Purchasing power , the ability to purchase goods and services, is decreased by rising prices. “How much will your dollar buy?” (in 2009 vs. 1979)
Price level is the relative cost of goods and services in the entire economy at a given point in time. Economists measure this over time by creating an index of prices.
A price index is a measurement that shows how the average price of a standard group of goods changes over time.
The consumer price index ( CPI ) is computed each month by the Bureau of Labor Statistics.
The CPI is determined by measuring the price of a standard group of goods meant to represent the typical “ market basket ” of an urban consumer.
Changes in the CPI from month to month help economists measure the economy’s inflation rate.
The inflation rate is the percentage change in price level over time .
Calculating Inflation rate
Calculating inflation is a simple rate of change calculation:
((CPI Year 2 – CPI Year 1)/(CPI Year 1)) * 100
For example: If CPI was 150.0 for 2008 and 165.0 for 2009
Inflation rate equals:
*(165-150)/(150)) * 100 = 10% (which is a high rate of inflation!)
Consumer Price Index (CPI)
How well do you remember 1985? (stolen from “The Wedding Singer” program)
What was the average income per year?
a. $35,000 c. $32,000
b. $22,000 d. $25,000
Answer: b, in today’s dollars, that’s $43,600
Census Bureau reports median income in 2007 was $50,233
What was the average price of a new car?
a. $15,000 c. $9,000
b. $20,000 d. $5,000
Answer: c, in today’s dollars that’s $17,800
According to the National Automobile Dealers Association the average price is $28,400 currently
What was the average price of a gallon of gas?
a. $1.09 c. $0.99
b. $1.10 d. $0.89
Answer: a, that’s $2.21 in today’s dollars
Currently, it is $2.864 in the U.S.
What was the average cost of a new home?
a. $59,000 c. $95,000
b. $75,000 d. $89,000
Answer: d, that’s $176,000 in today’s dollars
Currently, it is $258,600
What causes inflation?
Classic definition: “Too much money chasing too few goods.”
Hyperinflation: way too much money printed in an economy. Examples include Zimbabwe currently, Germany in the 1920s, Argentina in the 80s, and many others.
Cost Push Theory
Demand Pull Theory
The Quantity Theory
The quantity theory of inflation states that too much money in the economy leads to inflation .
Adherents to this theory maintain that inflation can be tamed by increasing the money supply at the same rate that the economy is growing (GDP growth rate.) (This is the Fed’s job. More on that in Chapter 16.)
The Cost-Push Theory
According to the cost-push theory, inflation occurs when producers raise prices in order to meet increased costs.
Cost-push inflation can lead to a wage-price spiral — the process by which rising wages cause higher prices, and higher prices cause higher wages.
The Demand-Pull Theory
The demand-pull theory states that inflation occurs when demand for goods and services exceeds existing supplies .
Other terms to know:
Deflation—a sustained drop in the price level, which leads to lower economic growth and employment. Worse than inflation!
Winners and Losers
High inflation is a major economic problem, especially when inflation rates change greatly from year to year
In an inflationary economy, a dollar loses value. It will not buy the same amount of goods that it did in years past.
When a bank's interest rate matches the inflation rate, savers break even. When a bank's interest rate is lower than the inflation rate, savers lose money.
If wage increases match the inflation rate, a worker's real income stays the same. If income is fixed income, or income that does not increase even when prices go up, the economic effects of inflation can be harmful .
Yay! Inflation helps you if…
Inflation is good for:
Real estate values (land) rise with inflation
Borrowers can pay back their loans with dollars that are worth less than the dollars they borrowed.
OUCH! Inflation hurts when…
Inflation is bad for:
People on fixed incomes
Banks and other lenders
Consumers and businesses who want to take out new loans.
Types of Unemployment
Occurs when people change jobs, get laid off from their current jobs, take some time to find the right job after they finish their schooling, or take time off from working for a variety of other reasons
Occurs when workers' skills do not match the jobs that are available. Technological advances are one cause of structural unemployment
Types of Unemployment
Occurs when industries slow or shut down for a season or make seasonal shifts in their production schedules
Unemployment that rises during economic downturns and falls when the economy improves
How to calculate unemployment
Unemployed / Civilian Labor Force X 100 = Unemployment Rate (%)
“ Unemployed”: those currently not working who have actively sought work in the past 4 weeks.
“ Civilian Labor Force”: All non-military, non-institutionalized people age 16 and older who have a job or are actively seeking work. (If you don’t have a job or are looking, you’re not in the labor force.)
Why is measuring unemployment important?
A nation’s unemployment rate is an important indicator of the health of the economy.
What is wrong with the unemployment rate?
Watch out for “Hidden Unemployment!”
Sometimes people are underemployed , that is working in a job for which they are over-qualified , or working part-time when they desire full-time work.
Discouraged workers are people who want a job, but have given up looking for one. They are considered to have dropped out of the labor force. (Not in the numerator or denominator of the calculation of the unemployment rate.) http://www.bls.gov/
Full employment is the level of employment reached when there is no cyclical unemployment.
Unemployment will NEVER be 0%!
Economists generally agree that in an economy that is working properly, an unemployment rate of around 4 to 6 percent is normal.
Economists refer to this level of unemployment as the “ Natural Rate of Unemployment .”
(Frictional + Structural + Seasonal) = N. R. U.
1. Unemployment that occurs when workers’ skills do not match the jobs that are available is known as
(a) frictional unemployment.
(b) structural unemployment.
(c) seasonal unemployment.
(d) cyclical unemployment.
2. The unemployment rate
(a) is the percentage of the labor force that is unemployed.
(b) is the number of people who are unemployed.
(c) includes only discouraged workers.
(d) is the percentage of the labor force that is underemployed.