Inflation, GDP, and Unemployment Unit 2 Inflation, GDP, and Unemployment

Inflation

McDonald's Hamburger Prices [1955]--15 cents [1964]--15 cents [1968]--18 cents [1974]--30 cents [1979]--38 cents [1984]--50 cents [1987]--62 cents [1990]--75 cents [1991]--59 cents [1995]--85 cents [2000]--89 cents [2007]--89 cents Why did the price of these hamburgers increase over time? Did the hamburgers get bigger? Did the quality improve?

Inflation Price level – the weighted average of the prices of all goods and services in an economy Inflation – a rise in the general level of prices

Inflation Price level – the balloon Inflation – the guy blowing up (inflating) the balloon

Inflation Inflation and deflation measure the average or general tendency of price changes Prices of individual goods and services rise and fall at different rates The prices of some goods may fall during periods of inflation, even though most prices are rising The U.S. has not experienced a period of significant inflation since the 1970s & 80s

Inflation How does inflation affect the value of a dollar? Inflation decreases the value (purchasing power) of a dollar

Inflation What movie made the most money all-time?

Inflation Would that answer change if we adjusted for inflation? www.boxofficemojo.com

Nominal vs. Real Nominal Real An unadjusted rate, value, or change in value What movie made the most in nominal terms? Rate, value, or change in value adjusted for inflation What movie made the most in real terms?

Real Real values are more important than nominal values for economic measures, such as GDP and personal incomes, because they help ascertain the extent to which increases over time are driven by inflation and what is driven by actual growth.

Inflation What would happen if prices increase at a faster rate than people’s salaries or wages? Real wages - Income of an individual after taking into consideration the effects of inflation on purchasing power

Consumer Price Index (CPI) A measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services Measures changes in price levels as experienced by consumers in their day to day purchases of goods and services A way to compare purchasing power and measure inflation

Consumer Price Index May 30, 2018.

Calculation Inflation rate – the percentage change in the price level (CPI year 2 – CPI year 1)/CPI year 1

Unanticipated Inflation Winners Losers Debtors (Borrowers) Holders of assets that rise in value faster than other assets (i.e. gold) Savers (at a fixed rate) Creditors (Lenders) Individuals living on a fixed income Unless there’s a COLA (Cost of Living Adjustment)

Demand Pull & Cost Push Demand Pull Inflation Cost Push Inflation Prices rise because demand shifts to the right Increase in the number of products produced and sold What is the overall impact on the economy? Prices rise because supply shifts to the left What could cause this? Decrease in the number of products produced and sold What is the overall impact on the economy? Stagflation – increasing inflation & unemployment

Deflation Deflation – a general downward movement in the prices of goods and services May sound good, but… Often accompanied by falling wages and increasing unemployment

Deflation During periods of deflation, debtors have to repay their loans with dollars that are more valuable (have more purchasing power) Debtors have borrowed cheap dollars and are repaying with dollars that will buy more Consumers and producers who are in debt suffer As their income drops, their loan payments remain the same

Visual 1.3 Compare the decade 1929-1939 with 1989-1999. How would you describe each decade? Refer to the second graph. During the period 1929-1940, in which years did the price level rise relative to the previous year and during which years did the price level fall relative to the previous year?

Gross Domestic product

Gross Domestic Product The market value of all the final goods and services produced in an economy in a year Sometimes called National Income Economists use real GDP data to measure the growth of the economy by comparing the change in real GDP from one year to the next U.S. average growth of 3 to 3.5% annually GDP is called Output and abbreviated Y Potential GDP or Full Employment Output Maximum level of output an economy can sustain over the long run

Which country has the highest GDP? https://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)

NOT included in GDP Sale of used goods Financial transactions Sale of stocks and bonds Products made overseas Ford cars made in Japan Products that are not finished dye bought by a factory for sheets Products that are not paid for with money Unpaid housework, leisure time, work you do for yourself, goods acquired via barter, social well-being Government transfer payments (social security, etc.) Negative costs like pollution

What makes up GDP? Y = C + I + G + NX

C = Consumption Money that is spent by consumers to buy consumer goods Who are consumers? Who buys the final goods and services produced in our economy? Households and Individuals

I = Investment Money that is spent on increasing the productivity of a business Capital (goods used to make more goods) Capital Goods (factories, bulldozers, tools) Who invests? Who spends money on increasing business productivity? Businesses Purchase of a new home Increase in business inventories This “Investment” does not include transfers of stock ownership

G = Government Spending Money spent by government Raised via taxes (taxation) Raised via borrowing (bonds, securities, etc) Spent on: Military Police protection Court System Infrastructure (roads, water, electricity, etc) This “Government Spending” does not include transfer payments (i.e. Social Security)

NX = Net Exports Exports minus imports

Y = C + I + G + NX Notice that the components of GDP are spent by… Households and Individuals Businesses Governments People in foreign countries

GDP is not a perfect measure: INFLATION Need to adjust for inflation to compare GDP from different time periods Real GDP = (nominal GDP x 100)/CPI

GDP is not a perfect measure: POPULATION Need to adjust for population to compare economies from different countries GDP per capita = GDP divided by population Per capita means per person

Adjusting for Inflation and Population Real GDP per capita

Visual 1.5 What does the trend line on the first graph indicate? What period is most noticeably below the trend? What does this suggest happened during that time? GDP growth was below the trend during all of the years shown on the second graph. During which years was GDP growth the lowest?

unemployment

Unemployment Civilian, non-institutionalized persons 16 years of age or older are classified as unemployed if they… Do not have jobs & Have actively looked for work in the prior 4 weeks

Definitions of Employed, Unemployed and Unemployment Rate Employed = everyone currently working, including part-time workers Unemployed = people looking for work or temporarily laid off from work Discouraged workers = want a job, but gave up looking Unemployment Rate = unemployed labor force Labor force = employed + unemployed Labor force participation rate = labor force population aged 16 and older

May 31, 2018. Unemployment Rate

Labor Force Participation Rate May 31, 2018. Labor Force Participation Rate

Visual 1.6 During what years did the economy experience the lowest rates of unemployment? What events were occurring from 1943 to 1945? Why would unemployment be lowest at this time? During what year did the economy experience the highest rate of unemployment? What was the rate?

Types of Unemployment Frictional Unemployment Short-run unemployment Fired/laid off/quit and are looking for another job Just entered the labor force Seasonal unemployment

Types of Unemployment Structural Unemployment Long-run unemployment Job has become obsolete Don’t have the skills needed in the job market

Types of Unemployment Cyclical Unemployment Unemployment associated with economic downturns Lost job in the recession Fluctuations in the business cycle

Other Employment Concepts Natural Rate of Unemployment Lowest rate of unemployment that an economy can sustain over the long run Structural + Frictional No cyclical unemployment Approximately 5% in the U.S. Full Employment GDP Gap The amount by which potential GDP exceeds actual GDP – shows the cost of unemployment

Phases of the Business Cycle

Real GDP May 31, 2018.

May 31, 2018. Real GDP

Circular Flow Leakages – anything outside the model (e.g. savings, imports)

Macroeconomic Goals Full Employment Price Stability Economic Growth