1. 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.
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4. Real
Verses
Nominal
Growth:
What
Increased?
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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
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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
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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.
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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.
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9. Price Indexes
• 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 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.
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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
• 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
Money Supply Manufacturers’ New Building Permits
New Orders
New plant and Average Work Week
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
Labor cost per sales ratio
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. Unemployment
The unemployment rate is the percentage of the labor
force that is not working.
Rate of number unemployed
Unemploymen = number in the Labor Force
t
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

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

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.