2. Economic Growth
• The growth rate of real Gross
Domestic Product (GDP) per
capita is the most common
measurement of increasing
– 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
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
• Adjusting for Inflation requires a price index of
Calculating a Price Index:
the old fashioned, simple way
• Select a basket of goods
• Price of that basket of goods in Y2 divided by
the price of that same basket in Y1
Basket cost in Y2 _
Basket cost in Y1
Calculating an Index
price index = current cost of basket
base period cost of basket
• 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
• When using the index to calculate “real” values, use it in its decimal form.
• When using an index to calculate an inflation rate you can use the decimal
form or the published form, so long as you are consistent.
Calculating “Real” Values
Real GDP, Real Wage, Real Price, Real
Real Value of Xt
Price index at time t
• Note: when using this formula, be sure you use the
price index in its decimal form, not in its expanded
percentage (published) form.
8. Real Value of Xt
Price index at time t
Example: an entertainment price index might have 2
movies, 1 concert and 1 bowling trip.
In year 1, movies $5, concerts $9, bowling $3
The basket in year 1 is $22
In year 2, movies $5.50, concerts $10, bowling $3
The basket in year 2 is $24.
Price index in Year 1 is $22/$22= 1.0 (or 100 in published form)
Price index in Year 2 is $24/$22= 1.091 (or 109.1 in published
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
• The value of a price index in any particular year indicates how
prices have changed relative to a base year. (1982-84)
• The base year is the year against which all other years are
compared; the index in the base year is 100.
• The published form of an 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.
11. Sources of Economic Growth
• Growth of population and increased labor
• Growth of productivity (output per worker)
– Increase in capital per worker
– Increase in total factor productivity
– Increase in technology or human capital
12. 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.
13. Growth and the environment:
• In early stages of economic
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
14. 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
15. Business Cycles
• Business Cycle: the pattern of real GDP rising and
• 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.
16. The Business Cycle
line is also
Growth line or
17. Economic Indicators
• Leading Indicators
• Variables that fairly consistently changes before real GDP
• 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
18. Indicators of Business Cycle
Average Work Week
New Building Permits
Interest Rate Spread
New plant and
19. Indicators of Business Cycle
and trade sales
20. Indicators of Business Cycle
Prime interest rate
Labor cost per
unit of output
21. Great Depression
Year U.S. Unemployment Rate
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
number in the Labor Force=
23. Interpreting the
• 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.
24. Types of 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.
25. Types of 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.
26. Types of 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
Example: Advancements in technology have
resulted in consistent declines in employment in
the agriculture, forestry and fishing industries.
27. Cyclical Unemployment
A product of business cycle fluctuations.
As a recession occurs, cyclical unemployment
increases, and as growth occurs, cyclical
As the housing boom of the early 21st century
slows, unemployment in related industries like
builders and real estate agents increases.
Types of Unemployment
28. 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 non-labor resources are
fully utilized and unemployment is at its natural rate.
• GDP gap = potential real GDP – actual GDP
29. 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.
30. 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
31. Unemployment by
During a recession, more
people are unemployed,
and the average duration of
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
whose numbers increase
greatly during a recession.
32. Inflation in the United States
• Inflation means a sustained
rise in the price level
• Deflation means a
sustained fall in the price
• During 2009, the United
States experienced several
months of deflation, but
prices began to rise again
late in the year.
33. World inflation averages
• Inflation was much
higher in the 1970s
and 1980s than it
• During the 1990s,
inflation fell, first in
countries and then
Calculating an Inflation Rate
Inflation or deflation π = change in index X 100
initial value of the index
• 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
35. 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
• The real rate of interest is
the nominal rate adjusted
by subtracting the rate of
• R = nominal rate of interest
• r = real rate of interest
• π = rate of inflation
r = R - π
36. 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.
37. Real Price = Nominal price/index (decimal form)
Which Car below is more expensive in REAL
A.Dec 1976 Ford LTD Wagon = $6000
B.Dec 2001 Ford Windstar = $14000
• CPI Dec 1976 = 58.2
• CPI Dec 2001 = 180.9
38. Real Price = Nominal price/index (decimal form)
Who makes the most money?
A.$12,000 annual salary in 1972
B.$ 45,000 annual salary in 2010
CPI 1972 = 41.8
CPI 2010 = 218.0
39. Real Price = Nominal price/index (decimal form)
• Who paid the highest tuition in real terms?
A.$800 per semester tuition in 1983
B.$2000 per semester tuition in 2010
• CPI in 1983 = 97.8
• CPI in 2010 = 218.0
40. Inflation = Δindex/initial index
Number of years
CPI in Dec 1972: 42.5 and CPI in Dec 1973: 46.2
•What is the inflation rate from December 1972 to
E.None of these
41. CPI 2007 = 210.0 CPI 2008 = 210.2
•What was inflation December 2007 to
E.None of these are correct within a reasonable
42. CPI 1970 = 39.8 CPI 1980 = 86.3
What was the inflation rate from December
1970 to December 1980?