BUS 530: ECONOMIC CONDITIONS ANALYSIS
LECTURE: 1
Introduction and Data of Macroeconomics
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Prerequisites Bus 525
Requirements and Grading Four class tests (20%) One midterm (20%) Paper (20%) Final (40%)
Class Materials N Gregory Mankiw. Macroeconomics. Sixth Edition. Web-page: http://fkk.weebly.com
Office: NAC 751 Office hours: Friday 2pm-3pm, Sunday 5pm-6:30 pm.
Course Overview
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Activity Schedule : BUS 530Class Date Exams Test/Paper
1 27May
2 3 June
3 10 June Class test 1
4 14 June(Regular ST)
5 17 June Mid-term
6 24 June Class test 2
7 1 July
8 8 July
9 15 July Class test 3
10 22 July
11 29 July
12 5 August Class test 4
13 10 Aug-30 Aug Final Paper3
• There will be only one make-up for all examinations (mid-terms and final, no make-up for class tests ) towards the end of the course to accommodate force majeure. All examination dates are pre-announced. Please make necessary arrangements with your office.
• Historically, the performance of students taking make-up examinations were always poorer compared to students taking examinations on schedule.
• I hope you will appreciate that it is not practical to offer a customized course for any or group of individual student(s).
Make-up Policy
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Learning Objectives
We will begin with:the issues macroeconomists studythe tools macroeconomists usesome important concepts in macroeconomic analysis
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Important Issues in Macroeconomics
Macroeconomics, the study of the economy as a whole, addresses many topical issues:
Why does the cost of living keep rising?Why are millions of people unemployed,
even when the economy is booming?What causes recessions? Can the government do anything to combat
recessions? Should it?
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What is the government budget deficit? How does it affect the economy?
Why does countries such as the U.S. have such a huge trade deficit and China have huge trade surplus ?
Why are so many countries poor? What policies might help them grow out of poverty?
Macroeconomics, the study of the economy as a whole, addresses many topical issues:
Important Issues in Macroeconomics
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The Historical Performance of Bangladesh Economy
Source: Bangladesh Bank
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010300
350
400
450
500
550
600
Real GDP per capita of Bangladesh
Year
2000
USD
8
GDP versus Population Growth Rates in the 1980’s
1.0
3.0
5.0
7.0
3.80
2.38
4.02
5.18
3.22
4.25
3.73
2.16
2.61
5.94
Gro
wth
Rat
e o
f G
DP
(%
)
GDP Growth Rate in the 1980’s
GDP and Population Growth Rates
Source: BBS and World Bank
1970's 1980's 1990's 2000's0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
4.15
3.22
4.80
5.81
2.502.33
2.15
1.37
GDP Growth Rate
Population Growth Rate
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The Historical Performance of Bangladesh Economy
Source: Bangladesh Bank
10
FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY113
3.5
4
4.5
5
5.5
6
6.5
7
5.27
4.42
5.26
6.275.96
6.636.43
6.215.88
5.83
6.66
Real GDP Growth Rate
GDP Growth Rate
Gro
wth
rat
e of
GD
P (%
)
Growth rate remains robust…2010
Bangladesh India Pakistan Sri Lanka China0
2
4
6
8
10
12
6.1
8.8
4.1
8
10.4
Gro
wth
Rat
e of
GD
P (%
)
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The Historical Performance of Bangladesh Economy
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20110.00
2.00
4.00
6.00
8.00
10.00
12.00
Bangladesh Inflation Rate
Year
Perc
enta
ge
Source: Bangladesh Bank
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Inflation situation
•
Source: Central bank of respective country
Bangladesh India Pakistan Sri Lanka China0
2
4
6
8
10
12 10.8610.36
10.8
5.5
3.98
Comparison of Inflation Rate on April '12
Rate
of i
nflati
on (y
ear t
o ye
ar)
The Historical Performance of Bangladesh Economy
1984 1985 1986 1989 1991 1996 2000 2003 20050
0.51
1.52
2.53
3.54
4.55
Bangladesh Unemployment Rate
Year
Perc
enta
ge
The unemployment rate of Bangladesh does not show the correct picture. According to CIA Factbook, 40% are under employed.
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Trend in the value of Bangladeshi Taka against US $
Source: Bangladesh Bank
1973-74 1980-81 1990-91 2000-01 2010-110
10
20
30
40
50
60
70
80
90
7.97
16.26
35.68
53.96
82
15
0
10,000
20,000
30,000
40,000
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
U.S. Real GDP Per Capita (2000 dollars)
Great Depression
World War II
First oil price shock
Second oil price shock
long-run upward trend…
9/11/2001
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U.S. Inflation Rate(% per year)
-15
-10
-5
0
5
10
15
20
25
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
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U.S. Unemployment Rate(% of labor force)
0
5
10
15
20
25
30
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
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Why Learn Macroeconomics?
1. The macroeconomy affects society’s well-being.
In the US, each one-point increase in the unemployment rate
is associated with: 920 more suicides 650 more homicides 4000 more people admitted to state mental institutions 3300 more people sent to state prisons 37,000 more deaths increases in domestic violence and homelessness
In the US, each one-point increase in the unemployment rate
is associated with: 920 more suicides 650 more homicides 4000 more people admitted to state mental institutions 3300 more people sent to state prisons 37,000 more deaths increases in domestic violence and homelessness
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Why Learn Macroeconomics?
2. The macroeconomy affects your well-being.
-3
-2
-1
0
1
2
3
4
5
1965 1970 1975 1980 1985 1990 1995 2000 2005
-7
-5
-3
-1
1
3
5
unemployment rate inflation-adjusted mean wage (right scale)
chan
ge fr
om 1
2 m
os e
arlie
r
perc
ent c
hang
e fr
om 1
2 m
os e
arlie
rIn most years, wage growth falls when unemployment is rising. In most years, wage growth falls when unemployment is rising.
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How Economists Think?Economists use models to understand what goes on in the economy.
Economic models:
…are simplified versions of a more complex reality• irrelevant details are stripped away
…are used to • show relationships between variables• explain the economy’s behavior• devise policies to improve economic
performance
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Endogenous vs. Exogenous Variables
• The values of Endogenous variables are determined in the model.
• The values of Exogenous variables are determined outside the model: the model takes their values & behavior as given.
• In the model of supply & demand for cars,endogenous: , , d sP Q Q
exogenous: , sY P22
A Multitude of Models
No one model can address all the issues we care about. e.g., our supply-demand model of the car market…
can tell us how a fall in aggregate income affects price & quantity of cars.
cannot tell us why aggregate income falls.So we will learn different models for studying different issues
(e.g., unemployment, inflation, long-run growth). For each new model, you should keep track of
its assumptions which variables are endogenous, which are exogenousthe questions it can help us understand, and those it cannot
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What is a Macro Model?
• A macro model is a mathematical structure that describes the economy. A mathematical structure is a set of equations, which allow us to understand the economy more fully and to predict what happens to it.
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Feature of a Good Macro Model
• Should include the variable that we want to predict• Should capture the most important factors whose
effects we want to determine• Its equations should be consistent with the way
the variables are defined and measured• Its equations should be easily defended• Should make predictions that are qualitatively in
line with the real world• Should be easy to use
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A Simple Sample Model
Y = C + I + GHere, Y = income
C = consumption I = investment G = government spending
This comes from the definition of GDP and the way it is measures. Remember, that GDP is a measure of output, income and spending
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Another Simple Sample Model
C = 0.9 (Y – T) It relates consumption to income taxes. When
income tax is deducted from a person’s paycheck, disposable income is found.
The equation suggests people spend 90% of their disposable income and save the rest
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Class Exercise 1
1. Solve for Y, given G = 2000T=2000I = 900
2. What is Y, if taxes fall from 2000 to 1900?
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Now, we will discuss……the meaning and measurement of the most important macroeconomic statistics:– Gross Domestic Product (GDP)– The Consumer Price Index (CPI)– The Unemployment Rate
The Data of Macroeconomics
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Gross Domestic Product (GDP) is the market value of all final goods and services newly produced in a country in a given period of time.
The Consumer Price Index (CPI) measures the level of prices.
The Unemployment Rate tells us the fraction of workers who are unemployed.
GDP, CPI, Unemployment Rate
Gross Domestic Product: Expenditure and Income
Two definitions:– Total expenditure on domestically-produced
final goods and services.
– Total income earned by domestically-located factors of production.
Expenditure equals income because every Taka spent by a buyer
becomes income to the seller.
Expenditure equals income because every Taka spent by a buyer
becomes income to the seller.
Income Expenditure and the Circular Flow
Households Firms
Goods
Labor
Expenditure (Tk.)
Income (Tk.)
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Value Added
Definition: A firm’s value added is
the value of its output minus
the value of the intermediate goods the firm used to produce that output.
Class Exercise 2
– A farmer grows a bushel of wheat and sells it to a miller for $1.00.
– The miller turns the wheat into flour and sells it to a baker for $3.00.
– The baker uses the flour to make a loaf of bread and sells it to an engineer for $6.00.
– The engineer eats the bread.
Compute & compare value added at each stage of production
and GDP
Final goods, Value added, and GDP
• GDP = value of final goods produced = sum of value added at all stages of production.
• The value of the final goods already includes the value of the intermediate goods, so including intermediate and final goods in GDP would be double-counting.
Rules for computing GDP1) To compute the total value of different goods and services, the national income accounts use market prices. Thus, if
GDP = (Price of apples Quantity of apples) + (Price of oranges Quantity of oranges)
= ($0.50 4) + ($1.00 3)GDP = $5.00
If apples cost $0.50 each and oranges cost $1.00 each
2) Used goods are not included in the calculation of GDP.3) The treatment of inventories depends on if the goods are stored orif they spoil. If the goods are stored, their value is included in GDP.If they spoil, GDP remains unchanged. When the goods are finally soldout of inventory, they are considered used goods (and are not counted).
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4) Intermediate goods are not counted in GDP– only the value offinal goods. Reason: the value of intermediate goods is already included in the market price. Value added of a firm equals the value of the firm’s output less the value of the intermediate goodsthe firm purchases.
5) Some goods are not sold in the marketplace and therefore don’thave market prices. We must use their imputed value as an estimateof their value. For example, home ownership and government services.
Rules for Computing GDP
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Real GDP Versus Nominal GDP
The value of final goods and services measured at current prices is called nominal GDP. It can change over time either because there is a change in the amount (real value) of goods and services or a change in the prices of those goods and services. Hence, nominal GDP or Y = P y, where P is the price level and y is real output– and remember we use output and GDP interchangeably. Real GDP or, y = YP is the value of goods and services measured using a constant set of prices.
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39
Real GDP is computed in our apple and orange economy.
For example, if we wanted to compare output in 2002 and output in 2003, we would obtain base-year prices, such as 2002 prices.
Real GDP in 2002 would be: (2002 Price of Apples 2002 Quantity of Apples) +(2002 Price of Oranges 2002 Quantity of Oranges).Real GDP in 2003 would be:(2002 Price of Apples 2003 Quantity of Apples) +(2002 Price of Oranges 2003 Quantity of Oranges).Real GDP in 2004 would be:(2002 Price of Apples 2004 Quantity of Apples) +(2002 Price of Oranges 2004 Quantity of Oranges).
Example
GDP 2008 (nominal) = 500 * 6 + 200 * 30 = 9000GDP 2009 (nominal) = 600 * 5 + 150 * 60 = 12000
GDP 2009 (real) = 600 * 6 + 150 * 30 = 8100
So nominal GDP rose, while real GDP actually fell
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Average prices in 2001and 2002 are used to measurereal growth from 2001 to 2002.Average prices in 2002 and 2003are used to measure real growth from 2002 to 2003 and so on. These growth rates are united to form a chain that is used to compare output between any two dates.
In some cases, it is misleading to use base year prices that prevailed 10 or 20 years ago (i.e. computers and college). In 1995, the US Bureau of Economic Analysis decided to use chain-weighted measures of real GDP. The base year changes continuously over time. This new chain-weighted measure is better than the more traditional measure because it ensures that prices will not be too out of date.
Chain-Weighted Measure of Real GDP
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Chain-Weighted Real GDP
Over time, relative prices change, so the base year should be updated periodically.
In essence, chain-weighted real GDP updates the base year every year,
so it is more accurate than constant-price GDP.Your textbook usually uses constant-price real
GDP, because: the two measures are highly correlated.constant-price real GDP is easier to compute.
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43
Governmentpurchases of goods
and services
Y = C + I + G + NX
Total demandfor domestic output (GDP)
is composed of
Consumptionspending byhouseholds
Investmentspending by
businesses andhouseholds Net exports
or net foreigndemand
This is the called the national income accounts identity.
Components of Expenditure
Bangladesh GDP Composition, 2009 - 2010
-8.9
15.38
24.41
79.9%
-62093
110523
169511
BDT 554771
Net Exports
Government
Investment
Consumption
% of GDPTk. crore
Source: Bangladesh Bank & Unnayan Onneshon
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Consumption (C)
– Durable goods last a long time ex: cars, home appliances
– Nondurable goodslast a short time ex: food, clothing
– Serviceswork done for consumers ex: dry cleaning, air travel.
Definition: The value of all goods and services bought by households. Includes:
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U.S. Consumption, 2005
41.3
20.5
8.2
70.0%
5,154.9
2,564.4
1,026.5
$8,745.7
Services
Nondurables
Durables
Consumption
% of GDP$ billions
Investment (I)
Definition 1: Spending on [the factor of production] capital.Definition 2: Spending on goods bought for future useIncludes:– Business Fixed Investment
Spending on plant and equipment that firms will use to produce other goods & services.
– Residential Fixed InvestmentSpending on housing units by consumers and landlords.
– Inventory InvestmentThe change in the value of all firms’ inventories.
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U.S. investment, 2005
0.2
6.1
10.6
16.9%
18.9
756.3
1,329.8
$2,105.0
Inventory
Residential
Business fixed
Investment
% of GDP$ billions
Investment vs. Capital
Note: Investment is spending on new capital.
Example (assumes no depreciation): – 1/1/2006:
economy has $500b worth of capital
– during 2006:investment = $60b
– 1/1/2007: economy will have $560b worth of capital
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Stocks vs. Flows
A flow is a quantity measured per unit of time. E.g., “U.S. investment was $2.5 trillion during 2006.”
Flow Stock
A stock is a quantity measured at a point in time.
E.g., “The U.S. capital stock was $26 trillion on January 1, 2006.”
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Stocks vs. Flows - examples
the govt budget deficitthe govt debt
# of new college graduates this year
# of people with college degrees
a person’s annual saving
a person’s wealth
FlowStock
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Class Exercise 3
Stock or flow?• the balance on your credit card statement• how much you study economics outside of
class• the size of your compact disc collection• the inflation rate• the unemployment rate
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Government Spending (G)
• G includes all government spending on goods and services..
• G excludes transfer payments (e.g., unemployment insurance payments), because they do not represent spending on goods and services.
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U.S. Government Spending, 2005
Federal
18.9%$2,362.9Govt spending
State & local
Defense
7.0
11.9
4.7
2.3
877.7
1,485.2
587.1
290.6Non-defense
% of GDP$ billions
Net exports: NX = EX – IM
def: The value of total exports (EX) minus the value of total imports (IM).
Source: Bangladesh Bank 55
Class Exercise 4
Suppose a firm • produces $10 million worth of final goods• but only sells $9 million worth.
Does this violate the expenditure = output identity?
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Why Output = Expenditure
• Unsold output goes into inventory, and is counted as “inventory investment”……whether or not the inventory buildup was intentional.
• In effect, we are assuming that firms purchase their unsold output.
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GDP: An important and versatile concept
We have now seen that GDP measures– total income– total output– total expenditure– the sum of value-added at all stages
in the production of final goods
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Other Measurements of Income
Gross National Product (GNP): Total income earned by the nation’s factors of production, regardless of where located.
Gross Domestic Product (GDP):Total income earned by domestically-located factors of production, regardless of nationality.
(GNP – GDP) = (factor payments from abroad) – (factor payments to abroad)
Net National Product (NNP), we subtract the depreciation of
capital-- the amount of the economy’s stock of plants,
equipment, and residential structures that wears out during the
year:
NNP = GNP – Depreciation National Income = NNP- Indirect Business Taxes Personal Income = National Income- Corporate Profits- Social Security
contributions-Net Interest+ Dividends + Govt. Transfer +Personal Interest Income Disposable Personal Income = Personal Income – Personal Tax
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(GNP – GDP) as a percentage of GDP selected countries, 2010
U.S.A. 0.40% Bangladesh 4.31% Brazil -14.29% China -3.39% India -5.88% U.K. 4.35%
Source: World Bank
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Real vs. Nominal GDP
• GDP is the value of all final goods and services produced.
• Nominal GDP measures these values using current prices.
• Real GDP measure these values using the prices of a base year.
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Class Exercise 3
• Compute nominal GDP in each year.
• Compute real GDP in each year using 2006 as the base year.
2006 2007 2008
P Q P Q P Q
good A $30 900 $31 1,000 $36 1,050
good B $100 192 $102 200 $100 205
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Answers
Nominal GDP multiply Ps & Qs from same year
2006: $46,200 = $30 900 + $100 192
2007: $51,400 2008: $58,300
Real GDP multiply each year’s Qs by 2006 Ps
2006: $46,2002007: $50,000 2008: $52,000 = $30 1050 + $100 205
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Real GDP Controls for Inflation
Changes in nominal GDP can be due to:– changes in prices. – changes in quantities of output produced.
Changes in real GDP can only be due to changes in quantities,because real GDP is constructed using constant base-year prices.
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Bangladesh Nominal and Real GDP, 1950–2006
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20100
100000
200000
300000
400000
500000
600000
700000
800000
Nominal GDPReal GDP
Year
BDT
in c
rore
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GDP Deflator
The Inflation Rate is the percentage increase in the overall level of prices.
One measure of the price level is the GDP Deflator, defined as Nominal GDP measures the current Taka value of the output of the
economy.
Real GDP measures output valued at constant prices. The GDP deflator, also called the implicit price deflator for GDP,
measures the price of output relative to its price in the base year. It
reflects what’s happening to the overall level of prices in the economy.
Nominal GDP
GDP deflator = 100Real GDP
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Class Exercise 4
• Use your previous answers to compute the GDP deflator in each year.
• Use GDP deflator to compute the inflation rate from 2006 to 2007, and from 2007 to 2008.
Nom. GDP Real GDPGDP
deflatorInflation
rate
2006 $46,200 $46,200 n.a.
2007 51,400 50,000
2008 58,300 52,000
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Answers
Nominal GDP
Real GDPGDP
deflatorInflation
rate
2006 $46,200 $46,200 100.0 n.a.
2007 51,400 50,000 102.8 2.8%
2008 58,300 52,000 112.1 9.1%
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Two arithmetic tricks for working with percentage changes
Example: If your hourly wage rises 5% and you work 7% more hours, then your wage income rises approximately 12%.
1. For any variables X and Y,
percentage change in (X Y ) percentage change in X + percentage change in Y
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Two arithmetic tricks for working with percentage changes
Example: GDP deflator = 100 NGDP/RGDP.
If NGDP rises 9% and RGDP rises 4%, then the inflation rate is approximately 5%.
2. percentage change in (X/Y ) percentage change in X percentage change in Y
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Consumer Price Index (CPI)• A measure of the overall level of prices • Published by the Bureau of Statistics• Uses:
– tracks changes in the typical household’s cost of living
– adjusts many contracts for inflation (“COLAs”)– allows comparisons of Taka amounts over time
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How the Bureau of Statistics constructs the CPI
1. Survey consumers to determine composition of the typical consumer’s “basket” of goods.
2. Every month, collect data on prices of all items in the basket; compute cost of basket
3. CPI in any month equals
Cost of basket in that month
Cost of basket in base period100
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The Consumer Price Index (CPI) turns the prices of many goods and services into a single index
measuring the overall level of prices.
Computing the CPI
For example, suppose that the typical consumer buys 5 apples and 2 oranges every month. Then the basket of goods consists of 5 apples and 2 oranges, and the CPI is:
CPI= ( 5 Current Price of Apples) + (2 Current Price of Oranges) ( 5 2002 Price of Apples) + (2 2002 Price of Oranges)
In this CPI calculation, 2002 is the base year. The index tells how much it costs to buy 5 apples and 2 oranges in the current year relative to how much it cost to buy the same basket of fruit in 2002.
Class Exercise 5
Basket contains 20 pizzas and 10 compact discs.
prices:pizza CDs
2002 $10 $152003 $11 $152004 $12 $162005 $13 $15
For each year, compute the cost of the basket the CPI (use 2002 as the
base year) the inflation rate from
the preceding year
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Cost of Inflationbasket CPI rate
2002 $350 100.0 n.a.2003 370 105.7 5.7%2004 400 114.3 8.1%2005 410 117.1 2.5%
Answers
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The Composition of the CPI’s “basket” of Bangladesh in 2010
54.81
4.95
9.09
5.061.68
3.79
5.68
13.50
Food & beverageCloth & foot wearHousing & Housing rentFuel and& LightingHousehold effectMedicalEducationMiscelleneous
Source: Bangladesh Bureau of Statistics
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Reasons Why The CPI may Overstate Inflation
• Substitution bias: The CPI uses fixed weights, so it cannot reflect consumers’ ability to substitute toward goods whose relative prices have fallen.
• Introduction of new goods: The introduction of new goods makes consumers better off and, in effect, increases the real value of the dollar. But it does not reduce the CPI, because the CPI uses fixed weights.
• Unmeasured changes in quality: Quality improvements increase the value of the dollar, but are often not fully measured.
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The GDP deflator measures the prices of all goods produced, whereas the CPI measures prices of only the goods and services bought by consumers. Thus, an increase in the price of goods bought by firms or the government will show up in the GDP deflator but not in the CPI.
Also, another difference is that the GDP deflator includes only those goods and services produced domestically. Imported goods are not a part of GDP and therefore don’t show up in the GDP deflator.
The final difference is the way the two aggregate the prices in the economy. The CPI assigns fixed weights to the prices of different goods, whereas the GDP deflator assigns changing weights.
The CPI versus the GDP Deflator
Two measures of inflation in Bangladesh
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20100.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
9.00
10.00
0.00
50.00
100.00
150.00
200.00
250.00
300.00
GDP DeflatorCPI
Year
Ann
ual P
erce
ntag
e
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The labor force is defined as the sum of the employed and unemployed, and the unemployment rate is defined as the percentage of the labor force that is unemployed.The labor force participation rate is the percentage of the adult population who are in the labor force.
Measuring Unemployment
Unemployment Rate = Number of Unemployed Labor Force X 100
Labor-Force Participation Rate = Labor Force Adult Population
100
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Categories of the population• Employed
working at a paid job • Unemployed
not employed but looking for a job • Labor force
the amount of labor available for producing goods and services; all employed plus unemployed persons
• Not in the Labor force not employed, not looking for work
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Class Exercise 6
U.S. adult population by group, June 2006Number employed = 144.4 millionNumber unemployed = 7.0 millionAdult population = 228.8 million
Use the above data to calculate the labor force the number of people not in the labor force the labor force participation rate the unemployment rate
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Summary
1. Gross Domestic Product (GDP) measures both total income and total expenditure on the economy’s output of goods & services.
2. Nominal GDP values output at current prices; real GDP values output at constant prices. Changes in output affect both measures, but changes in prices only affect nominal GDP.
3. GDP is the sum of consumption, investment, government purchases, and net exports.
slide 86CHAPTER 2 The Data of Macroeconomics 86
Summary
4. The overall level of prices can be measured by either– the Consumer Price Index (CPI),
the price of a fixed basket of goods purchased by the typical consumer, or
– the GDP deflator, the ratio of nominal to real GDP
5. The unemployment rate is the fraction of the labor force that is not employed.
slide 87CHAPTER 2 The Data of Macroeconomics 87