Because of the circular flow, what happens in one part of the economy, tends to affect others

Cost-push inflation (STAGFLATION) is caused by an increase in firm’s costs due to rising input prices (wages, raw materials, energy) or supply shocks (natural disasters, diseases)Solutions: (SUPPLY SIDE POLICY)•Legislation – cut unemployment benefits, increase retirement age, eliminate minimum wage•Cut taxes on businesses or use subsidies•Reduce income taxes•Loosen laws for immigration, train labor

Demand-pull inflation is caused by "too much demand chasing too few goods and services”

Can occur due to too much money being available

People want to spend, driving demand up

Not enough supply leads to prices going up

Can occur when the economy expands too rapidly

(Look out China!)

Inflation and UnemploymentCosts of inflation

·Loss of purchasing power:·Loss of savings:·Higher interest rates for borrowers·Effect on international competitiveness:

So…Inflation is always bad right?

Deflation

Deflation: defined as a decrease in prices due to a decrease in the amount of money / credit in the economy or lack of spending

Problems with this:·Unemployment – Businesses cant stay in business because the prices of their goods are too cheap

·Delayed consumption: People start saving – causing a deflationary spiral.·Declining investment: Businesses don’t have money to invest. Banks stop lending in fear of businesses going under·Cost to borrowers:.

Would the following people be HELPED or HURT by inflation?

- People living on fixed incomes.- Banks that have made long-term, fixed-

rate loans.- A person who purchased a home with a

bank loan.- A college graduate with loans to pay back.

• Banks lose money•Lent $ at one rate, but return comes back at different rate•Less likely to make loans to businesses and consumers

• Businesses and consumers less likely to spend.

• People living off a fixed-income lose purchasing power and end up with lower standard of living.• The entire economy must absorb new, higher costs (menu costs)

• If the inflation rate is greater than that of other countries, domestic products become less competitive on a global market

Problems with unexpected inflation:

Create a “Market Basket”a number of goods that are representative of the economy cost of this basket is then compared over time

Results in a “price index”% change in the price of the basket today vs at start of the year.

US uses the CPI

* Consumer Price Index (CPI) – Measures % change in price for the CONSUMERuses specific consumer goods and services

About 80,000 different items trackedgasoline, food, clothing, refrigerators, automobiles, Dr. visits etc.

Producer Price Index (PPI) Measurs % change in price for the SELLER

Measuring Inflation: The CPI

You are employed if….

•Did at least 1 hr of work last week as a paid employee

•Worked in your own business or profession

•Worked at least 15 hrs per week as an “unpaid” worker on a family owned farm or business

•Were temporarily absent from work due to illness, injury, weather, vacation or strike

Definition of Unemployment: Percentage of the labor force out of work.

Those NOT employed fall into four categories of unemployment

Frictional:Structural:Seasonal Cyclical:

Unemployment that does not go away on its own even in the long run.

It is the amount of unemployment that the economy normally experiences.

AKA “Full Potential”Generally about 4 – 5% unemployment

in the US

An auto assembly line worker is unemployed due to a sales slump.

- What type of unemployment is this?- Draw a graph showing it.- Explain what the government can do to

ameliorate (ease) this type of unemployment.

A snow plow driver during the summer.

A record player repairman who has not learned the latest laser disk player repair technology.

A computer programmer who quits her job to look for a job with better benefits

A recent business school graduate looking for her first job

A person who can’t find a job because companies are cutting back on labor due to an increase in the minimum wage.

Helps us to calculate the wealth of the country

GDP = C+I+G+Ex-Im

Consumptionbusiness InvestmentGovernment purchasesExportsImports

Final goodsFinal goods are goods are goods ready for consumptionready for consumption..

i.E it is sold to its final user

Pants from Khols

Used shirt from Salvation Army

New Car

Tires for car

Salesman’s commission for selling car

Which of these are final goods???

$1$1

$4$4

$7$7

$8$8

$1$1 $1$1 $1$1

$4$4$4$4

$7$7

Val

ue

of

Ou

tpu

t($)

Val

ue

of

Ou

tpu

t($)

$20$20

$12$12

$5$5

$1$1

Final GoodFinal GoodRetail PantsRetail Pants

WWholesaleholesale

PantsPants

ClothCloth

CottonCotton

Val

ue

Ad

ded

($)

Val

ue

Ad

ded

($)

Intermediate GoodIntermediate Good

SSum = um = $$3838CottonCottonFarmerFarmer

TextileTextileMillMill

PantsPantsManufacturerManufacturer

00RetailRetailStoreStore

$20 = sum$20 = sum

88

77

44

11

So, to avoidSo, to avoid “multiple counting”“multiple counting”, we count the, we count the $20 $20 final price, notfinal price, not $38$38..

$20 Pair of Pants from Kohls$20 Pair of Pants from Kohls

3. Purely Financial TransactionsPurely Financial Transactions – stocks, bonds, CDs. There is no current productionno current production. Ex: If 100 shares of Dell stock100 shares of Dell stock is bought

I’m not buying a Dell computerI’m not buying a Dell computerbut part ownership of Dell.but part ownership of Dell.

Exchanging one financial asset for anotherExchanging one financial asset for another[swapping bits of paper][swapping bits of paper]

Buying stock is not buying a product but Buying stock is not buying a product but buying buying ownership of the firmownership of the firm. Buying bonds is . Buying bonds is making a loan..

4. 4. Public Transfer PaymentPublic Transfer Paymentss –welfare, unemployment, social –welfare, unemployment, social securitysecurity. [There is nono contribution to final productioncontribution to final production]

“Now that I’ve gotten my welfare check, I can get an iPhone”

Also, Private Transfer Payments, like your parents giving you $250 cash for Christmas, or - $100 for making an “A” in economics. [Just transferring funds from one private individual to another private individual]

Unreported “legal”“legal” business activity does not count.This is two-thirdstwo-thirds of the “underground economy.”“underground economy.”

Then he has LASIK but the

surgeon doesn’t reportdoesn’t report

$500$500 of his $3,400 bill?

And what if thiswaitress doesn’tdoesn’treport all tipsreport all tips?

And what if the dentist doesn’t doesn’t report $400 forreport $400 forteeth whiteningteeth whitening?

Before LASIK SurgeryBefore LASIK Surgery

Making money illegally (drug money)and making it look like it was legallyearned (like buying a laundry mator car wash that deal in cash) and report it as legally earned.

Illegal business activity, because it goes unreported, also does

not count. Making up 1/31/3 of the “underground economy,”“underground economy,” it includes murder for hire, gambling, drugs, prostitution, and money laundering.

“I’m getting $1,000 to killyou, Ziggy, but at least itwill not count in GDP.”

Money Laundering

Work in your own householdown household or volunteer workvolunteer work in the community does not count because there was no payment.

You need to do some ofYou need to do some ofthis housework.this housework.

IfIf U. S. corporationsU. S. corporations produce goods overseasproduce goods overseas, it does not count in GDP, but would count in GNP.it does not count in GDP, but would count in GNP.Remember, we are measuring production insideRemember, we are measuring production insidethe U.S. Imports represent production outside ofthe U.S. Imports represent production outside ofthe U.S. the U.S.

GM in GM in FranceFrance

Nike in Nike in IndonesiaIndonesia