Principles of MacroEconomics: Econ101

 Recurrent swings (up and down) in Real GDP; alternating periods of expansions and recessions.

Level of real output Time Peak Recession Expansion Trough Growth Trend

 Expansion: when Real GDP is rising.  Peak: when Real GDP stops rising, it has hit the peak.  Recession: when Real GDP is actually declining.  Two consecutive quarters of decline  Depression: if decline is very large  Trough: when Real GDP stops falling, it has hit the trough  Recovery: period while Real GDP is making up for the production that was lost during a recession.

From 1929 to 2009, real GDP increased at an average rate of 3 percent a year.

Business Cycle Fluctuations  Economic shocks  Prices are “sticky” downwards  Economic response entails decreases in output and employment

Current Population Survey / Household Survey  Conducted every month  U.S. Bureau of the Census  Sample of 60,000 households  16 years of age and older  Labor Participation: Employed / Unemployed  BLS: calculates monthly unemployment rate

Labor force participation rate: The percentage of the working-age population that is in the civilian labor force: Labor force LFPR = x 100 Working-Age Population Labor force: The labor force is the sum of those people who are officially employed and unemployed.

Unemployment Rate: The percentage of the civilian force that is unemployed: Number of unemployed persons UR = X 100 Labor force

 Distinguishing between the unemployed and those not in labor force.  Discouraged Workers  Part-time vs. Full-time jobs  Inaccurate responses to survey  Beware of Liars  Working in the Underground Economy

Frictional unemployment: Short-term unemployment arising from the process of matching workers with jobs. Structural unemployment: Unemployment arising from a persistent mismatch between the skills and characteristics of workers and the requirements of jobs.

Cyclical unemployment: Unemployment caused by a business cycle recession. Natural rate of unemployment: The normal rate of unemployment, consisting of structural unemployment plus frictional unemployment.

Unemployment Rates in Developed Countries

Potential Real GDP: The amount of production we need to have in order to have full employment. Potential GDP is a goal – the amount an economy would like to produce in order to have full employment. Real GDP: Remember………..Real GDP is the amount we actually produce GDP Gap: The difference between the actual Real GDP and the Potential Real GDP

Recessionary Gap: Occurs when Real GDP falls below Potential Real GDP. Therefore, in this case, the unemployment rate is above the natural rate of unemployment. That is, the economy is not exhibiting full employment. Inflationary Gap: Occurs when Real GDP falls above Potential Real GDP. Therefore, in this case, the unemployment rate is below the natural rate of unemployment. That is, the economy can provide jobs to whomever wants one and inflation is on the rise.

1. What is the major difference between a person who is frictionally unemployed and one who is structurally unemployed? The frictionally unemployed person has readily transferable skills, and the structurally unemployed person does not.

2. If the cyclical unemployment rate is positive, what does this imply? It implies that the (actual, measured) unemployment rate in the economy is greater than the natural unemployment rate. For example, if the unemployment rate is 8 percent and the natural unemployment rate is 6 percent, the cyclical unemployment rate is 2 percent.

 Defining Price Level and Inflation  Calculating the Consumer Price Index (CPI)  COLA  Calculating Percentage Changes in the CPI  Overstating the CPI  GDP Deflator  Nominal Interest Rate vs. Real Interest Rate  The Effects of Inflation

 Price Level: A weighted average of the prices of all good and services.  Inflation: An increase in the price level  Deflation: A decrease of the price level  Price Index: A measure of the price level

Consumer price index (CPI): An average of the prices of the goods and services purchased by the typical urban family of four. The CPI Market Basket, December 2004

Base Year: The year chosen as a point of reference or basis of comparison for prices in other years; a benchmark year. COLA: Cost of living adjustment…….income is adjusted automatically to reflect the increases in prices, as measured by the increase in the CPI.

 Substitution Bias  Outlet Bias  Increase in Quality Bias  Overstated by 1%?

In 2005 the CPI was 195.3; in 2006 the index was What was the percentage change in prices from ? Click below for answer %

YearAnnual YearAnnual

Demand-Pull inflation  Excess spending relative to output  Central bank issues too much money Cost-Push inflation  Due to a rise in per-unit input costs  Supply shocks

Cost-push inflation  Reduces real output  Redistributes a decreased level of real income Demand-pull inflation  One view is that zero inflation is best  Another view is that mild inflation is best

Nominal income  Unadjusted for inflation Real income  Nominal income adjusted for inflation Anticipated vs. unanticipated income Percentage change in real income = Percentage change in nominal income Percentage change in price level 

GDP Deflator: Another measure of the price level. Evaluates changes in the prices of ALL products…….calculated as nominal GDP divided by Real GDP x 100. GDP Deflator = Nominal GDP x 100 Real GDP

 No fixed Market Basket  Base Year is different from CPI  GDP Deflator measures changes in the prices of all goods and services, whereas the CPI measures only a basket of goods.

 Winners  Debtors  Nominal interest rate: interest rate quoted  Real interest rate: nominal interest rate minus the rate of inflation  Homeowners  Wage earners  Government  Losers  Creditors  Savers  Wage Earners

1. What is a base year? It is a year that is used for comparison purposes with other years.

2. Explain how the CPI is calculated. The CPI is calculated as follows: (1) define a market basket, (2) determine how much it would cost to purchase the market basket in the current year and in the base year (3) divide the dollar cost of purchasing the market basket in the current year by the dollar cost of purchasing the market basket in the base year, and (4) multiply the quotient by 100.

4. Assume there are three goods in the economy: Quantity 2000 Quantity 2008 Price 2000 Price 2008 A $1 $3 B 5 10 $2 $6 C $5 $15 Using this data, calculate the GDP Deflator for 2008.