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GDP – measures legal production in the U.S. in one year. GDP – measures legal production in the U.S. in one year. GDP measures all final goods/services.

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Presentation on theme: "GDP – measures legal production in the U.S. in one year. GDP – measures legal production in the U.S. in one year. GDP measures all final goods/services."— Presentation transcript:

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2 GDP – measures legal production in the U.S. in one year. GDP – measures legal production in the U.S. in one year. GDP measures all final goods/services GDP measures all final goods/services produced by workers and capital located produced by workers and capital located in the U.S., regardless of ownership. in the U.S., regardless of ownership. [Domestically located resources] [Domestically located resources] Final goods are goods ready for consumption. Final goods are goods ready for consumption.

3 1.Second Hand Sales[no production] 2.Public/Private Transfer Payments 3.Purely Financial Transactions 4.Intermediate Goods 5. U.S. Corporations producing overseas 6. Non-market transactions [household or volunteer work] Underground Economy 7. Illegal business activity 8. Unreported legal business activity

4 Intermediate Goods – components of the final good. A. Ford buys batteries tires for its cars. A. Ford buys batteries or tires for its cars. B. KFC buys chickens to eventually sell to customers. B. KFC buys chickens to eventually sell to customers.

5 [It has not been produced again in 2010 & would not count.] 2nd Hand Sales 2nd Hand Sales – no current production. – no current production. A Chevy bought in 2010 A Chevy bought in 2010 The salesman is doing productive work. His commission would count. B. Boots produced in 1980 are bought in a Thrift Store in They also have not been produced again. Salesmans commission would count. You are buying his services. Salesman Shoe salesman 57 Chevy This falls under the rule of Do Not Double Count.

6 Purely Financial Transactions Purely Financial Transactions – stocks, bonds, CDs. no current production There is no current production. 100 shares of Dell stock Ex: If 100 shares of Dell stock is bought Im not buying a Dell computer but part ownership of Dell. Exchanging one financial asset for another. This represents transfer of ownership from one shareholder to another. [swapping bits of paper]. Buying stock is not buying a product but buying ownership of the firm. Buying bonds is. ownership of the firm. Buying bonds is making a loan.

7 A. P ublic T ransfer Payment s –welfare, unemployment, social securitynocontribution to final production security. [There is no contribution to final production] Now that Ive gotten my welfare check, I can get a white iPad 2 B. 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]

8 legal Unreported legal business activity does not count. two-thirdsunderground economy. This is two-thirds of the underground economy. Then he has LASIK but the doesnt report surgeon doesnt report $500 $500 of his $3,400 bill? And what if this doesnt waitress doesnt report all tips report all tips? And what if the doesnt dentist doesnt report $400 for teeth whitening teeth whitening? Before LASIK Surgery

9 Illegal business activity, because it goes unreported, also 1/3 underground economy, does not count. Making up 1/3 of the underground economy, also called the [ black market ]. It includes murder for hire, gambling, drugs, prostitution, and money laundering. Ida Ho Give me the money in your purse. At least it will not count in GDP! Money Laundering Making money illegally (drug money) and making it look like it was legally earned (like buying a laundry mat or car wash that deal in cash) and report it as legally earned. And, what is money laundering?

10 S elf E mployed $255 O ther Legal $25 R ents & Royalties $ 30 C orporate Profits $50 Interest $55 Wages and Salaries $185 Drugs $120 Bribery $35 Gambling and Loan Sharking $10 Pornography $20 Fraud $30 Other Illegal $20 Prostitution $30 Stolen Goods $35 I llegal $300 B Legal $600 B What gets reported is the Above Ground W hat doesnt get reported is the Underground

11 own household volunteer work Work in your own household or volunteer work in the community does not count because there was no payment. You need to do some of this housework.

12 own householdvolunteer work Work in your own household or volunteer work in the community does not count because there was no payment. dont marry your maid, yardman, So, dont marry your maid, yardman, fitness instructor or fitness instructor, or you will hurt GDP.

13 IfU. S. corporationsproduce goods overseas If U. S. corporations produce goods overseas, it does not count in GDP, but would count in GNP. Remember, we are measuring production inside the U.S. Imports represent production outside of the U.S. GM in France Nike in Indonesia

14 New Toyota Tundra truck ___ ___ 1. New Toyota Tundra truck manufactured in San Antonio and sold to your economics teacherthe year it was produced sold to your economics teacher the year it was produced. ___ ___ 2. You buy a new Wii at GameStop in Does it resell it on eBay in March of 2010 count if you resell it on eBay in March of 2010? On the next slide, read each sentence and determine, To Be or Not To Be Counted? That is the question. If Yes, put Y and tell if it is C, Ig, G, or X. If No, put N and give the number from below on why it is not counted in GDP. GDP DOES NOT INCLUDE Second hand sales 1. Second hand sales [no current production] [but the salesmans commission counts] transfer payments 2. Public/Private transfer payments [no current production] Purely financial transactions 3. Purely financial transactions [no current production] [brokers fees do count] Intermediate goods 4. Intermediate goods [component of final good] U.S. corporations producing overseas 5. U.S. corporations producing overseas. Non-market transactions 6. Non-market transactions [ household or volunteer work. Underground Economy [not reported] Underground Economy [not reported] Illegal business activity 7. Illegal business activity [prostitution, murder-for-hire, illegal drugs, etc.] Unreported legal business activity 8. Unreported legal business activity [off the books] Example: YC 1N

15 ___ ___ 1. You buy a purple Tinky Winky, [produced in TX] from Wal-Mart. paint your house ___ ___ 2. You and your family paint your house. [labor involved] marry your housemaid ___ ___ 3. You marry your housemaid. [working-for-love] [her services] buy 100 shares of Microsoft ___ ___ 4. You buy 100 shares of Microsoft Corporation. babysit your little sister ___ ___ 5. You volunteer to babysit your little sister to help your parents while they work ford Mustang ___ ___ 6. Bob buys a 1965 ford Mustang convertible, in 2010, which is in mint condition. commission1965 Ford Mustang ___ ___ 7. The salesman gets a commission [pay] for selling that 1965 Ford Mustang in volunteer to cook ___ ___ 8. You and your friend volunteer to cook at the senior class picnic. ___ ___ 9. Dr. Payne does $1,000 worth of dental work but reports only $500 of it. $500 the dentist keeps Does the $500 the dentist keeps and doesnt report count? $100 billssmuggled drugs ___ ___ 10. You are given suitcase full of $100 bills from the sale of smuggled drugs. mother is teaching you to read ___ ___ 11. Your mother is teaching you to read [& not having much success]. bakes you a home-baked loaf of bread ___ ___ 12. Your dad bakes you a home-baked loaf of bread. [his labor] buy a loaf of bread ___ ___ 13. You buy a loaf of bread from Krogers Grocery Store. government purchases 5 B-2 Bombers ___ ___ 14. The U.S. government purchases 5 B-2 Bombers for $2 B each. ton of sheet metal used in making car doors ___ ___ 15. Ford buys a ton of sheet metal used in making car doors. iPad 2 ___ ___ 16. You buy a new iPad 2 [produced in China] from the Apple store. cleaning your teeth ___ ___ 17. You send in a $90 check to your dentist for cleaning your teeth. buys a new house ___ ___ 18. Your family buys a new house next to the mansion of Bill Gates. teachers are hired ___ ___ additional teachers are hired by the Frisco ISD. $500 million worth of robots ___ ___ 20. GM invest in $500 million worth of robots to assemble their cars. volunteer 10 hours a week ___ ___ 21. You volunteer 10 hours a week of your time to work for senior citizens. 25,000 F150s ___ ___ 22. Ford produces 25,000 F150s in Denver which are not sold by the end of the year. Dell computers, Rusky Dell Dudes ___ ___ 23. R ussia buys 3,000 Dell computers, produced in NY, as they become Rusky Dell Dudes. mans wifeworking for him 16 hours per day ___ ___ 24. A mans wife does all his cooking and sewing, working for him 16 hours per day. producesNike Air Jordans in Vietnam ___ ___ 25. Nike produces $10 million worth of Nike Air Jordans in Vietnam. YC N6 N 6 N3 N6 N1 YC N 8N N 7 N 6 6 N 6 YC Y G N 4 N 5 YC Y Ig YG YIg N6 Y Ig YX N6 N nd Hd sales 2. Transfers 3. Financial 4. Intermediate 5. Overseas 6. Non-market 7. Illegal 8. Unreported

16 Gross Domestic Product GDP= C +I+G+Xn = Consumption + Investment +Government Spending+ Net Exports [(all exports) X-M (all imports)] Net Domestic Product (your value-what you could sell if ya had to!) NDP= GDP- Depreciation (the loss of value over time- replacement cost) National Income NI= NDP +NFFIEUS-Statistical Discrepancy Net Foreign Factor Income earned in US Personal Income (what you can pay in taxes, spend or save!) UC ST Transfer P PI= NI- Undistributed Corporate Profits–Corporate Income Taxes -Social Security-Taxes on production & iMports +Transfer Payments Disposable Income (what you can spend or save!) DI= PI- personal income taxes National Income Accounting U Ca n Se e Th e Toi let U Ca n Se e Th e Toi let Pa pe r

17 NDP NI PI DI GDP

18 -Personnel Taxes-$1,102 $10, 089 [C] C onsumption [66%] $12,392[births-deaths]Available for sale $12,026 PI is what we can spend, save, or pay in taxes. Income received by households,whether earned or unearned $10,924DI is what we can SPENDor SAVE. Y received/not earned Y earned/not received GDP Gross Domestic Product $14,256 NDP National Domestic Product $12,392NI National Income $12,288 PI Personal income $12,026 DI Disposable Income $10,924 G ross P rivate DomesticInvestment $1, 628 GovernmentPurchases$2,931 Xn(X-M)-$392 - Depreciation [Replacement Cap.] $1,864 $12,288 Income earned by U.S. resources plus taxes on pro- duction & imports Statistical Discrep. - Statistical Discrep.$209 [to make the income approach match the expenditure approach] +N.F.F.I.$105 +$2,528 Trans Pay -$418 Undis Cor Pro -$315 Corp Inc Tax -$967Soc Sec Con Ta xes on pro.& M ROW[$264] U.S. [$159] NFFI = $105 U Can See The ToiletPaperU Can See The ToiletPaper

19 Depreciation1933 $7.6 billion [in current dollars] Depreciation, Investment & Disinvestment Positive Net Investment Ig exceeds Depreciation Negative Net Investment Depreciation exceeds Ig I g $1.6 billion D isinvestment of $6 billion Declining productive capacity I g($1.6) - D($7.6) = (Disinv. of $6) (Disinvest. of $6) + D($7.6)=($1.6) I g($1.6)–D isinv.($6)=( Depr. of $7.6) I g($2,105) - D($1,574) = (In of $531) I n($531) + D($1,574) = ( I g of $2,105) I g($2,105)- I n($531)=( Depr. of $ 1,574) Depreciation2005 $1,574 Trillion I g $2,105 Trillion In I nvestment of $ 531 bil. Expanding productive capacity

20 N.F.F.I. = $10 billion [U.S.A. Profits Overseas ] R est o f W o rld $220 billion $220 billion F oreign Profits in U.S.A. $210 billion If U.S. profits in the ROW [$220] are greater than If U.S. profits in the ROW [$220] are greater than foreign profits in the U.S. [$210], add the difference. foreign profits in the U.S. [$210], add the difference.

21 C = $_______ Ig = $_______ Ig = $_______ G = $_______ G = $_______ Xn = $_ ______ Xn = $_ ______ Gross Domestic ProductGDP Gross Domestic Product (GDP) - Consumption of fixed capital Net Domestic ProductNDP Net Domestic Product (NDP) N + Net For. Factor Inc. Earn. U.S. Statistical Discrepancy -Statistical Discrepancy National IncomeNI National Income (NI) - U - Undistributed Corporate Profits -C -Corporate income taxes -S -Social Security Contributions T -Taxes on prod. & imports +T +Transfer payments Personal IncomePI Personal Income (PI) - Personal Taxes Disposable IncomeDI Disposable Income (DI) [18 th Edition] NIA Practice – How To Do It Personal taxes 403-Undistributed corp. profits 46 Personal taxes 403-Undistributed corp. profits 46 Imports 362-Social Security contrib. 169 Imports 362-Social Security contrib Transfer payments 283Personal consumption 2,316 +Transfer payments 283Personal consumption 2,316 -Corporate Income Taxes 88Gross private domes invest Corporate Income Taxes 88Gross private domes invest Taxes on prod. & imports 231Government purchases 673 -Taxes on prod. & imports 231Government purchases 673 Exports 465Depreciation [Capital consumption] 307 Exports 465Depreciation [Capital consumption] 307 Statistical Discrepancy 10N.F.F.I.E. in the U.S. -12 $112 NFFI = -$12 2, , , , , ,612 ROW $ 100 English C Accounting C American History D Economics F -10 Im going through an academic recession.

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24 Business Cycle PEAK Level of business activity Time Trough TROUGH Expansion GROWTH TREND Expansion PEAK Inflation Too much money Contraction Unemployment Contraction

25 Economic Growth expand the productive cap acity of the economy ability to produce MORE goods and ser vices We ONLY have Economic Growth when we expand the size of the productive cap acity of the economy - the ability to produce MORE goods and ser vices. Real Capital

26 Size of employed labor force Quantity of real capital Discovery of new raw materials Average hours of work Increase in inputs [such as land, labor and capital] [33%] Technological advance Education and training Use resources in the least costly way [Productive efficiency] Allocate resources among production techniques that produce goods/services that maximize societys well-being. Increase productivity of these inputs [66%] Real GDP two main ways in which RGDP can grow There are two main ways in which RGDP can grow. inputs 1. Increase in inputs [land, labor, or capital] {33%} productivity 2. Increase in productivity of these inputs {66%} x =

27 1. Real GDP 2. Unemployment 3. Core Inflation [taking out food and energy]

28 Nominal GDP [prices of output in the current year] [measures output and prices] and Real GDP [base year prices of the year being measured] [measures only output]

29 Importance of Real GDP in Determining a Recession Apple GDP Example A country produces 10 apples in base year x $1; & GDP both=$10 Nominal [current] & Real [constant] GDP both=$10 Year 2: A country produces 10 apples x $1.25; Nominal GDP =$12.50 (no recession but worse off) [Real GDP would = $10 (10 apples x $1)] Or Year 2: A country produces 9 apples x $ 1.25; Nominal GDP =$ but (9 apples x $1) Nominal GDP =$ but real is $9 (9 apples x $1) ( recession although nominal GDP is up) Real GDP measures current output at base-year prices.

30 Nominal [ ] GDP v. Real GDP Nominal [Current) GDP v. Real (constant) GDP Price of Market Basket(2001 [nominal GDP] $64 Price of Market Basket(2001) [nominal GDP] $64 GDP Price Index = Price of same Market Basket(1998)x100;[Real GDP] $50x100=128 GDP Price Index = Price of same Market Basket(1998)x100; [Real GDP] $50x100=128 [GDP Deflator] in the base year (1998)[$64/128 x 100 = $50] [GDP Deflator] in the base year (1998) [$64/128 x 100 = $50] B ase year [$50/$50=1x100=100] $46/$50x100=92 [deflation of 8%]

31 Real GDP takes the air out of the nominal GDP balloon. The effects of inflation have been eliminated, so the real remaining changes are real changes. Nominal GDP – measured in terms of money. [Current output measured in current prices] Real GDP – measured in terms of goods/services. [Current output measured in base-year prices] $13, $11,541 [$13,847/ x 100=$11,541] Real GDP [& Nominal GDP] $9,847 Real GDP $11,541 GDP Deflator [119.98] + $1,694 trillion Nominal GDP [$13,847] Inflation component Base Year [not $4 trillion ]

32 Depreciation1933 $7.6 billion [in current dollars] Depreciation, Investment & Disinvestment Positive Net Investment Ig exceeds Depreciation Negative Net Investment Depreciation exceeds Ig I g $1.6 billion D isinvestment of $6 billion Declining productive capacity I g($1.6) - D($7.6) = (Disinv. of $6) (Disinvest. of $6) + D($7.6)=($1.6) I g($1.6)–D isinv.($6)=( Depr. of $7.6) I g($2,105) - D($1,574) = (In of $531) I n($531) + D($1,574) = ( I g of $2,105) I g($2,105)- I n($531)=( Depr. of $ 1,574) Depreciation2005 $1,574 Trillion I g $2,105 Trillion In I nvestment of $ 531 bil. Expanding productive capacity

33 Expanding/Static/Declining Productive Capacity Expanding/Static/Declining Productive CapacityMaintaining our production possibilities Expanding Productive Capacity Static Productive Capacity Declining Productive Capacity increased decreased No change

34 Non-market Transactions dont count Earthquakes, divorces, etc. increase GDP Leisure isnt factored in Improved Product Quality The Underground Economy GDPs impact on the Environment Per Capita Output low GDP per capitamore infants with low birth weighthigher rates of infant mortalityhigher rates of maternal mortalityhigher rates of child malnutrition safe drinking waterfewer go to schoolfewer teachersfewer TVstelephonesfewer paved roadsfewer Olympic medals Countries with low GDP per capita have more infants with low birth weight, higher rates of infant mortality, higher rates of maternal mortality, higher rates of child malnutrition, and less common access to safe drinking water. Also, fewer go to school and they have fewer teachers. They have fewer TVs and telephones, fewer paved roads. They also win fewer Olympic medals. SHORTCOMINGS OF GDP

35 GDP Deflator[GDP Price Index] = Later CPI/Base CPI x 100 Market Basket cost $50.00 in base year Base Year $50.00/$50.00 x 100 = 100 $75.00 Later year, lets say the basket cost $ % inflation $75.00/$50.00 x 100 = 150 or 50% inflation $ Later year, Lets say the basket cost $ % deflation $25.00/$50.00 x 100 = 50 or 50% deflation.

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37 P ractice F ormulas P ractice F ormulas $6,7374]/126.1[1987($4,540)]x100 = $5,343 [+$803.] $6,737[1994]/126.1[1987($4,540)]x100 = $5,343 [+$803.] Real GDP deflates nominal GDP to actual value [ takes the air out of the nominal balloon]Real GDP deflates nominal GDP to actual value [ takes the air out of the nominal balloon] Base year[$50/$50=1x100=100] $46/$50x100=92[deflation of 8%] Nominal GDP(2001[nominal GDP] $64 Nominal GDP(2001) [nominal GDP] $64 GDP Price Index = Real GDP(1998) x 100;[Real GDP] $50 x 100 = 128 GDP Price Index = Real GDP(1998) x 100; [Real GDP] $50 x 100 = 128 [GDP Deflator] [The base year is 1998] [GDP Deflator] [The base year is 1998] [$64/128 x 100 = $50] Unemployment 5,655,000 Labor Force x 100 = unemployment rate; 140,863,000 x 100 = 4% [Employed + unemployed] [135,208,000+5,655,000] [2000] OkunsLaw or GDP gap3 % Okuns Law or GDP gap)=U nemployment R ate over 6% x 2; 7.5%, so 1.5%x2 = 3 %. Or, $3 billion GDP Gap[$100 billion nominal GDP x.03% = $3 billion]. (2000-later year) (1999-earlier year) [*Change/original x 100] (2000-later year) (1999-earlier year) [*Change/original x 100] Current years index – last years index (5.6) Current years index – last years index (5.6) C.P.I. = Last years index(1999-earlier year) x 100; x100 = 3.4% _________________________ Rule of 70 Rule of 70 = % annual rate of increase (3%) = 23 years 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 [% change in real income = % change in nominal income - % change in PL.] 5%10%5% 5% 10% 5% 70

38 Real GDP takes the air out of the nominal GDP balloon. The effects of inflation have been eliminated, so the real remaining changes are real changes. Nominal GDP – measured in terms of money. Current output measured in current prices] [Current output measured in current prices] Real GDP – measured in terms of goods/services. Current output base-year prices [Current output measured in base-year prices] $6,737/126.1 $5,343 [$6,737/126.1 x 100=$5,343] Real GDP [& Nominal GDP] $4,540 Real GDP $5,343 GDP Deflator [126.1] + $803 billion Nominal GDP [$6,737] Inflation component Base Year $2,197 trillion [not $2,197 trillion ]

39 Real GDP Nominal GDP REAL GDP= Index x 100 real GDP Ex:Using the above formula, what is the real GDP for 1994 if nominal GDP was $6,947 trillion and the GDP deflator was 126.1? $6,947 x 100 =5,509 trillion 126.1

40 Real GDP = Nominal GDP/Index X 100 Real GDP = Nominal GDP/Index X 100 $9,299.2[1999]/104.77[1996] x 100 = $8,875.8 [So, +$1,062.6] Real GDP deflates nominal GDP to actual value [takes the air out of the nominal balloon] $5,250.8 $3,774.7 $5, x 100=$_____ x 100=$_____ x100=$_____ 4,839 3,492 4,848 NS 12 and real GDP 12. Using the above formula, what is the real GDP for 1994 if nominal GDP was $6,947 trillion and the GDP deflator was 126.1? ($6,611/$5,610/$5,509) trillion. 13.real GDP 13. For 1996, what would real GDP be if nominal GDP were $7,636 trillion and the GDP deflator were 110.2? ($6,929/$9,628/$6,928). [$6,947/126.1 x 100 = $5,509 trillion [$7,636 trillion/110.2 x 100 = $6,929 trillion] Nominal Real

41 UNEMPLOYMENT #Unemployed Unemployment Rate= Labor Force x million, civilian labor force Ex:If the total population is 280 million, and the civilian labor force 129,558,000 with jobs and 6,739,000 unemployed includes 129,558,000 with jobs and 6,739,000 unemployed but employment rate? looking for jobs what is the unemployment rate? 6,739,000 x 100 =4.9% 129,558, ,739,000

42 Unemployment 15,100,000 Unemployment Rate = Labor Force x 100; 9.8% = 154,082,000 x 100 [Employed + unemployed] [138,982,000+15,100,000] [Employed + unemployed] [138,982,000+15,100,000] I n Forney, 42 are unemployed & 658 are employed. T he unemployment r ate is __ %. One mil. are unemployed & 19 mil. are employed. The unemploy. rate is __%. 6 5 NS 41 NS million, civilian labor force 41. If the total population is 280 million, and the civilian labor force 129,558,000 with jobs and 6,739,000 unemployed includes 129,558,000 with jobs and 6,739,000 unemployed but employment rate looking for jobs, then the unemployment rate would be ____%. 4.9 [6,739,000/136,297,000 x 100 = 4.9%] (Sept. of 2009)

43 T he unemployment rate in June of 2010 was 9.7%. The next month, 125,000 jobs were lost. D id the unemployment rate go up in July, 2010? No, 652,000 more workers became No, because 652,000 more workers became discouraged total to 2.6 million discouraged [bringing the total to 2.6 million] quit looking, the July unemployment rate and quit looking, the July unemployment rate actually improved to 9.5%. But, the economy was obviously worse off. Jan, June, % discouraged workers The discouraged workers had looked in the last year but not in the last month.

44 GDP GAP/Okuns Law Okuns Law= 6%- current unemployment rate x 2 = ___x GDP = ___ Ex: The Actual unemployment rate is 7.3%. The GDP is 300 Billion. What is the GDP Gap? 6% - 7.3% (1.3) 1.3x2+ 2.6% 2.6% x 300 Billion = 780 million

45 Nominal GDP is $100 b illionAnd if it were $ 300 b illion Unemployment [Lets say that Nominal GDP is $100 b illion.][And if it were $ 300 b illion?] Rate 1. 7%; real unempl. is __%; % gap is ___ %; output forgone is ___ B ___ B 2. 8%; real unempl. is __%; % gap is ___ %; output forgone is ___ B ___ B 3. 13%; real u nempl. is __%; % gap is ___ %; output forgone is ___ B ___ B 4. 14%; real u nempl. is __%; % gap is ___ %; output forgone is ___ B ___ B 6%Y*FYPYA $10 tr. $10 tr. [Frictional+Structural] 3 % 3 % AD 1 AS Arthur Okun GDP Gap unemployment rate above 6% x 2 [ GDP Gap = unemployment rate above 6% x 2] E 2 Recessionary Gap(Y R ) Potential output ($10)exceedsactual output($9). Potential output ($10) exceeds actual output($9). Actual unemployment rate(11%)exceedsPotential unemp. rate(6%). Actual unemployment rate(11%) exceeds Potential unemp. rate(6%). 11%YRYA $9 Tr. $9 Tr. 1% AD 2 5% Cyclical(real) Unempl. 10%[5%x2=10%] Negative Gap [Okuns Law] FE GDP Bulls Eye $100 B $300 B

46 Okuns Law GDP Gap = Unemployment Rate over 6% x 2 7.5% unemployment, so 1.5% x 2 = 3%. [$3 bil. GDP Gap($100 Bil. nominal GDPx3%; or $100 B x.03 =$3 B.) on Practice Formulas 1. Unemployment is 7 % ; Nominal GDP is $200 billion. Real unemp. is __%. The % gap is __%. Y being forgone is $__ B. 2. Unemployment is 8%; Nominal GDP is $500 billion. Real unemp. is __%. The % gap is __%. Y being forgone is $__ B. 3. Unemployment is 10%; Nominal GDP is $100 billion. Real unemp. is __%. The % gap is __%. Y being forgone is $__ B. Unemployment Rate over 6% x NS 43 & 44 NS 43 & Unemployment is 17%. Nominal GDP is $200 billion. What % is the GDP gap? __% What output is forgone? $___ 44. Unemployment is 16%. Nominal GDP is $300 billion. What % is the GDP gap? __% What output is forgone? $___

47 Sometimes the economy is turbocharged and we are cranking out more than can be sustained. During a recession, actual Y falls below potential Y. Usually potential & actual output track pretty closely. Although output is rising [2%], there is still a $900 billion output gap, so how long will it take to eliminate the output gap & put 7 million back to work. It all depends on the pace of the growth. POTENTIAL Y $14.1 Trillion Actual Y $13.2 T rillion At 6% growth, the unemployment rate would reach its potential, 5 % unemployment in At 3% the unemployment rate would reach 5 % in At 2%, the unemployment rate would rise, reaching 11.9% in Heres what would happen to the unemployment rate [8.9 now] under three growth scenarios: Even when the economy is functioning at its potential, about 5% of the labor force is unemployed. PROJECTED

48 CPI / INFLATION Current years index – last years index C.P.I. = Last years index x 100 Ex:The CPI was in 1999 and in Therefore, the rate of inflation for 2000 was? x 100 =4.9% 166.6

49 NS 50, 51, & 52 NS 50, 51, & in in The CPI was in 1999 and in Therefore, the rate of inflation for 2000 was (2.7/3.4/4.2)% CPI falls from 160 to If the CPI falls from 160 to 149 in a particular year, the economy has experienced (inflation/deflation) of (5/4.9/6.9)% to If CPI rises from to in a particular year, the rate of inflation for that year is (1.6/2.0/4.0)%. [-11/160 x 100 = -6.9%] (2006-later year) (2005-earlier year) (2006-later year) (2005-earlier year) Current years index – last years index – [6.7] Current years index – last years index – [6.7] C.P.I. = Last years index(2006-earlier year) x 100; x 100 = 3.3% (6.7) (-4) (33) (6.7) (-4) (33) x 100 = ____ 120 x 100 = ____ 300 x 100 = ____ x 100 = ____ 120 x 100 = ____ 300 x 100 = ____ [Change/Original X 100 = inflation] 5.4 % -3.3 % 11 % [5.6/166.6 x 100 = 3.4%] So, 3.3% increase in Social Security benefits for 2007

50 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. YearPrice of Hot DogsPrice of Hamburgers 2009 $1$ $1$ $2 $ $2 $3 Step 3. Compute the basket cost for each year ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4), so $ ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6), so $ ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6), so $14 Step 4. Choose one year as a base year (2009) and compute the CPI 2009 ($8/$8) x 100 = (14/$8) x 100 = (14/$8) x 100 = 175 Step 5. Use the CPI to compute the inflation rate from previous year %( )/100 x 100 =75% 2010 (175/100 x 100 = 175%) or to get actual % ( )/100 x 100 =75% Or, Change $14$8 Or, Change $14-$8 ($6) Original 75% Original $8 x 100 = 75%

51 (42%) buys the following quantities of (42%) 18. Suppose that a consumer buys the following quantities of these three commodities in 2007 and 2008 these three commodities in 2007 and CommodityQuantity2007 perUnit Price2008 perUnit Price CommodityQuantity2007 per Unit Price2008 per Unit Price Food5 units $6.00 $5.00 Clothing2 units $7.00 $9.00 Shelter3 units $12.00 $19.00 concluded about the CPI for this individual Which of the following can be concluded about the CPI for this individual from 2007 to 2008 [inflation] from 2007 to 2008 [inflation]? 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) Y ear 2 [2008]: [5 f ood x $5 = $25; 2 c lothing x $9 = $18; 3 s helters x $19 = $57, for dollar value [basket cost ]of $100. CPI =125 $100/$80125 for dollar value [basket cost ]of $100. CPI =125 ($100/$80 X 100 = 125) or (125/100 x 100 = 125 for 2008) Change $100-$80 [$20] Original = $80 x 100 = 25%; so the CPI for this individual is 25%.

52 YearCPIInflat YearCPIInflat Year CPI Inflat Year CPI Inflat ftp://ftp.bls.gov/pub/ special.requests/cpi/ cpiai.txt

53 Rule of 70 _______70___________ Rule of 70 = % annual rate of increase Ex: The GDP is growing at 1.6%. At this rate the standard of living will double in __ years? 70 = 44 years (43.75 years) 1.6% Ex: Inflation is growing at 5%. At this rate prices will double in __ years? 70 = 14 years 5% Ex: Interest rates are currently at 3%. At this rate investments will double in __ years? 70 = 23 years ( years) 3% [

54 __________________________ Rule of 70 Rule of 70 = % annual rate of increase (3%) = 23 years Inflation [Inflation (prices to double)] Investments [Investments to double] GDP 10 = ________12 = _____ 9 = _______ [GDP (standard of living) to double] 7 years 6 years 8 years 70 70

55 Real Income Value nominal income –inflation rate= real income Ex: The inflation rate rose by 3%, but the income level rose by 5%, what happened to the real income? 5%-3%=2%

56 NominalIncome RealIncome InflationPremium - 16 % 10 % 6%6%6%6% [ Nominal income – inflation rate = Real Income] =

57 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 [% change in real income = % change in nominal income - % change in PL.] 5%10%5% 5% 10% 5% Nominal income rose by 10%,PL increased by 4% real income rose by Nominal income rose by 10%, PL increased by 4% - then real income rose by ___%. Nominal income rose by 20%,PL increased by 5% real income rose by Nominal income rose by 20%, PL increased by 5% - then real income rose by ___% You will get a 10% raise

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59 3. Gala Land produces 3 final goods: bread, water, and fruit. The table [right] shows this years output and price for each good. (a) Calculate this years nominal GDP. (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. (ii) This years real GDP (c) S ince 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. (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. (a): 400x$6=$2,400; 1,000x$2=$2,000; 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. and 800x$2 = $1,600 for a Nominal GDP of $6,000. Answer to 3. (b) (i): Answer to 3. (b) (i): Change/Original x 100; therefore 50/100 x 100 = 50% inflation rate. Change/Original x 100; therefore 50/100 x 100 = 50% inflation rate. Answer to 3. (b) (ii): Answer to 3. (b) (ii): Nominal GDP/GDP deflator x 100 = Real GDP; $6,000/150 X 100 = Real GDP of $4,000. Nominal GDP/GDP deflator x 100 = Real GDP; $6,000/150 X 100 = Real GDP of $4,000. Answer to 3. (c): Inflation between these years has increased 50%; wages have increased 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. only 20%; therefore workers real wages or real purchasing power has decreased. 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 isnt worth what it was when he took out the loan. 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 isnt worth what it was when he took out the loan. This Years Output This Years Price 400 loaves of bread $6 per loaf 1,000 gallons of water $2 per gallon 800 pieces of fruit $2 per piece

60 3. Gala Land produces 3 final goods: bread, water, and fruit. The table [right] shows this years output and price for each good. (a) Calculate this years nominal GDP. (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. (ii) This years real GDP (c) S ince 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. (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. This Years Output This Years Price 400 loaves of bread $6 per loaf 1,000 gallons of water $2 per gallon 800 pieces of fruit $2 per piece

61 15. The business cycle is defined as the _______ and _______ in business activity. A. EXPANSION B. PEAK C. CONTRACTION D. TROUGH ___ 16. High point of expansion ___ 17. Period of growth ( GDP increases ) ___ 18. Bottoming out of business activity ___ 19. Laid off workers are called back. ___ 20. Near or at full employment ( 4-6% ) ___ 21. H ave averaged 11 months since W.W.II. NS upturns downturns B D A B C A

62 22. During a recession, jobs relating to (durable/nondurable) goods are affected the most because they are postponable and have monopoly power (few sellers). (durable/nondurable) goods are affected the most because they are postponable and have monopoly power (few sellers). 23. (Leading/Coincident/Lagging) indicators – statistics that illustrate the direction the economy is heading in 6-9 months. 24. (Leading/Coincident/Lagging) indicators – snapshot of the economy at this time. 25. (Leading/Coincident/Lagging) indicators – statistics that tell where the economy has been. 26. Full employment occurs when we have ______% unemployment. The current unemployment rate is ____%. 27. (Discouraged workers/Temporary unemployed workers) are those who have given up looking for a job. 28. The presence of discouraged workers & counting part-time workers as fully employed results in the official rate being (understated/overstated). 29. If 2 million out of 8 million unemployed workers become discouraged & quit looking for work, the official rate would (incr/decr/be unchanged). & quit looking for work, the official rate would (incr/decr/be unchanged). 30. If 3 million part time workers switch to full time work, the official rate will (fall/rise/remain unchanged). NS

63 NS short-term 31. (Frictional/Structural/Cyclical) is temporary, short-term unemployment. long-term 32. (Frictional/Structural/Cyclical) is technological, long-term unemployment. recessions 33. (Frictional/Structural/Cyclical) is unemployment resulting from recessions. A. FRICTIONAL B. STRUCTURAL C. CYCLICAL recession ___ 34. Michael lost his job due to the recession [business cycle downturn]. College graduate ___ 35. College graduate is searching for his first job. quitting ___ 36. Amanda is quitting Wendys to work at McDonalds. decrease in AD ___ 37. There are job losses at Ford due to a decrease in AD. LifeguardsSantas ___ 38. Lifeguards in the winter and Santas during the spring. auto replaces carriage makers ___ 39. The auto replaces carriage makers. ATM machines replace bank tellers ___ 40. ATM machines replace bank tellers. cost of unemployment 45. The cost of unemployment can be measured by the amount by which (potential/actual) GDP exceeds (potential/actual) GDP. unemployment rate is 8%, 46. If the unemployment rate is 8%, we can infer that the (potential/actual ) GDP is in excess of (potential/actual) GDP. general increase in prices 47. (Inflation/Disinflation/Deflation) is a general increase in prices. decline in prices 48. (Inflation/Disinflation/Deflation) is a decline in prices. decrease in the rate of inflation 49. (Inflation/Disinflation/Deflation) is a decrease in the rate of inflation. C A A C A B B

64 increase in 54. (Demand-pull/Cost-push) inflation results from an increase in aggregate demand aggregate demand [AD]. increase in 55. (Demand-pull/Cost-push) inflation results from an increase in production costs production costs [wages or input cost]. benefits from inflation 56. The only group that benefits from inflation are (creditors/debtors/fixed income pensioners). misery index 59. The misery index is equal to the _______________________ plus the ________________ current misery index 60. The current misery index is ______. [changes every month] NS unemployment r ate [7.3%] inflation rate [1.5%] (These 2 figures chg each month) 8.8% This changes every month. Highest ever- June % Lowest ever July % Invented in 1970s- post-dated back to the 50s…

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66 47. Inflation – overall increase in prices 48. Deflation – decrease in prices (1955) 49. Disinflation – decrease in inflation( ) 49. Disinflation – decrease in inflation( ) Up in 2007 % Legal Svc 5.2 Col. Tuition 5.8 Tech. Svc. 1.7 Hospitals 5.4 Col. Fees 5.8 Comp. Train5.3 Med. Serv. 5.4 Down in 2007 % Gasoline 43.1 TVs 19.4 Homes 18.2 Toys 6.8 Girls c lothing 3.6 New cars 3.2 Boys clothing 1.1 Furniture 0.1 Take some money out of circulation to make it more valuable. Above about % inflation is considered too much. [3.9% in 2008; -0.4% in 2009; and 1.6% in 2010]

67 AD 1 AD 2 Demand-Pull Inflation [Good News – more jobs; Bad News – higher prices] AS PL 1 PL 2 Y*Y*Y*Y* YIYIYIYI Good News - more jobs Bad News -higher prices E1E1E1E1 E2E2E2E2

68 AD 2 AD 1 Disinflationary Recessions [Good News–lower prices; Bad News–job losses] AS PL 1 PL 2 YRYRYRYR Y*Y*Y*Y* Good news -lower prices Bad news - job losses

69 Adverse Supply Shocks [bad news – job losses; bad news – inflation] AD AS 1 PL 1 Y*Y*Y*Y* Y R 10 % 10 % AS 2 $2.25 This economy isstagnating but inflating. Stagflation PL 2 [10 % ] Stagnating Inflating cognitive This created cognitive dissonance dissonance among many.

70 Traditional Fiscal Policy [G & T] will not work with Stagflation AD 1 4% Y*Y*Y*Y* 10 % 10 % 10 % AS 2 Stagflation AD 2 15% 15 % AD3

71 [good news–job gains; good news–disinflation] AD AS 1 PL 1 Y*Y*Y*Y* PL 2 Y2Y2Y2Y2 $1.50 AS 2

72 PPI 1. PPI – (Production Price Index) wholesale prices [what retailers are buying] CPI 2. CPI – (Consumer Price Index) retail prices [what consumers are buying] GDP D eflator 3. GDP D eflator – production prices [what consumers, businesses, government, and foreigners are buying that we produced.]

73 Consumer Price Index (CPI) [CPI measures cost of living relative to a base year[100] [CPI measures cost of living relative to a base year[100] 364 items23,000 T he CPI is a market basket of 364 items at 23,000 establishments87 cities establishments in 87 cities that the typical does not include exports householder buys. It does not include exports does include because we do not buy exports but does include imports55% of the CPI is services imports. About 55% of the CPI is services. Food & energy make up 23% of the CPI. Core inflation makes sense only for people who dont eat or drive. Core

74 Health4.3% Transportation18.3% Shelter27.9% Household10.0% Clothing6.6% Alcohol4.5% Recreation10.4% Food18.0%

75 1.Substitutes not counted 2.Quality not considered (airbags) 3.No discount stores (outlet bias) 4.New items not counted a. 1 st VCR, the Phillips 1500, the worlds 1 st VCR for home use sold for $1,295 but $50 today. They fell in price 70 % before entering the CPI. b. First solar powered calculators appeared in 1972 for $120 but didnt make the CPI until c. In 2000, a 20-inch LCD TV cost $5,000, today under $300. Brick d. Cell phones[ The Brick] were introduced in 1984 at $3,995. e. The camcorder cost $1,500 in 1987, now under $150. $650 f. 50 inch Flat Screen TV in 1999 cost $12,000, now $ Sharp QT-8D Calculator for $475 [4 functions] [First battery-powered electronic calculator] If orange goes from $1.00 to $2.00& Tomato juice goes from $1 to.80

76 *These could execute 330,000 computations per sec(2 billion now). 5 MB disk drives These had 5 MB disk drives. Today 500GB Dell makes computers with 500GB, 70,000 times larger 70,000 times larger. Stores were $3,300 selling them for $3,300 after buying $2,000 them for $2,000. M. Dell – 2 nd richest TX He bought parts from BYTE Magazine for $600 and sold them for $1,500-$2, IBM PC 4.77MHz 160 KB floppy drives $3, Compaq MHz 120 MB hard drive $2, Dell Optiplex GB 320 GB hard drive $700

77 Who is the Richest American Ever? Who is the Richest American Ever? John D. Rockefellers John D. Rockefellers [ ] wealth would be worth $200 billion $200 billion in todays money, or 2 1/2 times that of Bill Gates ($72 Billion). Babe Ruth$80,000in 1931 Babe Ruth made $80,000 in That would $1.1 mil. todayB arry Bonds be equivalent to $1.1 mil. today. [B arry Bonds $18 million got $18 million for his last year] Herbert H oovers salary P resident Herbert H oovers salary in 1931 $ 75,000 was $ 75,000. That would be equivalent to $1,075,657Pres. Obama $1,075,657 today. Pres. Obama is being $400,000Kennedy paid $400,000 a year. President Kennedy $100,000[$730,000 was paid $100,000 in 62 [$730,000 today ] $200 billionnot Although Rockefeller was worth $200 billion, he could not watch TV, play video games, surf the internet, or send 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. $ 80, 000= $ 1.1 M

78 Presidential pay history Date established Salary Salary in 2011 Dollars September 24, 1789 $25,000 $631,000 (1789) March 3, 1873 $50,000 $860,000 (1873) March 4, 1909 $75,000 $1,837,078 (1909) January 19, 1949 $100,000 $915,966 (1949) January 20, 1969 $200,000 $1,188,010 (1969) January 20, 2001 $400,000 $492,000 (2011) Obama would have to make $492,000 to buy what Bush could buy for $400,000 in Obama would have to make $492,000 to buy what Bush could buy for $400,000 in [$400,000 x 218.0/177.1 = $492,000] CPI *CPI was for 2010

79 1962 Prices2011 Prices [National Debt - $286 billion] [National Debt - $$ ] 1962 Prices v Prices [National Debt - $286 billion] [National Debt - $$ 316,722,162 so each citizen's share of this debt is $52, ] Tuition at Harvard - $900Tuition at Harvard - $900 Starting salary - $6,000 [college graduate]Starting salary - $6,000 [college graduate] FICA of of $4,800 [$150 maximum]FICA of of $4,800 [$150 maximum] Top marginal tax rate of 91% of incomes over $200,000.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]New house for $10-15,000 [2.5 times the income of a new college graduate] Coke -.5 centsCoke -.5 cents Movies -.50Movies -.50 Gas, a gallon - $.29Gas, a gallon - $ Chevy Impala- $1, Chevy Impala- $1,500 Tuition at Harvard - $Tuition at Harvard - $ 38,891 Median Starting salary - $45,400 [college graduate]Median Starting salary - $45,400 [college graduate] FICA of 6.2 of $113,700 [$7,049 maximum]FICA of 6.2 of $113,700 [$7,049 maximum] Top marginal tax rate of 35% of incomes over $388,350Top marginal tax rate of 35% of incomes over $388,350 New median house price is $242,000 [5.5 times the income of todays college grads]New median house price is $242,000 [5.5 times the income of todays college grads] Coke - $1Coke - $1 Movies - $10Movies - $10 Gas, a gallon - $3.50Gas, a gallon - $ Chevy Impala- $25, Chevy Impala- $25, Corvette $2, Corvette Grand $59,600

80 Cost-Push Inflation Cost-Push Inflation – 3 things may cause cost-push inflation. Wage-push 1. Wage-push – strong labor unions Profit-push 2. Profit-push – companies increase prices when their costs increase. Supply-side cost shocks 3. Supply-side cost shocks – unanticipated increase in raw materials such as oil. Demand-pull Cost-push Demand-Pull InflationAD Demand-Pull Inflation – increase in AD. [Too many dollars chasing too few goods] buyers side of the market. Originates from buyers side of the market. D 1 D 2 P2P2P2P2 Wage-priceSpiral S1S1S1S1 S2S2S2S2D PL 2 PL 1 S P1P1P1P1

81 Stagflation Stagflation Periods [ and ] stagnatinginflatingdisinflating Although the economy was stagnating, it was inflating, instead of disinflating.

82 Who is Hurt by Inflation?Who is Hurt by Inflation? –Fixed-Income Receivers –Savers –Creditors Who is Unaffected by Inflation?Who is Unaffected by Inflation? –Flexible-Income Receivers Cost-of-Living Adjustments (COLAs)Cost-of-Living Adjustments (COLAs) –Debtors –Government (as a big debtor) benefits big time


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