Inflation

Inflation: is the rise of the general level of prices.

Inflation rate measures the percentage increase in the price level over time

-          Offers a key indicator of the economy’s health.

Deflation is a decline in the general price level

Disinflation occurs when the inflation rate declines

Consumer price index (CPI): measures inflation by tracking the yearly price of a fixed basket of consumer goods and services

-          Indicates changes in the price level and cost of living

Solving inflation problems

a.       Finding inflation rate  using market basket data: Current year market basket value – base year market basket value)/ base year market basket value  x 100

b.      Finding inflation rate using price indexes: Current year price index- base year price index / base year price index x 100

c.       Estimating inflation using the rule of 70:

-          used to calculate the number of years for the price level to double at any given rate of inflation

-          Years needed to double inflation = 70/ annual inflation rate

d.      Determining wages: real wages = nominal wages/ price level x 100

e.      Real interest rate : Nominal interest rate- inflation premium

Real interest rate is the cost of borrowing or lending money that is adjusted for inflation

-          Always expressed as a percentage

Nominal interest rate: the unadjusted cost of borrowing or lending money

Causes of inflation:

Demand pull inflation: caused by an excess in demand over output that pulls prices upward ex. Concert: the more demand= higher prices

Cost push inflation: is caused by a rise in per unit production cost due to increasing resource costs

Effects of inflation:

Anticipated inflation: expected to inflate

Unanticipated inflation: no one has an idea, no notice prior

Hurt By inflation:

People on fixed income: social security, scholarship, grant

Savers

Lenders and creditors: they get less money than they loaned

Helped by inflation:

borrowers: debt will be repaid with cheaper dollars than those loaned out

Unemployment

Unemployment: Percentage of people who do not have jobs that are in the labor force

Labor force is the number of people in a country that are classified as either employed or unemployed

Unemployment rate = # of unemployed/ # of employed + # of employed x100

Ideal employement rate 4%

Ideal inflation rate is 2-3%

Not in labor force:

1.       Kids

2.       Military personnel

3.       Mentally insane

4.       Incarcerated

5.       Retired

6.       Stay at home parents

7.       Full time students

8.       Discouraged workers

Types of unemployment:

Frictional: “between jobs” choose new opportunities/ choices/ lifestyles/ educational levels

Seasonal: waiting for the right season to go to work. Ex. Santa, lifeguard

Structural: technology changing associated with a lack of skills or a declining industry.

Cyclical: unemployment that occurs due to a swing in the economy, has to do with the business cycle ex. In a trough. Bad for society and individuals

Full employment occurs when there is no cyclical unemployment present in the economy

Natural rate of unemployment (NRU): ideal rate 4 to 5% unemployed.

Why is unemployment bad?

1.       Not enough consumption (GDP)

2.       Too much poverty

3.       Too much government assistance

Why is unemployment good?

1.       Less pressure to raise wages

2.       More workers available for future expansions

Okun’s law

For every 1% of unemployment above the NRU causes a 2% decline in real GDP

GDP

National income accounting: Economists collect statistics on production, income, investments, and savings

GDP is the total dollar value of all final goods and services produced within a countries boarder within a given year

GNP( gross national product) a measure of what its citizens produced and whether they produced these items within its boarders

2 ways to calculate GDP:

Included in GDP:

Consumption ( C ): takes up 60% of the economy. It includes final goods and services

Gross private domestic investment (IG): factor equipment maintenance, new factory equipment, construction of housing, unsold inventory of products built in a year

Government spending (G): on anything public related

Net exports (Xn) : Exports - imports

C+IG+G+Xn= GDP

What’s not included:

Used/ second hand goods: already counted

Intermediate goods: goods and services purchased for resale or for further processing and manufacturing

Non market activities: ex. Volunteering, drug sales, underground activities

Financial transactions: stocks, bonds, real-estate

Gifts or transfer payments: 2 types

-private: produces no output, simply transferring funds from one person to another ex. Christmas gift, scholarship

- Public: where recipients contribute nothing to the current production ex. Social security, welfare payments

Expenditures approach: adding up the market value of all domestic expenditures made on all final goods/ services in a single year

C+IG+G+Xn= GDP

Income approach: adding up all the income earned by households and firms in a single year

GDP: W+R+I+P+ Statistical adjustments

-          Wages: compensation of employees/ salary

-          Rents: from tenets to landlords, from lease payments that corporations pay for the use of space

-          Interest: money paid by private businesses to the suppliers of loans used to purchase capital

-          Profit: corporate income taxes, dividends, undistributed corporate profits

-          (proprietor’s income)

Budget formula: (gov purchases of goods/services) + (gov transfer payments) – (gov tax and fee collections)

-          If the number is positive you have a budget deficit

-          If the number is negative you have a budget surplus.

Trade= exports – imports

GNP= GDP + net foreign factor income

Net national product (NNP) = GNP – depreciation

Net --- product (NDP) =GDP- Depreciation

National income= GDP- indirect bus. Taxes- depreciation – net foreign factor payment

National income= compensation of employees+ rental income+ interest income+ proprietors income+ corporate profits

Disposable personal income: national income- personal household taxes + gov transfer payments

Nominal vs. real GDP

Nominal GDP: The value of output produced in current prices,

-          Can increase from year to year if either output or price increase

Real GDP : the value of output produced in base year or constant prices

-          Adjusted for inflation

-          Can increase from year to year only if output increase

-          Base year price times current quantity

Formula for both= Price x quantity

Price index and GDP deflator

Price index is a measure of inflation by tracking changes in the price of a market basket of goods compared with the base year

 (Price of market basket of goods in current year/ price of market basket of goods in Base year) x 100

GDP deflator:  a price index used to adjust from nominal GDP to real GDP

-In the base year GDP deflator is equal to 100

-For years after the base year GDP deflator is greater than 100

- For year before the base year GDP deflator is less than 100

(Nominal GDP / Real GDP) x100

Inflation= ((New GDP deflator- Old GDP deflator)/ Old GDP deflator) x100