Economics

1. Measuring GDP
•Nominal GDP and Real GDP
–Real GDP is the value of final goods and services
produced in a given year when valued at the
prices of a reference base year.
–Currently, the reference base year is 2005 and
we describe real GDP as measured in 2005 dollars.
–Nominal GDP is the value of goods and services
produced during a given year valued at the prices
that prevailed in that same year.
–Nominal GDP is just a more precise name for
GDP.

2. Measuring GDP
•Calculating Real GDP
–Table 21.3(a) shows
the quantities
produced and the
prices in 2005 (the
base year).
–Nominal GDP in
2005 is $100 million.
–Because 2005 is the
base year, real GDP
equals nominal GDP
and is $100 million.

3. Measuring GDP
•Table 21.3(b) shows
the quantities
produced and the
prices in 2012.
•Nominal GDP in 2012
is $300 million.
•Nominal GDP in 2012
is three times its value
in 2005.

4. Measuring GDP
•In Table 21.3(c), we
calculate real GDP in 2012.
•The quantities are those of
2012, as in part (b).
•The prices are those in the
base year (2005) as in part
(a).
•The sum of these
expenditures is real GDP in
2012, which is $160 million.

5. The Uses and Limitations of Real
GDP
–Economists use estimates of real GDP for two
main purposes:
 To compare the standard of living over time
 To compare the standard of living across countries

6. The Uses and Limitations of Real
GDP
•The Standard of Living Over Time
–Real GDP per person is real GDP divided by the
population.
–Real GDP per person tells us the value of goods
and services that the average person can enjoy.
–By using real GDP, we remove any influence that
rising prices and a rising cost of living might have
had on our comparison.

7. The Uses and Limitations of Real
GDP
–Real GDP Fluctuations— The Business Cycle
–A business cycle is a periodic but irregular up-
and-down movement of total production and
other measures of economic activity.
–Every cycle has two phases:
1. Expansion
2. Recession
–and two turning points:
1. Peak
2. Trough

8. The Uses and Limitations of Real
GDP
–Figure 21.4 illustrates
the business cycle.
–An expansion is a
period during which
real GDP increases—
from a trough to a
peak.
–Recession is a period
during which real GDP
decreases—its growth
rate is negative for at
least two successive
quarters.

9. The standard of living depends on real GDP per
person.
Real GDP per person is real GDP divided by the
population.
Real GDP per person grows only if real GDP
grows faster than the population grows.
The Basics of Economic Growth

10. Employment and Unemployment
1. Why Unemployment Is a Problem?
–Because Unemployment results in
–a) Lost incomes and production
–The loss of a job brings a loss of income for the
unemployed worker and a loss of production.
–The loss of income is devastating for those who bear
it. Employment benefits create a safety net but don’t
fully replace lost wages, and not everyone receives
benefits.
–b) Lost human capital
–Prolonged unemployment permanently damages a
person’s job prospects by destroying human capital.

11. Employment and Unemployment
What are the 2 groups of population?
–The population is divided into two groups:
–1. The working-age population—the number of
people aged 16 years and older who are not in jail,
hospital, or some other institution
–2. People too young to work (under 16 years of
age) or in institutional care

12. Employment and Unemployment
–3. What are the 2 groups of working age
population?
–The working-age population is divided into two
groups:
–1. People in the labor force
–2. People not in the labor force
–The labor force is the sum of employed and
unemployed workers.

13. Employment and Unemployment
–4. what are the conditions done to be counted as
unemployed person?
–To be counted as unemployed, a person must be
in one of the following three categories:
–1. Without work but has made specific efforts to
find a job within the previous four weeks
–2. Waiting to be called back to a job from which
he or she has been laid off
–3. Waiting to start a new job within 30 days

14. Employment and Unemployment
•5. What are the 3 labor market indicators?
•Three Labor Market Indicators
1. The unemployment rate
2. The employment-to-population ratio
3. The labor force participation rate

15. • 6. What is the unemployment rate?
• The unemployment rate is the percentage of
the people in the labor force who are
unemployed.
• Unemployment rate= (number of people un
employed /labor force )* 100

16. Employment and Unemployment
•7. What is the employment to population ratio?
•The Employment-to-Population Ratio
–The employment-to-population ratio is the
percentage of the working-age population who
have jobs.
–The employment-to-population ratio is
–
= (Employment ÷ Working-age population)  100.
–In June 2010, the employment was 139.1 million
and the working-age population was 237.7 million.
–The employment-to-population ratio was 58.5
percent.

17. Employment and Unemployment
•7. What is the employment to population ratio?
•The Employment-to-Population Ratio
–The employment-to-population ratio is the
percentage of the working-age population who
have jobs.
–The employment-to-population ratio is
–
= (Employment ÷ Working-age population)  100.
–In June 2010, the employment was 139.1 million
and the working-age population was 237.7 million.
–The employment-to-population ratio was 58.5
percent.

18. Employment and Unemployment
Other Definitions of Unemployment
The purpose of the unemployment rate is to
measure the under-utilization of labor resources.
The unemployment rate gives a correct measure.
9. Why the unemployment rate gives an
imperfect measure?
But the official measure is an imperfect measure
because it excludes
1. Marginally attached workers
2. Part-time workers who want full-time jobs

19. Employment and Unemployment
–1. Marginally attached
–10. What is a Marginally Attached Workers?
–A marginally attached worker is a person who
currently is neither working nor looking for work
but has indicated that he or she wants and is
available for a job and has looked for work
sometime in the recent past.
–A discouraged worker is a marginally attached
worker who has stopped looking for a job because
of repeated failure to find one.

20. Employment and Unemployment
–2. Part-Time Workers Who Want Full-Time Jobs
–Many part-time workers want to work part time,
but some part-time workers would like full-time jobs
and can’t find them.
–In the official statistics, these workers are called
economic part-time workers and they are partly
unemployed.
–Most Costly Unemployment
–All unemployment is costly, but the most costly is
long-term unemployment that results from job loss.

21. Unemployment and Full Employment
11. What are the 3 types of unemployment?
Unemployment can be classified into three types:
1. Frictional unemployment
2. Structural unemployment
3. Cyclical unemployment

22. Unemployment and Full Employment
–1. Frictional unemployment:
–Is unemployment that arises from normal labor
market turnover.
–The creation and destruction of jobs requires
that unemployed workers search for new jobs.
–Increases in the number of people entering and
reentering the labor force and increases in
unemployment benefits raise frictional
unemployment.
–Frictional unemployment is a permanent and
healthy phenomenon of a growing economy.

23. Unemployment and Full Employment
–2. Structural unemployment:
–Is unemployment created by changes in
technology and foreign competition that change
the skills needed to perform jobs or the locations
of jobs.
–Structural unemployment lasts longer than
frictional unemployment.

24. Unemployment and Full
Employment
–3.Cyclical unemployment
–Is the higher than normal unemployment at a
business cycle trough and lower than normal
unemployment at a business cycle peak.
–A worker laid off because the economy is in a
recession and is then rehired when the expansion
begins experiences cycle unemployment.

25. Price Level, Inflation, and Deflation
The price level is the average level of prices and the
value of money.
A persistently (continuous) rising price level is called
inflation.
A persistently (continuous) falling price level is
called deflation.
Why we are interested in the price level?
Because we want to:
1. Measure the inflation rate or the deflation rate
2. Distinguish between money values and real values
of economic variables.

26. –NOTE:
•Unpredictable changes in the inflation rate
redistribute income in arbitrary ways between
employers and workers and between borrowers
and lenders.
•A high inflation rate is a problem because it diverts
resources from productive activities to inflation
forecasting.
–At its worse, inflation becomes hyperinflation—an
inflation rate that is so rapid that workers are paid
twice a day because money loses its value so
quickly.
Price Level, Inflation, and Deflation

27. How to measure inflation?
–Consumer prices index
What is the consumer price index?
–The Consumer Price Index, or CPI, measures the
average of the prices paid by urban consumers for
a “fixed” basket of consumer goods and services.

28. Price Level, Inflation, and Deflation
 What are the 3 stages in constructing the CPI?
Constructing the CPI involves three stages
1) Selecting the CPI basket
2) Conducting a monthly price survey
3) Calculating the CPI

29. Price Level, Inflation, and Deflation
–1) Selecting the CPI Basket:
–The first stage in constructing the CPI is to select
the CPI basket which contains goods and services.
–The CPI basket is based on a Consumer
Expenditure Survey, which is undertaken
infrequently.

30. Price Level, Inflation, and Deflation
–2) The Monthly Price Survey
–Every month, BLS (bureau of labor statistics)
employees check the prices of the 80,000 goods in the
CPI basket in 30 metropolitan areas. Because the CPI
aims to measure price changes, It is important that the
prices recorded each month refer to the exactly the
same items.
–3) Calculating the CPI
–1. Find the cost of the CPI basket at base-period prices.
–2. Find the cost of the CPI basket at current-period
prices.
–3. Calculate the CPI for the current period.

31. Price Level, Inflation, and Deflation
 What is the major purpose of measuring CPI?
• Measuring the Inflation Rate
The major purpose of the CPI is to measure
inflation.
The inflation rate is the percentage change in
the price level from one year to the next.
• The inflation formula is
• Inflation rate = [(CPI this year – CPI last year)
÷ CPI last year]  100.

32. Causes (and theories) of inflation
Some economists (both Keynes & Classical economists)
assert that inflation is caused by increase in demand in a
situation of given aggregate supply →demand inflation
According to classical economists, the increase in demand is
caused by an increase in money supply
According to Keynes it is increase in total spending & not in
money supply which is responsible

33. Causes (and theories) of inflation
contd..
A group of economists contend that inflation is
caused by an increase in cost of production that
results in a fall in aggregate supply →cost-push
inflation
Others believe that inflation results from an
amalgamation of demand & cost elements →
mixed inflation

34. The two main theories of inflation
The Demand-Pull inflation → originates from demand side of the
economy
If aggregate monetary demand for domestic output exceeds
the value of the full employment output at current prices, then the
price level will rise (fig text book)
The Cost-Push inflation → originates from supply side of the economy
It is caused by rising cost of production independently of the
excess demand in the market

35. Fiscal Policy
Def. Government decisions on spending and
taxation that are intended to improve or
maintain the economy.
Because the government is so large and has
such an impact on business, the decisions it
makes has a HUGE influence on the economy.

36. Fiscal Policy and the Economy
The total level of government spending can be
changed to help increase or decrease the output
of the economy
Expansionary Policies: Policies that try to
increase the output of the economy
Contractionary Policies: Policies that try to
decrease the output of the economy

37. Expansionary Policies
During a contraction or recession, the
government can do two things:
Decrease Taxes
Or
Increase Spending

38. Decreasing Taxes
Gives people more money to spend
More money = more demand
More demand = more production
More production = more jobs
More jobs = more demand etc. etc.

39. Increase Spending
Increases demand for goods
More demand = more production
More production = more jobs
More jobs = more demand etc. etc.

40. Contractionary Policies
During a period of excessive inflation (during a
period of expansion), the government can do
two things:
Increase Taxes
Or
Decrease Spending

41. Increase Taxes
People have less money to spend
Less money = less demand
Less demand = lower inflation

42. Decrease Spending
Less money in economy
Less money = less demand
Less demand = lower inflation

43. Budget Surplus:
A surplus implies the government has extra
funds; these funds can be allocated to pay
debts, which reduces the interest payable and
helps the economy in the future. For example,
a budget surplus can reduce taxes, start new
programs and fund existing public programs,
such as social security or Medicare.
Budget balance

44. fiscal deficit occurs when a government's
total expenditures exceed the revenue that
it generates, excluding money from
borrowings. Deficit differs from debt,
which is an accumulation of yearly deficits.
Budget Deficit

45. It is perfectly possible to run budget deficits
almost every year for decades, but as long as the
percentage increases in debt are smaller than
the percentage growth of GDP, the debt/GDP
ratio will decline at the same time
Debt/GDP ratio

46. Definition of Money
1. Money: The stock of financial assets that can easily be used to make
market transactions and that serves as a medium of exchange, a unit of
account, and a store of value.
2. Money functions as a medium of exchange and simplifies market
transactions.
3. Money functions as a unit of account because money provides the terms
in which prices of goods and services and debts are measured.
4. Money functions as a store of value that can be used for future market
purchases.
Alternative to money is barter: Barter system is a system in which goods and
services are exchanged directly without a common unit of account.

47. The Central bank
What is a central bank?
A central bank is the public authority that regulates a nation’s
depository institutions and control the quantity of money.
The Fed’s goals are to keep
Inflation in check,
Maintain full employment,
Moderate the business cycle.
Contribute toward achieving long-term growth.
In pursuit of its goals, the Fed pays close attention to the federal funds
rate—the interest rate that banks charge each other on overnight
loans of reserves.

48. Monetary policy or credit policy is the process by
which the monetary authority of a country controls
the supply and availability of money, often targeting
a rate of interest for the purpose of promoting
economic growth and stability.
It employs a variety of methods to control
outcomes like inflation, economic growth, currency
exchange rates and lower unemployment.
Monetary policy

49. If the Fed engages in expansionary monetary policy, it increases the
amount of reserves in the system thereby lowering the federal funds
rate, which also lowers other interest rates in the economy.
(a) Expansionary Monetary Policy: Federal Reserve policy to increase the
rate of growth of real GDP by increasing the amount of bank reserves in
the system and lowering the federal funds and other interest rates.
(b) Contractionary Monetary Policy: Federal Reserve policy to decrease
the rate of growth of real GDP by decreasing the amount of bank