GDP. Inflation, And Unemployment

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  • Macroeconomics

  • Macroeconomics vs. Microeconomics

    Major issues: Determination of aggregate production, income, prices, and employmentImproving the performance of the macroeconomyLong-run: Economic growth and price stabilityShort-run: Reducing fluctuations in output, production and employment/unemploymentStylized Graph of the Business CycleCircular Flow: A model that demonstrates the relationships in the macroeconomy.

  • Figure 1 The Circular FlowCopyright 2004 South-WesternSpendingRevenueIncome = Flow of inputs and outputs = Flow of dollars

  • Macroeconomic VariablesThe circular flow diagram demonstrates that the important variables areOutput and income: real and nominal gross domestic product (GDP) Important implication from the circular flow diagram: Value of output=Aggregate expenditures or demand=Aggregate IncomeAggregate Prices InflationEmployment/Unemployment

  • The Measurement of Aggregate Output and IncomeBy definition, aggregate output is equal to aggregate income. The value of output is equal to the income (wages, interest, rents and profits) received by the factors.There are Various measures of aggregate output but we will use the concept of:Gross domestic product (GDP)

  • Gross Domestic ProductGDP is the market value of all final goods and services produced within a country in a given period of time.Market value prices, illegal, householdAll imputed values for rentFinal goods and services intermediate goods are not double countedProduced (newly) - products resold, inventoryWithin the country Excludes US production abroad includes ROW production with the USGiven period of time (generally yearly or quarterly)

  • Components of GDPSince aggregate production equals aggregate income, lets call GDP = YY can be broken up into the following partsConsumption HH spending on G&S (except new housing)Investment Business spending on K but includes HH of new housingGovernment Purchases of G&SNet Exports (= Exports Imports) Net addition (subtraction) attributable to purchases by ROW.

    Y = C + I + G + NX

  • BEA2002

    GDP10,480 C7,38570% Durable91112% Non-Dur2,08629% Services4,38858% I1,58915% Non-Res1,08068% Res50432% Chg Inv50% G1,93218%F67935%S&L1,25365%

    NX-426-4% X1,00610% I1,43314%

  • GDP DataThe US Department of Commerces Bureau of Economic Analysis has data on line:http://www.bea.doc.gov/Economic Report of the Presidenthttp://w3.access.gpo.gov/eop/Graphs and Datahttp://www.econmagic.com

  • Real GDP

  • Table 3 GDP, Life Expectancy, and LiteracyCopyright2004 South-Western

  • Economic GrowthEconomic growth is something that is very important in improving the standard of living of a population.The Rule of 70 illustrates how small changes in growth rates can affect the standard of living.Doubling Time = 70/(% growth rate)Examples: Growth Rate Doubling time 2% 35 years 4% 15 years 6% 11.5 years 10% 7 yearsNow, China has been growing pretty close to 10% for the last 20 or so years so the GDP has doubled once, doubled again, and doubled a third time, so it is 2x2x2=8 times larger than it was 20 years ago!

  • Figure 2 The Growth in Real GDP per Person

  • Determinants of Economic GrowthRemember our production possibilities curve and the first week!Increased number of resources: L, K, NR, EInvestmentGrowth in Labor ForceIncreased productivity of resources:Work EthicTechnologyEducationRisk-taking and innovationSocial system that allows the efficient use of resources and promotes productivityMarket system and self-interestLaws, property rights, and public orderPolitical and economic freedom

  • Table 1 The Variety of Growth ExperiencesCopyright2004 South-Western

  • Measuring the Cost of LivingInflation refers to a situation in which the economys overall price level is rising.The inflation rate is the percentage change in the price level from the previous period.

  • THE CONSUMER PRICE INDEXThe 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. When the CPI rises, the typical family has to spend more dollars to maintain the same standard of living

  • Calculating the Consumer Price IndexFix the Basket: Determine what prices are most important to the typical consumer.The Bureau of Labor Statistics (BLS) identifies a market basket of goods and services the typical consumer buys. The BLS conducts monthly consumer surveys to set the weights for the prices of those goods and services.Find the Prices: Find the prices of each of the goods and services in the basket for each point in time.Compute the Baskets Cost: Use the data on prices to calculate the cost of the basket of goods and services at different times.

  • Choose a Base Year and Compute the Index: Designate one year as the base year, making it the benchmark against which other years are compared. Compute the index by dividing the price of the basket in one year by the price in the base year and multiplying by 100.

  • Compute the inflation rate: The inflation rate is the percentage change in the price index from the preceding periodThe Inflation RateThe inflation rate is calculated as follows:

  • Calculating the Consumer Price Index and the Inflation Rate: Another ExampleBase 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.

  • FYI: Whats in the CPIs Basket?Copyright2004 South-Western

  • Problems in Measuring the Cost of LivingThe CPI is an accurate measure of the selected goods that make up the typical bundle, but it is not a perfect measure of the cost of living.

  • Problems in Measuring the Cost of LivingSubstitution biasIntroduction of new goodsUnmeasured quality changes

  • The GDP Deflator versus the Consumer Price IndexThe 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.

  • Figure 2 Two Measures of Inflation1965Percentper Year1510501970197519801985199020001995Copyright2004 South-Western

  • CORRECTING ECONOMIC VARIABLES FOR THE EFFECTS OF INFLATIONPrice indexes are used to correct for the effects of inflation when comparing dollar figures from different times.

  • Dollar Figures from Different TimesDo the following to convert (inflate) Babe Ruths wages in 1931 to dollars in 2001:

  • Table 2 The Most Popular Movies of All Times, Inflation AdjustedCopyright2004 South-Western

  • Real and Nominal Interest RatesInterest represents a payment in the future for a transfer of money in the past. 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 nominal interest rate that is corrected for the effects of inflation.

  • If you borrow $1,000 for one year, andNominal interest rate was 15%. During the year inflation was 10%.Then, Real interest rate = Nominal interest rate Inflation= 15% - 10% = 5%

  • Figure 3 Real and Nominal Interest Rates1965Interest Rates(percentper year)15105051970197519801985199019952000Copyright2004 South-Western

  • Inflation SummaryThe consumer price index shows the cost of a basket of goods and services relative to the cost of the same basket in the base year.The index is used to measure the overall level of prices in the economy.The percentage change in the CPI measures the inflation rate.

  • Inflation SummaryThe consumer price index is an imperfect measure of the cost of living for the following three reasons: substitution bias, the introduction of new goods, and unmeasured changes in quality.Because of measurement problems, the CPI overstates annual inflation by about 1 percentage point.

  • Inflation SummaryThe GDP deflator differs from the CPI because it includes goods and services produced rather than goods and services consumed.In addition, the CPI uses a fixed basket of goods, while the GDP deflator automatically changes the group of goods and services over time as the composition of GDP changes.

  • Inflation SummaryDollar figures from different points in time do not represent a valid comparison of purchasing power.Various laws and private contracts use price indexes to correct for the effects of inflation.The real interest rate equals the nominal interest rate minus the rate of inflation.

  • Business CycleEconomic fluctuations are irregular and unpredictable.Fluctuations in the economy are often called the business cycle.Most macroeconomic variables fluctuate together.As output falls, unemployment rises.

  • Figure 1 A Look At Short-Run Economic FluctuationsBillions of1996 DollarsReal GDP(a) Real GDP$10,0009,0008,0007,0006,0005,0004,0003,0002,00019651970197519801985199019952000Copyright 2004 South-Western

  • THREE KEY FACTS ABOUT ECONOMIC FLUCTUATIONSMost macroeconomic variables fluctuate together.Most macroeconomic variables that measure some type of income or production fluctuate closely together. Although many macroeconomic variables fluctuate together, they fluctuate by different amounts.

  • Figure 1 A Look At Short-Run Economic FluctuationsBillions of1996 Dollars(b) Investment Spending$1,8001,6001,4001,2001,00080060040020019651970197519801985199019952000Investment spendingCopyright 2004 South-Western

  • THREE KEY FACTS ABOUT ECONOMIC FLUCTUATIONSAs output falls, unemployment rises.Changes in real GDP are inversely related to changes in the unemployment rate.During times of recession, unemployment rises substantially.

  • EXPLAINING SHORT-RUN ECONOMIC FLUCTUATIONSShort Run Differs from the Long RunLong-run GrowthShort-run fluctuationsStylized Business CycleRecessionsDepressionsExpansions

  • Unemployment and Its Natural RateLong-run versus Short-run Unemployment:Long-run: The natural rate of unemployment Short-run: The cyclical rate of unemploymentNatural Rate of UnemploymentThe amount of unemployment that the economy normally experiences and does not go away on its own even in the long run. (sum of frictional, structural and seasonal unemployment)Cyclical UnemploymentAssociated with with short-term ups and downs of the business cycle and refers to the year-to-year fluctuations in unemployment around its natural rate.

  • Describing UnemploymentThree Basic Questions:How does government measure the economys rate of unemployment?What problems arise in interpreting the unemployment data?How long are the unemployed typically without work?

  • How Is Unemployment Measured?Unemployment is measured by the Bureau of Labor Statistics (BLS).It surveys 60,000 randomly selected households every month.Based on the answers to the survey questions, the BLS places each adult (over 16) years old into one of three categories:EmployedUnemployedNot in the labor force

  • Employed, Unemployed, Not in the Labor Force, Labor ForceEmployed: A person is considered employed if he or she has spent most of the previous week working at a paid job.Unemployed: A person is unemployed if he or she is on temporary layoff, is looking for a job, or is waiting for the start date of a new job.Not in the Labor Force: A person who fits neither of these categories, such as a full-time student, homemaker, or retiree, is not in the labor force. Labor ForceThe labor force is the total number of workers and the BLS defines the it as the sum of the employed and the unemployed.

  • Figure 1 The Breakdown of the Population in 2001Copyright2003 Southwestern/Thomson Learning

  • How Is Unemployment Measured?The unemployment rate is calculated as the percentage of the labor force that is unemployed.Unemployment Rate= (Unemployed/Labor Force)*100The labor-force participation rate is the percentage of the adult population that is in the labor force.Labor-force Participation Rate=(Labor Force/Adult Population)*100

  • Table 1 The Labor-Market Experiences of Various Demographic GroupsCopyright2004 South-Western

  • Figure 2 Unemployment Rate Since 1960Copyright2003 Southwestern/Thomson Learning108642019701975196019651980198519902005Percent ofLabor Force19952000

  • Figure 3 Labor Force Participation Rates for Men and Women Since 1950Copyright2003 Southwestern/Thomson Learning1008060402001950195519601965197019751980198519902000Labor-ForceParticipationRate (in percent)WomenMen1995

  • Issues in Measuring UnemploymentIt is difficult to distinguish between a person who is unemployed and a person who is not in the labor force.Discouraged workers, people who would like to work but have given up looking for jobs after an unsuccessful search, dont show up in unemployment statistics.Other people may claim to be unemployed in order to receive financial assistance, even though they arent looking for workLength of UnemploymentDuration of UnemploymentMost spells of unemployment are short.Most of the economys unemployment problem is attributable to relatively few workers who are jobless for long periods of time.

  • Why does unemployment occur?In an ideal labor market, wages would adjust to balance the supply and demand for labor, ensuring that all workers would be fully employed.Frictional unemployment refers to the unemployment that results from the time that it takes to match workers with jobs. In other words, it takes time for workers to search for the jobs that are best suit their tastes and skills.Structural unemployment is the unemployment that results because the number of jobs available in some labor markets is insufficient to provide a job for everyone who wants one.

  • Frictional Unemployment and Job SearchJob search the process by which workers find appropriate jobs given their tastes and skills. results from the fact that it takes time for qualified individuals to be matched with appropriate jobs.

  • Public Policy and Job SearchGovernment programs can affect the time it takes unemployed workers to find new jobs.Government-run employment agencies Public training programsUnemployment insurance

  • Effects of Unemployment InsuranceUnemployment insurance increases the amount of search unemployment.It reduces the search efforts of the unemployed.It may improve the chances of workers being matched with the right jobs.

  • Structural UnemploymentStructural unemployment occurs when the quantity of labor supplied exceeds the quantity demanded. Structural unemployment is often thought to explain longer spells of unemployment.

  • Public Policy and Job SearchWhy is there Structural Unemployment?Minimum-wage lawsUnions Efficiency wages

  • Figure 4 Unemployment from a Wage Above the Equilibrium LevelCopyright2003 Southwestern/Thomson LearningQuantity ofLabor0 Wage

  • Unemployment SummaryThe unemployment rate is the percentage of those who would like to work but dont have jobs.The Bureau of Labor Statistics calculates this statistic monthly.The unemployment rate is an imperfect measure of joblessness.In the U.S. economy, most people who become unemployed find work within a short period of time.Most unemployment observed at any given time is attributable to a few people who are unemployed for long periods of time.

  • Unemployment SummaryOne reason for unemployment is the time it takes for workers to search for jobs that best suit their tastes and skills.A second reason why our economy always has some unemployment is minimum-wage laws.Minimum-wage laws raise the quantity of labor supplied and reduce the quantity demanded.A third reason for unemployment is the market power of unions.A fourth reason for unemployment is suggested by the theory of efficiency wages.High wages can improve worker health, lower worker turnover, increase worker effort, and raise worker quality.

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