
anything themselves until this year…
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GDP Example 2
Consider an isolated island economy with only three industries: fish, wool, and
cloth. There are no other inputs or production that is not listed here.
1. Commercial fishermen catch boatloads of fish per year, all of which is bought by
consumers for a total of $25,000.
2. Sheep herders raise sheep which they use to produce wool, all of which is sold
to cloth producers for a total price of $30,000.
3. The cloth producers use the wool to produce 11,000 yards of cloth per year,
which they sell to households for $100,000 total. (Households use the cloth to
make their own clothing.)
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GDP Example 2, continued
39
a)
Calculate value added by each industry: fish, wool, and cloth.
b)
What is the total value added in the economy?
c)
What are the final goods sold in the economy? What is the total value of final
goods sold?
d)
What is the island’s GDP?
e)
What happens if the wool was produced the year before?
f)
What other changes would effect GDP?
Unemployment
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Unemployment
 When there is unemployment, the economy isn’t utilizing all
of its factors of production:
The economy is inside of its PPF.
 By decreasing unemployment, we increase output.
 By increasing output, we decrease unemployment.
 (Also, unemployment can decrease human capital, which can
cause the PPF to shift in…)
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Unemployment Rate
Unemployment rate =
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# of people unemployed
Labor force
Unemployment
 Who’s considered unemployed? :
Must be eligible for the labor force:
1.
•
16 or older and not in jail, hospital, or some other institutional care
Must not have a job
3. Must meet one of the following descriptions
2.
1.
2.
3.
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Without work but has made specific efforts to find a job within past 4
weeks
Waiting to be called back to a job from which he or she was laid off
Waiting to start a new job within 30 days
Dividing up the population
Total Population
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Dividing up the population
Labor force eligible population
Total Population
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Dividing up the population
Labor Force
Eligible but don’t participate
Labor force eligible
Total Population
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Employed
Unemployed
Dividing up the population
Labor force
Labor force eligible
Total Population
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Employed
Unemployed
Dividing up the population
Labor force
“Not in Labor Force”
Labor force eligible
Total Population
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3 types of unemployment
Structural – comes from the rigidity of the labor market;
minimum wages, lack of required skills; things that could
be fixed through better policy, education, or training
2. Frictional – the natural flow of people between jobs or
careers, or transition into the workforce
3. Cyclical – unemployment resulting from economic
downturns
1.
Natural Rate of Unemployment = Structural + Frictional
(Natural Rate exists even if a healthy economy)
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Types of unemployment
 A mother returns to work after raising her children?
 Frictional
 Graduate from college and must find a job?
 Frictional
 Unemployment caused by a minimum wage law?
 Structural
 Unemployment resulting from lack of information about
available jobs? (i.e., bad matching)
 Structural
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Types of unemployment
 Real estate brokerage lays off some of its agents in a bad
economy?
 Cyclical
 A steel plant lays off some of its works after the government
eliminates steel tariffs
 Structural (skills don’t match the needs of employers)
 GM lays off workers due to poor economic conditions?
 Cyclical
 GM lays off workers due to changing production technology?
 Structural (skills don’t match the needs of employers)
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Types of unemployment
 A college student decides they want to work on the side
while taking classes
 Frictional
 You move to NYC then start looking for a job?
 Frictional
 A 15 year old is looking for a summer job?
 Not counted as unemployed (younger than 16)
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Types of unemployment
 A laid off worker decides to return to school instead of
searching for a job
 Not in labor force
 A laid off worker plays video games all day instead of looking
for a job, since she doesn’t expect to find one in such a bad
economy
 Not in labor force (“discouraged worker”)
 A worker at a pizza joint is searching for a job as an engineer
 Not counted as unemployed (she is “underemployed”)
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http://www.phdcomics.com/comics/archive/
phd100108s.gif
Labor Market
 Supply, determined by workers
 Demand, determined by employers
 At Equilibrium, everyone looking for a job is employed
 Unemployment is a surplus of workers in this model
 If there is unemployment, then the wage rate should fall to
the equilibrium wage. (But, “sticky” wages might delay the
adjustment to equilibrium.)
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Labor market in a downturn


Demand for workers decreases
Wages are slow to respond (“Sticky” wages)
Why might wages be sticky?
current employee happiness
contracts (unions)
bills – have expenses that must be paid
This causes unemployment, until wages adjust, or economy
recovers
56
Fighting unemployment
 If macroeconomic policy increases output (GDP), this will
increase the demand for workers, thus reducing
unemployment.
57
Inflation
 Inflation = “An increase in the overall price level”
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Inflation
 If prices go up, wages will go up too. Why are we concerned
with inflation?
 People on fixed income
 Incentives to save or invest
 Stability (how to set interest rates, etc.)
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Types of Inflation
 Demand-Pull Inflation
 Caused by an increase in aggregate demand
 e.g., consumers start spending a higher portion of their income,
or a jump in government spending
 Cost-Push Inflation
 Caused by an increase in costs
 e.g., changes in the price of factors of production; natural
resources increase in price (supply-shock), wages increase
annually which can push up the price (wage-price spiral)
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Measuring Inflation
 Consumer Price Index (CPI)
 CPI = A price index computed each month by the Bureau of
Labor Statistics using a pre-defined “market basket”
purchased monthly by the typical family.
61
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.
 Data from the Consumer Expenditure Surveys includes interviews with about
7,000 families from around the country, and another 7,000 families keeping
diaries listing everything they bought during 2-week periods.
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What goods and services does the
CPI market basket include?
 FOOD AND BEVERAGES (e.g., breakfast cereal, milk, coffee, chicken, wine,







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full service meals, snacks)
HOUSING (e.g., rent of primary residence, owners' equivalent rent, fuel oil,
bedroom furniture)
APPAREL (e.g., men's shirts and sweaters, women's dresses, jewelry)
TRANSPORTATION (e.g., new vehicles, airline fares, gasoline, motor vehicle
insurance)
MEDICAL CARE (e.g., prescription drugs and medical supplies, physicians'
services, eyeglasses and eye care, hospital services)
RECREATION (e.g., televisions, toys, pets and pet products, sports
equipment, admissions);
EDUCATION AND COMMUNICATION (e.g., college tuition, postage,
telephone services, computer software and accessories);
OTHER GOODS AND SERVICES (e.g., tobacco and smoking products,
haircuts and other personal services, funeral expenses).
How is the CPI price data
collected?
 Each month, BLS data collectors visit or call thousands of retail stores, service
establishments, rental units, and doctors' offices, all over the United States, to
obtain information on the prices of the thousands of items used to track and
measure price changes in the CPI.
 These economic assistants record the prices of about 80,000 items each month,
representing a scientifically selected sample of the prices paid by consumers for
goods and services purchased.
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Links
 Source for the previous three slides:
http://www.bls.gov/cpi/cpifaq.htm
 Relative importance of different items in CPI:
ftp://ftp.bls.gov/pub/special.requests/cpi/cpiri2010.txt
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Calculating Avg Inflation
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Using the CPI
 Inflation = Percent Change in Prices
= Percent Change in CPI
67
Using the CPI (Example 1)
 Base Year CPI is always normalized to equal 100.
 CPI in base year: 100
 CPI in year two: 105.1
 Inflation between base year and year two =
(Year two CPI) – (Base year CPI)
(Base year CPI)
68
Using the CPI (Example 1)
 Inflation between base year and year two =
(105.1) – (100)
(100)
 If year two CPI was 107.4?
 If year two CPI was 97.2?
 If year two CPI was 159.8?
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= 0.051 = 5.1%
Using the CPI (Example 2)
 CPI in year one: 201.6
 CPI in year two: 207.3
 Inflation between year one and year two =
(Year two CPI) – (Year one CPI)
(Year one CPI)
70
Using the CPI (Example 2)
 Inflation between year one and year two =
(207.3) – (201.6)
(207.3)
71
= 0.028 = 2.8%
Using the CPI (Example 3)
 CPI in year one: 184.3
 CPI in year two: 170.0
 Inflation between year one and year two =
(170.0) – (184.3)
(184.3)
72
= -0.078 = -7.8%
CPI by city
City
Miami
Detroit
New York
San Francisco
1990
128
128.6
138.5
132.1
2000
167.8
169.8
182.5
184.1
2010
223.1
205.1
240.8
227.7
Inf. 90-00
Inf. 00-10
Avg Inf. 90-00
Avg Inf. 00-10
Avg Inf. 90-10
73
CPI by city
City
Miami
Detroit
New York
San Francisco
1990
128.0
128.6
138.5
132.1
2000
167.8
169.8
182.5
184.1
2010
223.1
205.1
240.8
227.7
Inf. 90-00
31.1%
32.0%
31.8%
39.4%
Inf. 00-10
33.0%
20.8%
31.4%
23.7%
Avg Inf. 90-00
Avg Inf. 00-10
Avg Inf. 90-10
74
Using the CPI (Example 4)
 CPI0 = value in initial year
 CPIT = value T years later
 AvgInf = Average inflation between year 0 and year T
CPI0 ( 1 + AvgInf )T = CPIT
 Solving for AvgInf:
AvgInf = ( CPIT / CPI0 )(1/T) - 1
75
Using the CPI (Example )
 CPI in year one: 128.0
 CPI in 10 years later: 167.8
 Average Inflation = ( CPIT / CPI0 )(1/T) – 1
= ( 167.8/ 128.0)(1/10) – 1
= 0.02744 = 2.7%
76
CPI by city
77
City
Miami
Detroit
New York
San Francisco
1990
128
128.6
138.5
132.1
2000
167.8
169.8
182.5
184.1
2010
223.1
205.1
240.8
227.7
Inf. 90-00
31.1%
32.0%
31.8%
39.4%
Inf. 00-10
33.0%
20.8%
31.4%
23.7%
Avg Inf. 90-00
2.7%
2.8%
2.8%
3.4%
Avg Inf. 00-10
2.9%
1.9%
2.8%
2.1%
Avg Inf. 90-10
2.8%
2.4%
2.8%
2.8%
http://www.bls.gov/cpi/
How to calculate the CPI
Determine the “market basket” of goods
2. Calculate inflation from the base year for the market basket
3. Multiply by 100 (e.g., 4.6% inflation becomes 4.6)
4. Add to base year CPI which is always 100 (e.g., 100 + 4.6
= 104.6)
1.
78
Calculating CPI (Example 1)
Good
Market
Basket
Quantity
Price 1998
Price 1999 Expend.
1998
Gasoline
100 gal
$1.40/gal
$1.60/gal
Bread
150 loaves
$1.30/loaf
$1.20/loaf
Milk
300 quarts
$0.75/qrt
$0.77/qrt
Total:
79
Expend.
1999
Calculating CPI (Example 1)
Good
Market
Basket
Quantity
Price 1998
Price 1999 Expend.
1998
Expend.
1999
Gasoline
100 gal
$1.40/gal
$1.60/gal
$140
$160
Bread
150 loaves
$1.30/loaf
$1.20/loaf
$195
$180
Milk
300 quarts
$0.75/qrt
$0.77/qrt
$225
$231
Total:
$560
$571
Inflation between 1998 and 1999 ?
80
Calculating Inflation
 Price of market basket in 1998 = 560
 Price of market basket in 1999 = 571
 Inflation between 1998 and 1999?
(Market Basket Price 1999) – (Market Basket Price 1998)
(Market Basket Price 1998)
(571) – (560)
(560)
81
= 0.0196 = 1.96%
Calculating CPI
 If 1998 is the base year and inflation is 1.96%, what is the
CPI in 1999?
 100 + 1.96 = 101.96
82
Calculating CPI (Example 1)
 If a different year is the base year and 1998 has CPI 204.3,
then what is the CPI in 1999?
 CPI in 1999 must be 1.96% higher than the CPI in 1998.
 CPI in 1999 = (CPI in 1998) x [1 + (1998 to 1999 inflation)]
 CPI in 1999 = (204.3) (1.0196) = 208.3
83
Calculating CPI (Example 2)
 Last year, a typical family spent $35 on sandwiches and $27
on soda. Prices were $5/sandwhich and $3/soda.
 What is the CPI market basket?
 7 sandwiches and 9 sodas
 If last year was the base year, what is the base year CPI?
 100 (it’s always 100 in the base year)
84
Calculating CPI (Example 2)
 Last year, a typical family spent $35 on sandwiches and $27
on soda. Prices were $5/sandwich and $3/soda. The market
basket is therefore 7 sandwiches and 9 sodas.
 This year, prices are $7/sandwich and $5/soda.
 What was the market basket price last year?
 $35 + $27 = $62
 What is the market basket price this year?
 $7 x 7 + $5 x 9 = $49 + $45 = $94
85
Calculating CPI (Example 2)
 Last year, a typical family spent $35 on sandwiches and $27
on soda. Prices were $5/sandwich and $3/soda. The market
basket is therefore 7 sandwiches and 9 sodas.
 This year, prices are $7/sandwich and $5/soda.
 What was inflation this year?
(Market basket price this year) – (Market basket price last year)
(Market basket price last year)
($94) – ($62)
($62)
86
= 0.516 = 51.6%
Calculating CPI (Example 2)
 In the base year, a typical family spent $35 on sandwiches and
$27 on soda. Prices were $5/sandwich and $3/soda. The
market basket is therefore 7 sandwiches and 9 sodas.
 This year, prices are $7/sandwich and $5/soda.
 What is the CPI this year?
 151.6
87
One last example
 Suppose that
 The CPI in 1980 equals 82.4
 The CPI in 1990 equals 130.7
 Inflation between 1990 and 2000 was 31.8%
 Questions:
 What was inflation between 1980 and 1990?
 What is the CPI in 2000?
 What was inflation between 1980 and 2000?
88
One last example
 Suppose that
 The CPI in 1980 equals 82.4
 The CPI in 1990 equals 130.7
 Inflation between 1990 and 2000 was 31.8%
 What was inflation between 1980 and 1990?
 (130.7 – 82.4) / 82.4 = 0.586 = 58.6%
89
One last example
 Suppose that
 The CPI in 1980 equals 82.4
 The CPI in 1990 equals 130.7
 Inflation between 1990 and 2000 was 31.8%
 What is the CPI in 2000?
 Must be 31.8% higher than 1990 CPI
 (130.7)(1+0.318) = (130.7)(1.318) = 172.3
90
One last example
 Suppose that
 The CPI in 1980 equals 82.4
 The CPI in 1990 equals 130.7
 Inflation between 1990 and 2000 was 31.8%
 What was inflation between 1980 and 2000?
 (172.3-82.4)/(82.4)= 1.091 = 109.1%
 Why is this more than 58.6% + 31.8%?
91