Price indexes are also the basis for measuring inflation. The inflation rate is the percent change in price over time

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1 Economics 102 Discussion Handout Week 7 Spring 2018 Market Baskets and the CPI A price index measures the general price level in an economy in a given year. The most widely used price index is the Consumer Price Index (CPI) A market basket is a hypothetical bundle of goods thought to represent the consumption of a typical household CPI = Cost of market basket in a given year Cost of market basket in base year Scale Factor Price indexes are also the basis for measuring inflation. The inflation rate is the percent change in price over time Price index in year 2 Price index in year 1 Inflation Rate = 100 Price index in year 1 If the inflation rate is positive from one year to another, we claim there was inflation during that time period. If the inflation rate is negative, we claim that there was deflation. If there is a decrease in the inflation rate we claim there was disinflation Review: Real vs. Nominal GDP and CPI Year Quantity of Shirts Price of Shirts $6 $5 $8 Quantity of Pants Price of Pants $10 $12 $15 1. What is the Nominal GDP in 2014? a) $100 b) $270 c) $156 d) $ What is the Real GDP in 2013 using 2012 as the base year? a) $156 b) $108 c) $186 d) $ What is the GDP Deflator in 2014 using 2013 as the base year? a) 100 b) c) d) What is the inflation rate from using 2012 as the base year? a) 0% b) 1.4% c) 2.6% d) -1.9% 5. Using 2012 as the market basket and 2013 as the base year, what is the CPI for 2014? a) b) 140 c) 98 d)

2 6. (Midterm 2, Summer 2017) You are provided the following information about the CPI in four different communities in City CPI in that City in 2016 Bigtown 120 Meritville 140 Econoland 90 Inspiration 110 a. Given the above information, which city has the lowest purchasing power for a dollar in 2016? b. Suppose you wanted to get a sense of the difference in the cost of living between Bigtown and Meritville. If you had $90 in Bigtown, how many dollars would you need in Meritville to have the same real purchasing power? Show how you found your answer. c. Return to the initial information you were given. You have the following job offers in these four communities. You are asked to rank them from highest real salary to lowest real salary. Provide the formula you will use to do this ranking and then the ranking from highest to lowest. Show your work. City Salary Offer Bigtown $60,000 Meritville $77,000 Econoland $44,100 Inspiration $54,450 i. The formula used for this computation is:

3 ii. The ranking from highest real salary to lowest real salary is provided in the following table: Cities Ranked from Highest Real Salary To Lowest Real Salary The Unemployment Rate Employment is the total number of people currently employed, either full time or part time. Unemployment is the total number of people who are actively looking for work but aren t currently employed. From here, we can define the labor force, labor force participation rate, and unemployment rate mathematically Labor Force = Employment + Unemployment Labor Force Participation Rate = Labor Force Population age 16 and older 100 Unemployment Rate = Unemployment Labor Force 100 Discouraged workers are non-working people who are capable of work but have given up looking for work given the state of the job market. Marginally attached workers would like to be employed and have looked for a job in the recent past but are not currently looking for work. - Discouraged workers are a part of the marginally attached workers category Underemployment is the number of people who work part time because they cannot find fulltime work - Note that the underemployed and marginally attached are not considered unemployed

4 The Natural Rate of Unemployment Frictional unemployment is unemployment due to the time workers spend in the job search Structural unemployment is the unemployment rate that results when there are more people seeking jobs in a particular labor market than there are jobs available at the current wage rate The natural rate of unemployment is the unemployment rate that arises from the effects of frictional plus structural unemployment Natural Rate of Unemployment = Frictional + Structural Cyclical unemployment is the deviation of the actual rate of unemployment from the natural rate Actual Unemployment = Natural Rate of Unemployment + Cyclical 7. Consider the community of Clarkville. There are six hundred people who live in Clarkville and your task is to answer the following set of questions based on the information below: In Clarkville there are 90 people who are less than 16 years old In Clarkville there are 40 people who are over 70 years old and are fully retired In Clarkville there are 60 people who are currently not working, are available to work, and have submitted job applications during the past four weeks In Clarkville there are 40 people who are currently not working, are available to work, but who have given up submitting job applications because they do not believe there is any work to be had in Clarkville In Clarkville there are 70 full-time college students who are not currently seeking work In Clarkville there are 140 people who are working part-time but who would like to work fulltime The rest of the Clarkville population is over 16 years old and currently working a. What is the number of employed people in Clarkville?

5 b. What is the number of unemployed people in Clarkville? c. What is the labor force equal to in Clarkville? d. What is the unemployment rate in Clarkville? e. How would the unemployment rate change in Clarkville if discouraged workers were counted as unemployed workers? f. How would the unemployment rate change in Clarkville if part-time workers were counted as unemployed workers rather than employed workers? 4. For the following questions, determine whether the form of unemployment is structural, frictional, cyclic, or none of these choices. a. Shrek spends one evening crunching the numbers and realizes that given recent economic forecasts that tourism in his swamp will be down in the next year. He has a hard conversation with Donkey, where he tells Donkey he won t be able to employee him in the coming year, but can hopefully rehire him once a prince has come and saved the economy. b. Moisture farmers on the desert planet of Tatooine had for a long time been a vital part of the planet s economy, however recent developments in terraforming and space irrigation

6 have led to it being an outdated and inefficient practice, leaving hundreds of thousands of moisture farmers out of work. c. A young economist decides that she did not get her PhD so that should could make millions on Wall Street, and quits her high-profile job in Manhattan to find an academic position, realizing it might take some time to find a suitable job. d. One day, everyone wakes up and finds that all economic assumptions of rationality are met, allowing individuals to optimize and any kinds of contracts can be written between agents. This leads to the insurance companies becoming obsolete, as individuals can now perfectly self-insure. e. Harry decides that after defeating Lord Voldemort, saving the wizarding world, and rebuilding the Auror Department that he doesn t need to work anymore.