Unemployment, CPI, Foreign Exchange & Balance of Payments Review Day #3: Friday May 6th Unit- #2 & #5 Macro Review Unemployment, CPI, Foreign Exchange & Balance of Payments

4-Types of Unemployment Structural Skills do not match demand for labor Cyclical too low a level of GDP (recession) Frictional Temporarily between Jobs Seasonal Based on time of year Natural Rate of Employment (also called full employment) About 4.5% in USA Allows for some Frictional & Structural Natural Rate is where: Cyclical unemployment is zero Seasonal “factored out”

Measuring Inflation GDP deflator – uses price of all goods/services included in GDP Very Broad index but only has domestically produced goods CPI index – uses prices of a consumer market basket of goods & services Very narrow index but has international goods What should be in basket? Inflation Index: 1990 100 2000 115 Substitution Bias New goods Quality changes Base year always 100 Use to calculate inflation rates COLA = cost of living adjustment

Determinants of Exchange Rates Market for Foreign Exchange 1. Changes in Consumer Tastes 2. Relative Income Changes 3. Relative Inflation 4. Relative Real Interest Rates 5. Speculation & Investment Where people go to “swap” currencies U.S. Income Rises Demand Imports Demand Foreign Currency Dollar Depreciates Foreign Currency Appreciates

If U.S. Price Level Falls => Market for Foreign Exchange Graphing Exchange Rates U.S. goods look “cheap” => Europeans ↑U.S. exports => Demand for dollars ↑ => Dollar appreciates If U.S. Price Level Falls => Dollars Euros Euro Price of a dollar Qty of Dollars D1 S1 -------------- .75 Euro Q1 Dollar Price of a Euro Qty of Euros D1 S1 -------------- 1.3 $ Q1 D2 S2

a Financial Account Surplus with China Balance of Payments Current Account Considered the U.S. Trade Balance (Exports – Imports) (NX) + Investment Income (bond interest, stock dividends) Financial Account Foreign purchase of US assets – U.S. purchase of foreign assets Assets = Stocks, bonds, factories, land, etc… Example: Financial Act. Surplus = Money flows into US If one account is positive the other Must be negative. They generally sum to ZERO! Example: USA has a Current account deficit & a Financial Account Surplus with China

China & Balance of Payments China buys U.S. Bonds Financial Account Surplus Imports > Exports Current Account Deficit Official Reserves Fed holds quantities of foreign currency called reserves Used to offset discrepancy in current account vs. financial account If both accounts do Not sum to zero, reserves are used to Offset minor difference

Phillips Curve: Inflation vs. Unemployment Rate (percent) Inflation Rate (percent per year) SHORT RUN Phillips Curve Phillips curve (output is 8,000) B 4 6 7,500) A 7 2 Natural rate of unemployment Long-run Phillips curve Unemployment Rate Inflation B A 3. . . . and increases the inflation rate . . . LONG RUN Phillips Curve You may have to draw a Phillips Curve Remember—Unemployment on x-axis

Economic Schools of Thought NeoClassical Economics |--------------------------------| Classical Economics |----------------------------| Keynesian Economics |----------------------------| 1900 1929 1980 2008 1936 1979 Great Depression? Prices were not flexible! What Now? Keynesian Economics did not help here!

Practice Test