Transcript Chapter 5

1. GROWTH OF REAL GDP
AND BUSINESS CYCLES
Learning Objectives
1. Define real gross domestic product and
explain how its calculation avoids both
double-counting and the effects of
changes in the price level.
2. Identify the phases of a business cycle.
3. Relate business cycles to the overall
long-run trend in real GDP in the United
States.
1. GROWTH OF REAL GDP
AND BUSINESS CYCLES
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The Business cycle is the economy’s
pattern of expansion, then contraction,
then expansion again.
Nominal GDP is the total value of final
goods and services for a particular
period valued in terms of prices for that
period.
Real GDP is the total value of all final
goods and services produced during a
particular year or period, adjusted to
eliminate the effects of changes in
prices.
1.1 Phases of the Business
Cycle
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An expansion is a sustained period in
which real GDP is rising.
A recession is a sustained period in
which real GDP is falling.
A peak is the point of the business cycle
at which an expansion ends and a
recession begins.
A trough is the point of the business
cycle at which a recession ends and an
expansion begins.
Phases of the Business Cycle
1.2 Business Cycles and the Growth
of Real GDP in the United States
2 PRICE LEVEL CHANGES
Learning Objectives
1. Define inflation and deflation, explain how their
rates are determined, and articulate why pricelevel changes matter.
2. Explain what a price index is and outline the
general steps in computing a price index.
3. Describe and compare different price indexes.
4. Explain how to convert nominal values to real
values and explain why it is useful to make this
calculation.
5. Discuss the biases that may arise from price
indexes that employ fixed market baskets of
goods and services.
2 PRICE LEVEL CHANGES
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Inflation is an increase in the average level of
prices.
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Deflation is a decrease in the average level of
prices.
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Redistributes wealth
Creates uncertainty reduces lending
hurts lenders and benefits borrowers
Redistributes wealth
Creates uncertainty
hurts borrowers and benefits lenders
Hyperinflation is an inflation rate in excess of
200% per year.
Disinflation is a decrease in the level of inflation.
e.g. inflation fell from 5% to just 3%.
2.1 Why Do We Care?
2.2 Price Indexes
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A price index is a number whose movement
reflects movement in the average level of
prices.
A base period is a time period against which
costs of the market basket in other periods
will be compared in computing a price index.
The consumer price index (CPI) is a price
index whose movement reflects changes in
the prices of goods and services typically
purchased by consumers.
2.2 Price Indexes
Item
Quantity 2007 Cost in 2007
in Basket Price
Basket
2008
Price
Cost in 2008
Basket
DVD rental
4
$2.25
$9.00
$2.97
$11.88
Movie admission
3
7.75
23.25
8.00
24.00
Popcorn
3
2.25
6.75
2.25
6.75
Soft drink
3
3.00
9.00
2.75
8.25
2007
$48.00
2008
$50.88
Total cost of basket
Movie Price
Index
MPI2008 = $50.88/$48 = 1.06
EQUATION 2.1
CPI = current cost of basket /base-period cost of basket
2.2 Price Indexes
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The implicit price deflator is a price index
for all final goods and services produced; it is
the ratio of nominal GDP to real GDP.
EQUATION 2.3
Implicit price deflator = nominal GDP/real GDP
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The personal consumption expenditures
price index is a price index that includes
durable goods, nondurable goods, and
services and is provided along with estimates
for prices of each component of consumption
spending.
2.3 Computing the Rate of
Inflation or Deflation
EQUATION 2.4
perc
cha
in
in
Rate
of
inflatio
or
defla

initi
va
of
in
1.06
1.0
Movie
inflatio
rate
in
2008

.06

6%
1.0
2.4 Computing Real Values
Using Price Indexes
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The real value is a value expressed in units
of constant purchasing power
(adjusts for inflation).
The nominal value is a value expressed in
dollars of the current period.
EQUATION 2.5
X
t
Real
value
of
X

t
price
index
atttim
2.4 Computing Real Values
Using Price Indexes
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Are price indexes accurate measures of price-level
changes?
– Components of market basket are fixed.
– New goods are excluded.
– Quality changes may not be accounted for.
– Indexes do not account for changes consumers
make in terms of where they shop.
Sources of Bias
1997 Estimate
2006 Estimate
Substitution
0.4
0.4
New products and quality change
0.6
0.3
Switching to new outlets
0.1
0.1
Total
1.1
0.8
0.8-1.6
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Plausible range
3. UNEMPLOYMENT
Learning Objectives
1. Explain how unemployment is measured in the
United States.
2. Define three different types of unemployment.
3. Define and illustrate graphically what is meant
by the natural level of employment. Relate the
natural level of employment to the natural rate
of unemployment.
3.1 Measuring Unemployment
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The labor force is the total number of people
(age 16 and over) working or unemployed.
The unemployment rate is the % of the
labor force that is unemployed.
Employed
144,958
Is person
working?
Is person
looking and
available for
work?
Unemployed
10,080
Not in
labor force
79,038
The unemployment rate in August 2008 was 6.5 percent:
Unemployment rate = 10,080/(10,080+144,958) = 0.065 = 6.5 percent
3.2 Types of Unemployment
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The natural level of employment is the
employment level at which the quantity of labor
demanded equals the quantity supplied.
The natural rate of unemployment is the rate of
unemployment consistent with the natural level of
employment.
Frictional unemployment occurs because it takes
time for employers and workers to find each other.
Structural unemployment results from a mismatch
between worker qualifications and the characteristics
employers require.
Cyclical unemployment is the excess of the
unemployment that exists at the natural level of
employment.
The Natural Level of
Employment
Natural Level of
Employment
Real wage
S1
we
D1
Le
Level of employment per period
Unemployment Rate,
1960-2008