The CPI is 127.

2. Question Words to Look For
 If a question asks you to IDENTIFY, you need one short
phrase.
 The word ILLUSTRATE requires a graph.
 If asked to DEFINE a concept devote more time.
 If asked to INDICATE, say what is expected to happen.
 For example: if the FED sells bonds interest rates will
increase.
 The most time-intensive prompt involves EXPLAIN.
 If told the Peso is appreciating and are asked to explain
how this will impact prices in the U.S. your response
must clearly state what will happen and why.
BECAUSE:

3. Section 03: Measurement of
Economic Performance
• Module 10: Circular Flow and GDP
• Module 11: Real GDP
• Module 12: Calculating Unemployment
• Module 13: Categories of Unemployment
• Module 14: Inflation
• Module 15: Measuring & Calculating Inflation

4. Sec 03
Measure of
Economic
Performance:
Vocab
• Gross Domestic
Product
• Business Cycle
• Frictional
Unemployment
• Structural
Unemployment
• Cyclical
Unemployment
• Natural rate of
unemployment
• Nominal interest
rate
• Real interest
rate
• Inflation rate
• Transfer
Payments
• Intermediate
Goods
• Final Goods

5. Gross Domestic Product
Y = C + I + G + NX
• C = Consumer spending
• I = Investment spending
• G = Government Spending
• NX = Exports - Imports

6. Business Cycle

7. Business Cycle

8. Business Cycle

9. Three Kinds
of
Unemployment
Frictional
Structural
Cyclical

10. Frictional
Unemployment
• Unemployment due to
movement from one job to
another.
– Graduating students until
they find work.
– Mothers who rejoin the
workforce.
• Frictional unemployment
isn't harmful BECAUSE
frictional unemployment
means workers are moving
to better jobs.

11. Structural
Unemployment
• Unemployment due to a
mismatch between the
economy and skills of workers:
• New Technology
– Makes jobs obsolete and
allows firms to produce with
fewer workers
• Global Competition
– Firms relocate factories to
nations with cheaper labor

12. Cyclical
Unemployment
• Unemployment over 4% is
cyclical and means
recession.

13. Natural Rate of
Unemployment:
NRU
• A healthy economy will have
some unemployment at about 4%
Frictional + Structural = NRU
• If frictional = 2% and
structural = 2% the economy is
at the NRU.
• Any unemployment rate over
NRU means cyclical
unemployment and recession.
• Subtract 4% from the actual
unemployment rate to find the
cyclical rate.

14. 2.3 Unemployment and Natural Rate of Unemployment

15. Unemployment
Why is this
significant?
Unemployment Rate is an
indicator of the health of an
economy.
If unemployment is low, then
production is high, RGDP is
increasing & inflation is near.
If unemployment is high, then
production is low, GDP is
decreasing & recession is near.

16. Interest Rates
The price of money
Nominal Interest
Rate
• The advertised
price of a loan:
Real Interest Rate
•The actual price of
loan, adjusted for
inflation.
If a loan carries a nominal ir of 8%, but the
inflation rate is 5%, then the real ir is 3%.
Real ir = Nominal ir – Inflation

17. Econ Fact
• Households loan money
• Investors borrow money
• Banks are the middle-
men

18. Inflation rate
• Inflation is the percentage increase in Price
Level from one year to another.
• Inflation shows how Price Level has risen or
the value of money has fallen.
• Inflation makes consumers poorer in real sense.
• Inflation is particularly bad for savers because
it erodes purchasing power.
Inflation =
Price Year 2 – Price Year 1
Price Year 1
x 100

19. Transfer
Payments
• Government benefits
– Social Security
– Welfare
– Farm subsidies
– Unemployment
• Transfer payments do
not add to GDP since GDP
measures production.

20. Intermediate Goods Final Goods
Goods used in the
production of final
goods.
• Final Goods are counted in RGDP,
intermediate goods are not.
Goods produced
and consumed by
households.

21. Sec 03
Measure of
Economic
Performance:
Vocab
• Gross Domestic
Product
• Business Cycle
• Frictional
Unemployment
• Structural
Unemployment
• Cyclical
Unemployment
• Natural rate of
unemployment
• Nominal interest
rate
• Real interest
rate
• Inflation rate
• Transfer
Payments
• Intermediate
Goods
• Final Goods

24. Circular
Flow
Model

27. Circular Flow Model
Why is this
significant?
Illustrates the flow of
money, goods, wages,
rent, profit, land, labor,
capital & investment
between producers and
consumers.

28. Gross
Domestic
Product
• GDP tracks the size of
an economy.
• GDP represents the
market value of all
goods and services
produced in a year
within a country.
• Real GDP takes
inflation into account.

29. ACDC 2.2 Nominal & Real GDP
2 min

30. Per capita GDP 2015
Total
(Billions of $)
Per capita
(Dollars)
GDP (Y) $17,914 $51,486
Consumption 12,540 35,931
Investment 2,687 $7,700
Government
purchases
3,404 $9,753
Net Exports 900 $2,578

31. Real GPD
Inflation-adjusted measure of the value of all
final goods produced, in a given year.

32. Calculating Nominal GDP
Year Price
of Hot
Dogs
Quantity
of Hot
Dogs
Price of
Burgers
Quantity of
Burgers
2001 $1 100 $2 50
2002 $2 150 $3 100
2003 $3 200 $4 150
Year Calculating Nominal GDP
2001 $1 per dog x 100 dogs + $2 per burger x 50 burgers = $200
2002 $2 per dog x 150 dogs + $3 per burger x 100 burgers = $600
2003 $3 per dog x 200 dogs + $4 per burger x 150 burgers = $1,200
NGDP increased for 2 reasons: Quantity increased, inflation

33. Calculating Real GDP
Year Price
of Hot
Dogs
Quantity
of Hot
Dogs
Price of
Burgers
Quantity of
Burgers
2001 $1 100 $2 50
2002 $2 150 $3 100
2003 $3 200 $4 150
Year Calculating Real GDP (Base year 2001)
2001 $1 per dog x 100 dogs + $2 per burger x 50 burgers = $200
2002 $1 per dog x 150 dogs + $2 per burger x 100 burgers = $350
2003 $1 per dog x 200 dogs + $2 per burger x 150 burgers = $500
RGDP increased for 1 reason: Quantity increased.

34. Real GPD
•Economists use Real GDP to
determine whether an economy is
really growing or if it just
inflation.

35. Find Nominal and Real GDP
a) Calculate NGDP for 2008.
b) Calculate RGDP for 2010 (2008 base year)

36. Answer
A. Nominal GDP 2008
• ($900 × 10) + ($10 × 100) + ($15 × 2)
• $9,000 + $1,000 + $30 = $10,030
B. Real GDP 2010 (2008 is Base Year)
• ($900 × 12) + ($10 × 110) + ($15 × 3)
• $10,800 + $1,100 + $45 = $11,945

37. Module 12/13
Unemployment

38. Labor Calculations
• Labor Force
#employed + #unemployed but looking
• Labor-Force Participation Rate
(Labor Force/Adult population)100 = LFPR
• Unemployment Rate
(#unemployed/Labor force)100 = Unemployment

39. Unemployment and Recession
•Its important to see the connection between
unemployment, recession and RGDP.
•If unemployment ↑ over NRU we are in
recession & RGDP ↓. Think in terms of
“pressure”.
•Think in terms of pressure.
•Higher unemployment puts negative
pressure on production. Less production
puts negative pressure on output so Real
GDP decreases.

40. FRQ: Labor Force: 6 pts
1. Assume the following
a) Adult population: 205.2 million
b) Employed: 131.5 Million
c) Unemployed: 6.2 Million
2. What is the labor force and how is it
measured?
3. What is the unemployment rate and how is it
measured?
4. What is the Labor-Force Participation Rate and
how is it measured?

41. Answers
• Labor force = #employed + #unemployed
– Labor force = 131.5 + 6.2 = 137.7 million
• Unemployment = (#unemployed/Labor force)100
– Unemployment rate = (6.2/137.7)100= 4.5%
• LFPR = (Labor Force/Adult population)100
– LFPR = (137.7/205.2) 100 = 67.1%

42. Modules 14/15 Inflation
• Inflation refers to an increase in
the aggregate price level across an
economy over a sustained period.

43. Inflation Rate Problems
1) PL 2019 = $110 PL 2018 = $100
2) PL 2019 = $105 PL 2018 = $70
3) PL 2019 = $120 PL 2018 = $80
4) PL 2019 = $1110 PL 2018 $1000
5) PL 2019 = $120 PL 2018 = $60
6) PL 2019 = $150 PL 2018 = $50
Put the answer in percentage form

44. Inflation Rate Answers
1) PL 2019 = $110 PL 2018 = $100 → 10%
2) PL 2019 = $105 PL 2018 = $70 → 50%
3) PL 2019 = $120 PL 2018 = $80 → 50%
4) PL 2019 = $1110 PL 2018 $1000 → 11%
5) PL 2019 = 120 PL 2018 = 60 → 100%
6) PL 2019 = 150 PL 2018 = 50 → 200%

45. Modules 14/15 Inflation
• Inflation refers to an increase in the
aggregate price level across an economy over a
sustained period.
• PL Year 2 refers to the Aggregate Price
Level of the more recent year
• PL Year 1 refers to the Aggregate Price
Level of the base year.

46. Inflation Rate Problems
1) PL 2019 = $110 PL 2018 = $100
2) PL 2019 = $105 PL 2018 = $70
3) PL 2019 = $120 PL 2018 = $80
4) PL 2019 = $1110 PL 2018 $1000
5) PL 2019 = $120 PL 2018 = $60
6) PL 2019 = $150 PL 2018 = $50
Put the answer in percentage form

47. Inflation Rate Answers
1) PL 2019 = $110 PL 2018 = $100 → 10%
2) PL 2019 = $105 PL 2018 = $70 → 50%
3) PL 2019 = $120 PL 2018 = $80 → 50%
4) PL 2019 = $1110 PL 2018 $1000 → 11%
5) PL 2019 = 120 PL 2018 = 60 → 100%
6) PL 2019 = 150 PL 2018 = 50 → 200%

48. Another way to think about Inflation
• Joe borrows $1,000 for one year at 5%
interest. Neither Joe or the bank
anticipate inflation but there is an
unexpected inflation rate of 4%.
a) What was the real interest on the loan?
b) Who lost as a result of the loan, the
lender or the borrower? Explain.

49. Answer
a) What was the real interest rate?
• The real interest rate is 1%
b) Who lost as a result of the loan?
•The lender lost BECAUSE unexpected
inflation means the bank is being paid
back with money that is worth less
than expected.

50. Two Ways to Measure Inflation
GDP Deflator
Consumer
Price Index:
(CPI)

51. GDP Deflator
• The deflator solves for inflation by comparing
current prices to prices in a base year.
– If NGDP was $10 million in 2020 and $12
million in 2021
• Then NGDP grew by 20%.
– If prices rose by 10% during that time the
$12 million NGDP is inflated.
– The real economy only grew by 10% and RGDP
for 2021 is $11 million.

52. GDP Deflator = (NGDP/RGDP)100
• In this example, I’m giving you the two GDPs
you need:
• NGDP 2021 = $10
• RGDP 2021 = $8
• GDP Deflator = ____________
• Price level increased by: _____

53. GDP Deflator = (NGDP/RGDP)100
• Example:
• NGDP 2021 = $10
• RGDP 2021 = $8
• GDP Deflator = ($10/$8) x 100 = 125
• Price level increased by 25%.

54. Find GDP Deflator for each Year
Year NGDP RGDP GDP
Deflator
2015 75,000 75,000
2016 88,700 85,000
2017 101,600 88,000
GDP Deflator = (NGDP/RGDP)100

55. Answer
Year NGDP RGDP GDP
Deflator
Infl.
rate
2015 $75,000 ÷ $75,000 100 0
2016 $88,700 ÷ $85,000 104 4%
2017 $101,600 ÷ $88,000 115 15%
GDP Deflator = (NGDP/RGDP)100

56. Sometimes you
must calculate
NGDP and RGDP
yourself from a
table

57. GDP Deflator = (NGDP/RGDP)100
Year Ice-cream Candy
Quantity Price Quantity Price
2015 100,000 $2.00 200,000 $1.00
2017 150,000 $4.00 230,000 $3.00
• NGDP 2017 =
• RGDP 2017 = (Multiply base prices by current quantities)
GDP Deflator = (_________/_______) x 100
• GDP Deflator =
• Inflation rate =

58. GDP Deflator = (NGDP/RGDP)100
Year Ice-cream Candy
Quantity Price Quantity Price
2015 100,000 $2.00 200,000 $1.00
2017 150,000 $4.00 230,000 $3.00
• NGDP 2017 = $4 x 150,000 + $3 x 230,000 = $1,290,000
• RGDP 2017 = $2 x 150,000 + $1 x 230,000 = $530,000
GDP Deflator = (1,290,000/530,000) x 100
• GDP Deflator = 243.4
• Inflation rate = 143.4%

59. Consumer Price Index CPI

60. Easy CPI Problem
• 2021 basket = $1020
• 2020 basket = $950
• CPI = ___/___
• CPI = ___
• Multiply CPI by 100: ___
• Inflation = ___%

61. Answer
• 2021 basket =$1020
• 2020 basket = $950
• CPI = $1020/$950
• CPI = 1.07
• Multiply by 100 to get 107%
• Inflation = 7%

62. CPI Word Problem
Imagine a market basket of five sandwiches,
two magazines, and two jeans.
– In the base year, sandwiches cost $6,
magazines $4 each, and jeans $35.
– In the current year, sandwiches cost $7,
magazines $6, and jeans $45.
a) Find is the CPI?

63. Answer
a) Current prices = 5(7.00) + 2(6.00) +
2(45.00) = 137
b) Base prices = 5(6.00) + 2(4.00) +
2(35.00) = 108
c) CPI = (137 ÷ 108) × 100 = 127

64. Consumer Price Index (CPI)
• Find the CPI in 2017 using 2016 as the base year.
• Divide the price of the current year’s basket by
the base year’s basket.
(price of current basket/price of base basket) x100
(__ x __) + (__ x __) / (__ x __) + (__ x __)100
Year
s
Q of
Tea
Price of
tea
Q of Steak Price of
Steak
201
6
10 $4 5 $8
201
7
12 $6 8 $12

65. Consumer Price Index (CPI)
• CPI in 2017 with 2016 as base year.
(12 x $6) + (8 x $12) / (10 x $4) + (5 x $8)100
CPI = 210
Year
s
Q of
Tea
Price of
tea
Q of Steak Price of
Steak
201
6
10 $4 5 $8
201
7
12 $6 8 $12

66. CPI Limitations
1. Substitution bias
– Consumers switch to less expensive goods
2. New products
– Consumers switch to newer goods
3. Changes in quality
– Price stays the same but goods get better.

67. GDP Deflator v. CPI
• The deflator
Compares APL and
measures the
combined price of
ALL final goods.
• CPI is a measure of
two baskets with
different prices and
is a better
reflection of the
cost of living.
GDP Deflator = (NGDP/RGDP)100

68. Formulas
• Labor Force = employed + unemployed
• LFPR = (Labor Force/Adult population)100
• Unemployment Rate = (unemployed/Labor force)100

69. Review: Supply and Demand
• Graph each
situation:
• Increase
price of X
• Increase QD
of X
• Decrease QS
of X

70. FRQ Sec 01 Mod 01
Absolute & Comparative Advantage
Countries A & B produce two goods: cheese and
fish. The table summarizes productivity for
each country and commodity
Fish Cheese
(kg)
County
A
80 40
County
B
100 20
a)Which country has the absolute advantage in fish?
b)Draw a PPC for both countries. Place Fish vertical & Cheese
horizontal. Label each country’s curve.
c)Calculate opportunity cost of Country A to produce 1 unit (kg) of
cheese.
d)Calculate opportunity cost of Country B to produce 1 unit (kg) of
cheese.
e)Which country has the comparative advantage in producing cheese?
Explain.
f)What is an acceptable term of trade for cheese?

71. • COUNTY B has an
absolute advantage in the
production of fish
• In Country A the opportunity cost to produce 1 unit of
cheese is 2 fish: 80f = 40c 80/40 = 40/40 2f = 1c
• In County B the opportunity cost to produce 1 unit of
cheese is 5 fish: 100f = 20c 100/20 = 20/20 5f = 1c
• County A has comparative advantage in cheese
BECAUSE 2 < 5
• Acceptable term of trade for cheese is 2 ≤ x ≤ 5