Understanding Economics

Transcription

1 Understanding Economics CHAPTER 10 INFLATION AND UNEMPLOYMENT 1

2 Learning Objectives In this chapter you will: 1.learn about inflation, how it is measured, and its effect on nominal and real incomes 2.examine the official unemployment rate, the different types of unemployment, and the definition of full employment 2

3 The Consumer Price Index The consumer price index (CPI) is the most common measure of inflation monitors price changes in a representative shopping basket of consumer products includes quantities in a shopping basket determined in a base year compares prices in the current year with those in the base year In the example of the next slide, if the value of this basket rises from $50 to $53.5 during the course of a year, the annual inflation rate is 7 percent, with the consumer price index moving from 100 to 107 3

4 Simple Consumer Price Index Figure 10.1, Page 223 Results of 2003 Survey Prices Quantity Consumed per Month Expenditure per Month Weights Hamburgers Milkshakes $2.00 $ $20 $30 $20 $50 = 0.4 $40 $50 = 0.6 $50 Prices in 2004 Hamburgers Milkshakes Prices $2.20 $ Price 2003 Quantity $2.20 x 10 = $22.00 $1.05 x 30 = $31.50 $

5 What is CPI? CPI = Consumer Price Index Measures overall changes in price of shopping basket of consumer products 5

6 Consumer Price Index Weights (1992) Figure 10.2, Page 224 Health and personal care 4.3% Recreation, education, and reading 10.4% Alcoholic beverages and tobacco products 4.5% Transportation 18.3% Food 18.0% Clothing and footwear 6.6% Household operations and furnishings 10.0% Shelter 27.9% 6

7 Nominal Versus Real Income Nominal income is expressed in current dollars Real income is expressed in base-year dollars equals nominal income divided by CPI (expressed in hundredths) Cost of living: the amount consumers must spend on the entire range of goods and services they buy 7

8 Question What is the real income if nominal income is $1050 and CPI is 1.10 (aka 110%) Real Income = Nominal income/ CPI = $ What does this imply? Consumer s monthly income of $1050 has a purchasing power of $ What income would the consumer need to have the same purchasing power as his monthly income? 8

9 The Limitations of the CPI The CPI does not take full account of consumer differences, since it is based on the consumption patterns of an average household changes in spending patterns since it uses base-year quantities improvements in product quality 9

10 1. Consumer Differences Based on the consumption patterns of an average household

11 2. Changes in Spending Patterns changes in spending patterns since it uses base-year quantities Subjected to technological advances / fad Consumers tend to buy less of items whose prices rise over the time

12 3. Product Quality CPI cannot reflect improvements in product quality that are unmatched by changes in price Example: Stereos have improved tremendously in quality, yet their prices may not have increase proportionally (prices may even fall!) Standard of living may increase because of the increased quality, but this isn t reflected in CPI

13 Project ØCreate a music video on a concept of Economics (Could be ANY concept) ØMusic Video must be around 3 minutes to 5 minutes ØRefer to video: ØShould tell a story / have a theme ØExample: Taylor Swift Blank Space: ØEveryone must be featured (at least in the video); rapping/singing is allowed ØGroups of 4 (max)

14 The GDP Deflator The GDP deflator indicates price changes for all products appearing in GDP includes quantities that change each year compares prices in the current year with those in a reference year See Figure While the GDP deflator has a value of 100 in 2003, which is the reference year, it rises in proportion with the prices of the economy s output. 14

15 Simple GDP Deflator Figure 10.3, Page 226 (1) Year (2) Output of Microchips (3) Current Price (4) Output at Current Price (2) X (3) (5) Output at 2003 Price (2) X $0.20 (6) GDP Deflator [(4) (5)] x $ $ $

16 Finding Real Gross Domestic Product Figure 10.4, Page 227 (1) Year (2) Nominal GDP (current $ billions) (3) GDP Deflator (1997 = 100) (4) Real GDP (1997 $ billions) [(2) (3)] x $ $

17 Nominal Versus Real GDP Nominal GDP is expressed in current dollars Real GDP is expressed in reference-year dollars equals nominal GDP divided by the GDP deflator (expressed in hundredths) 17

18 The Inflation Rate 18

19 Incomes qinflation means not only measuring prices but expanding nominal incomes as well qif a household s nominal income increases steadily every year,, but inflation is at a higher rate, the household loses purchasing power qone of the most costly aspects of inflation for society is that this redistribution of purchasing power occurs in an arbitrary way qwinners are often those with substantial economic resources qlosers are not able to withstand a drop in purchasing power

20 Many labour unions negotiate income adjustments for their members o Wages are adjusted using CPI o COLA (Cost of living adjustment) clauses ØFully indexed incomes ØWhen Workers incomes automatically increase by the rate of inflation ØNominal income rises at the same rate as prices ØIe: inflation is 10%; a worker salary will go up by 10%

21 Inflation s Effects Inflation redistributes purchasing power in arbitrary ways because of various types of indexation full indexation (nominal income rises at the inflation rate) partial indexation (nominal income rises at less than the inflation rate) fixed incomes (nominal income stays constant) 21