1. Prosperity and Stability
Economics
Combined Version
Edwin G. Dolan
Best Value Textbooks
4th edition
Chapter 17
In Search of
Prosperity and Stability

2. Economic Growth
The growth rate of real Gross Domestic Product (GDP) per capita is the most common measurement of increasing prosperity
Nominal GDP is stated in terms of prices at which goods are actually bought and sold
Real GDP is adjusted to remove the effects of inflation
US growth rate of real GDP is about average for the world
About 2-3% per year

3. Real and Nominal GDP The term "real" means adjusted for inflation.
Nominal GDP is a measure of national output based on the current prices of goods and services. It is also called “money GDP”.
Real GDP is a measure of the quantity of final goods and services produced, obtained by eliminating the influence of price changes from nominal GDP.
Adjusting for Inflation requires a price index of some sort.

4. Real Verses Nominal Growth:
What Increased?

5. Calculating a Price Index: the old fashioned, simple way
Select a basket of goods
Price of that basket of goods in Y1 divided by the price of that same basket in Y2

6. Calculating an Index price index = current cost of basket
base period cost of basket
Notes:
This formula yields a decimal. To translate it into the published form of the index (like CPI) multiply it by 100 (as if you were turning it to a percentage).
When using the index to calculate “real” values, use it in its decimal form

7. Calculating “Real” Values Real GDP, Real Wage, Real Price, Real Income, etc.
Real Value of Xt = Xt
Price index at time t
Note: when using this formula, be sure you use the price index in it’s decimal form, not in its expanded percentage form.

8. Three Key Price Indexes
Consumer Price Index (CPI)
measures the impact of price changes on the cost of the typical bundle of goods and services purchased by households.
Producer Price Index (PPI)
A measure of the average prices received by producers for raw materials, intermediate, and final goods. The PPI used to be called the Wholesale Price Index (WPI).
GDP Deflator (GDP Price Index or GDPPI)
Is a broader price index than the CPI. It is designed to measure the change in the average price of all the goods and services included in GDP.

9. Price Indexes
The value of a price index in any particular year indicates how prices have changed relative to a base year. ( )
The base year is the year against which all other years are compared.
The index is 100  the percent change in prices from the base year.
This type of index suffers from substitution bias as some buyers will change the mix of goods that they buy in response to price changes.
Chain-type indexes of real GDP were created to correct for this bias. Such an index uses the mean of the growth rates using beginning and ending year prices.

10. Sources of Growth
Growth of population and increased labor force participation
Growth of productivity (output per worker)
Increase in capital per worker
Increase in total factor productivity

11. Productivity Growth in the United States
Productivity growth varies from year to year. In the 1970s U.S. productivity growth slowed down. It revived again during the hi-tech boom of the 1990s, but has recently slowed again.

12. Growth and the environment: Trade-off?
In early stages of economic development, increasing production of material goods often leads to reduced environmental quality (A to B)
In later stages, properly managed growth can increase both production of material goods and environmental quality

13. Actual and Natural/Potential GDP Growth
Because of increasing population and productivity, the nation’s natural or potential GDP increases steadily over time. As it does so, actual real output is sometimes above and sometimes below the natural level. The difference is called the output gap

14. Business Cycles
Business Cycle: the pattern of real GDP rising and falling.
Recession (Contraction): two or more successive quarters of falling real GDP.
Depression: a severe, prolonged economic contraction. Usually involves unemployment rising to greater than 10% for years.

15. The Business Cycle

16. Economic Indicators Leading Indicators Coincident Indicators
Variables that fairly consistently changes before real GDP changes
Coincident Indicators
Variables that fairly consistently changes at the same time as real GDP changes
Lagging Indicators
Variables that fairly consistently changes after real GDP changes

17. Indicators of Business Cycle
Leading Indicators
New Building Permits
Money Supply
Manufacturers’
New Orders
Average Work Week
New plant and
equipment orders
Interest Rate Spread
Unemployment Claims
Consumer Expectations
Stock Prices

18. Indicators of Business Cycle
Co-incident Indicators
Personal income
Payroll employment
Industrial production
Manufacturing
and trade sales

19. Indicators of Business Cycle
Lagging Indicators
Inventories to
sales ratio
Labor cost per
unit of output
Unemployment
duration
Prime interest rate

20. Great Depression Year U.S. Unemployment Rate 1929 3.2% 1930 8.7% 1931
15.9%
1932
23.6%
1933
24.9% 
1939
17.2%

21. number in the Labor Force
Unemployment
The unemployment rate is the percentage of the labor force that is not working.
The U.S. Labor Department defines the labor force as being equal to:
All U.S. residents
Over the age of 16
Who are not institutionalized
Who are working or looking for work
Rate of Unemployment
number unemployed
number in the Labor Force =

22. Interpreting the Unemployment Rate
Discouraged Workers are workers who have looked for work in the past year, but who have stopped looking because they believe no one will offer them a job.
Underemployment is the employment of workers in jobs that do not utilize their productive skills.

23. Types of Unemployment Seasonal Unemployment:
A product of regular, recurring changes in the hiring needs of certain industries on a monthly or seasonal basis.
For example, retail sales are higher during the holiday season therefore unemployment in this industry goes down during the months of November and December.

24. Types of Unemployment Frictional Unemployment
Usually short term, occurs because workers and employers have to find one another.
Example: College graduates seeking employment are a good example of frictional unemployment.

25. Types of Unemployment Structural Unemployment
Reflects an imperfect match-up of employee skills and the skill requirements of the available jobs or a permanent reduction in demand for an industry’s output.
Example: Advancements in technology have resulted in consistent declines in employment in the agriculture, forestry and fishing industries.

26. Types of Unemployment Cyclical Unemployment
A product of business cycle fluctuations. As a recession occurs, cyclical unemployment increases, and as growth occurs, cyclical unemployment decreases.
As the housing boom of the early 21st century slows, unemployment in related industries like builders and real estate agents increases.

27. Unemployment and Its Costs
Natural Rate of Unemployment The level of unemployment that results when the rate of unemployment is normal, considering both frictional and structural factors. Also called the NAIRU (Nonaccelerating Inflation Rate of Unemployment)
Potential Real GDP The level of output produced when nonlabor resources are fully utilized and unemployment is at its natural rate.
GDP gap = potential real GDP – actual GDP

28. Unemployment in the United States
The unemployment rate rises during contractions and falls during expansions. Because some people are always entering the labor force or changing jobs, it never falls to zero.

29. Unemployment: US vs Europe
The natural rate of unemployment varies from country to country, depending on cultural factors and labor laws. The natural rate has fallen over time in the United States while it has risen in Europe

30. Unemployment by duration
During a recession, more people are unemployed, and the average duration of unemployment also increases. Even during a recession, many of the unemployed are out of work for 14 weeks or less. Social costs of unemployment fall most heavily on the long-term unemployed, whose numbers increase greatly during a recession.

31. Inflation in the United States
Inflation means a sustained rise in the price level
Deflation means a sustained fall in the price level
During 2009, the United States experienced several months of deflation, but prices began to rise again late in the year.

32. World inflation averages
Inflation was much higher in the 1970s and 1980s than it is now
During the 1990s, inflation fell, first in advanced countries and then in developing countries

33. Calculating an Inflation Rate
Inflation or deflation = change in index X 100
initial value of the index
Notes:
Inflation is stated as a percentage, hence, the “X 100” which is just shifting a decimal to a percentage.
Price increases are referred to as Inflation, price decreases are Deflation
Once you’ve calculated the total inflation, you can divide it by the number of years to get an annualized inflation Rate

34. Inflation and interest rates
Inflation affects interest rates as well as prices
The nominal rate of interest is expressed in the ordinary way, in current dollars
The real rate of interest is the nominal rate adjusted by subtracting the rate of inflation
Let
R = nominal rate of interest
r = real rate of interest
π = rate of inflation
Then
r = R - π

35. Inflation and Growth
Inflation of more than a few percent per year tends to undermine economic growth. On average, countries with more than 100 percent annual inflation have negative economic growth.