Isues in economics today 6th by guell chapter06

Chapter 06
Every
Macroeconomic
Word You Ever
Heard: Gross
Domestic
Product,
Inflation,
Unemployment,
Recession, and
Depression
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Chapter Outline
• Measuring the Economy
• Real Gross Domestic Product and Why it is
Not Synonymous with Social Welfare
• Measuring and Describing Unemployment
• Business Cycles

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Microeconomics vs. Macroeconomics
• Microeconomics: that part of the
discipline of economics that deals with
individual markets and firms
• Macroeconomics: that part of the
discipline of economics that deals with
the economy as a whole

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Gross Domestic Product
• Gross Domestic Product: the
dollar value of all of the goods and
services produced for final sale in
the United States in a year
• “Final Sale” avoids double counting of
intermediate production
• “Sale” implies exclusively market
activities
• “produced in the United States” implies
that Hondas produced in the US count
but Fords produced in Mexico do not
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Measuring Prices
• Market Basket: what average
people buy and in what quantities
they buy it
• Base Year: year in which the market
basket is established and year to
which all other prices are compared
• Price of the Market Basket in the
Base Year: (PBYMB) national average
of the total cost of the market basket
for the first month in the first year
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Price Index
• Price Index: a device that centers the
price of the market basket around 100
• Consumer Price Index: the price index
based on what average consumers buy

Price of the Market Basket in 2010
CPI in 2010 =
x100
Price of the Market Basket in the Base Year of 1998

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Measuring Inflation
• Inflation Rate: the percentage increase in
the consumer price index

Inflation during 2010 =

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CPI on January 1, 2011 − CPI on January 1, 2010
x 100%
CPI on January 1, 2010

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Problems Measuring Inflation
• Changes in the Market Basket occur
every two years which is too infrequent
for some goods (like consumer
electronics).
• The treatment of improvements in the
quality of goods is inadequate.
• People change the places they buy
frequently.
• No accounting for substitutions.

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Bureau of Labor Statistics
Adjustments
• The BLS is dealing with

• Consumer electronics issues by
pricing an index of quality rather than
a specific item.
• The “infrequent updates problem” by
moving to a two-year chain-based

index, a price index that is based on
an biannually adjusted market basket.
• The CPI still overstates the cost-of-living by
0.8%.
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Alternative Measures of
Inflation

• Core CPI: The consumer price index that
has had the impact of food and energy costs
removed.
• Personal Consumption Expenditures
deflator: A chain-based price index that
adjusts for the substitution problem.
• Core PCE: The Personal Consumption
Expenditures deflator that has had the
impact of food and energy costs removed.
• Producer Price Index: A price index based
on what firms buy.
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Alternative Measures of
Inflation

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The CPI and Inflation in Selected
Year Base Years (1982-1984)
Year

CPI

Inflation Rate

1930

16.1

1950

25.0

1970

39.8

1990

133.8

6.1

1995

153.5

2.5

2000

174.0

3.4

2005

196.8

3.4

2009

217.2

3.3

2010

221.1

1.8

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Cost of Living Adjustments
• Cost of Living Adjustment or COLA:
a device that compensates people for
the fact that inflation makes the
spending power of their income less

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Inflation’s Winners and Losers
• Losers

• People on fixed incomes
• Lenders
• Winners

• Borrowers

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Interest and Expected Inflation
• If inflation
borrowers
• If inflation
borrowers

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exceeds expectations then
win and lenders lose

is less expectations then
lose and lenders win

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Real Gross Domestic Product
• Real Gross Domestic Product: an
inflation adjusted measure of GDP
• GDP Deflator: the price index used to
adjust GDP for inflation, including all goods
rather than a market basket

RGDP =

GDP

*100

GDP Deflator

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Post WWII RGDP 2000 in billions

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Problems With RGDP
• GDP only counts market sales so it ignores
home production.
• GDP ignores the value of leisure
• GDP ignores the composition of output
• GDP should be a per capita measure
• GDP ignores environmental measures
• GDP ignores the “underground economy”

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Measuring Unemployment

• Work Force: all those non-military
personnel who are over 16 and are
employed or are unemployed and actively
seeking employment
• Unemployment Rate: the percentage of
people in the work force who do not have
jobs and are actively seeking them

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Problems Measuring
Unemployment
• Underemployed : the state of working
significantly below skill level or working
fewer hours than desired
• Discouraged worker effect: when bad
news induces people to stop looking for
work causing the unemployment rate to
fall
• Encouraged worker effect: when good
news induces people to start looking for
work causing the unemployment rate to
rise (until they succeed in finding work)
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Annual Unemployment Rates

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Types of Unemployment
• Cyclically Unemployed: people lose their
jobs because of a temporary downturn in the
economy
• Seasonally Unemployed: (a subset of the
cyclically unemployed) people who lose their
jobs predictably every year at the same time
• Structurally Unemployed : people who
lose their jobs because of a change in the
economy that makes their particular skill
obsolete
• Frictionally Unemployed: people who are
unemployed for a short time in the transition

to an equal or better job

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The Business Cycle
• Business Cycle: regular pattern of ups and
downs in the economy
• Trough: the lowest point in the business cycle
• Recovery: the part of the growth period of
the business cycle from the trough to the
previous peak
• Expansion: the part of the growth period of
the business cycle from the previous peak to
the new peak
• Peak: the highest point in the business cycle
• Recession: the declining period of at least
two consecutive quarters in the business cycle

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The Business Cycle
Peak

ry
e
ov
c
Re

Ex
pa
ns
io

n

RGDP

Peak
Rec
e

Trough
ssi
on

time
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The Business Cycle 1981 to 2009

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