price indexes and inflation review: unemployment and production unemployment up employment down ...
DESCRIPTION
108.3 RateChange in the of =Price Index expressed Inflationas a percentage Year GDP Price Deflator 2009 = Rate of Inflation in 2014=== 1.5%TRANSCRIPT
Price Indexes and InflationReview: Unemployment and Production
Unemployment Up
Employment Down
Production Down
Unemployment Down
Employment Up
Production Up
Nominal GDP for 2014 = Sum of the market values of all final goods and services produced in the United States during 2014
Real GDP for 2014 = Sum of the market values of all final goods and services produced in the United States during 2014 evaluated at base year (2009) prices
2014 2014 2014 2014Auto Auto Beer Beer= P Q + P Q + ... = 17,420
2009 2014 2009 2014Auto Auto Beer Beer= P Q + P Q + ... = 16,090
Review: A Way to Measure Production How many final goods and services does the economy produce?
Nominal GDP increases when: Production (Q’s) increase and/or prices (P’s) increase
Problem: We only want to measure changes in production (Q’s), not changes in prices (P’s).
Solution: Keep prices (P’s) constant.
Nominal GDP for 2014 = Sum of the market values of all final goods and services produced in the United States during 2014
Real GDP for 2014 = Sum of the market values of all final goods and services produced in the United States during 2014 evaluated at base year (2009) prices
2014 2014 2014 2014Auto Auto Beer Beer= P Q + P Q + ... = 17,420
2009 2014 2009 2014Auto Auto Beer Beer= P Q + P Q + ... = 16,090
Price Indexes
GDP Price Deflator
Nominal GDP for 2014GDP Price Deflator for 2014= 100Real GDP for 2014
2014 2014 2014 2014Auto Auto Beer Beer2009 2014 2009 2014Auto Auto Beer Beer
P Q + P Q + ...= ×100P Q + P Q + ...
Hypothetical Questions:
What if prices were unchanged since 2009?
GDP Price Deflator
100What if prices had doubled since 2009? 200What if prices had tripled since 2009? 300
17,420 100 108.3 16,090
Since the base year (2009) prices have risen by about
8 percent on average.
For the economy as a whole, what is the “average” price?
GDP Price Deflator Consumer Price Index (CPI)
108.3 106.7
106.7
1.6106.7
1930 1940 1950 1960 1970 1980 1990 2000 20100
20
40
60
80
100
120
GDP Price Deflator: 1930-20142009 = 100.0
Rate Change in the of = Price Index expressed
Inflation as a percentage
1930 1940 1950 1960 1970 1980 1990 2000 2010-15.0
-10.0
-5.0
0.0
5.0
10.0
15.0
GDP Price Deflation Inflation Rate: 1930-2014
YearGDP Price Deflator
2009 = 1002013 106.7
2014 108.3
Rate of Inflation in 2014 == = 1.5%
How Social Security Unfairly Calculates the Cost of Living for Retirees8:38 am ETOct 20, 2015
DAVID BLANCHETT: Retirees got some bad news recently when it comes to Social Security: Their Social Security benefits won’t increase in 2016. The reason, according to the Department of Labor’s announcement on Oct. 15, was that living expenses were 0.4% lower in the third quarter from a year before, primarily because of lower gas prices....The Labor Department uses the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W, to measure inflation’s effects on Social Security beneficiaries’ costs. A cost-of-living increase for the following year’s benefits is determined by the average monthly CPI-W value in the third quarter of the current year....Consumer Price Index (CPI)
First, the Bureau of Labor Statistics decides upon the market basket of goods that is purchased by the typical American household:
Second, the Bureau of labor statistics calculates how much this market basket would have cost in the base year and how much it costs now.Third, it calculates the ratio of the costs and by convention multiplies the ratio by 100. The result is the CPI:
CPI for September 2015 = Cost of the Market Basket in September 2015
Cost of the Market Basket in Base Year× 100
x pounds of chicken y pounds of beef z gallons of gasoline n cans of beer
Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec2013 230.3 232.2 232.8 232.5 232.9 233.5 233.6 233.9 234.1 233.5 233.1 233.02014 233.9 234.8 236.3 237.1 237.9 238.3 238.2 237.9 238.0 237.4 236.2 234.82015 233.7 234.7 236.1 236.6 237.8 238.6 238.6 238.3 237.4
Increase in Change in Purchasing Power:Nominal Per Capita Increase in Change in Real Per Capita
Disposable Income (%) CPI (%) Disposable Income (%)1979-802009-10
Consumer Price Index (CPI)
CPI for September 2015 = Cost of the Market Basket in September 2015
Cost of the Market Basket in Base Year
The Effects of Inflation: Purchasing Power
10.52.8 3.0
1.2
13.51.6
Rate Change in the of = Price Index expressed
Inflation as a percentage237.4 238.0
238.0 100=
.6
238.0 100= = .2%
× 100
Market Basket: “Basket” of Goods consumed by the typical American household.
Does the CPI Overstate or Understate the Effect of Inflation?Substitution
Smith household
In September 2013, the Smith household was using all its income to purchase the typical market basket of goods;During the next year the household’s income rose by 1.7 percent, an amount just equal to the increase in the CPI.
Could the Smiths continue to consume the typical market basket of goods? If so, the Smiths would be just as well off.
Would the Smiths continue to consume the typical market basket of goods?
The Smiths would be better off.
Yes
No
Quality Improvements and New Products
CPI Ground Beef ($/lb) Turkey ($/lb)Sept 2013 234.1 3.50 1.82Sept 2014 238.0 4.10 1.58Percent change 1.7% 17.1% 13.2%
Personal computers
Cell phones
Atypical Households
Percent of Income SpentUrban
Workers ElderlyFood and beverages 15.70% 12.80%Housing 39.20% 44.50%Apparel 3.60% 2.40%Transportation 18.70% 14.50%Medical care 5.60% 11.30%Recreation 5.50% 5.30%
Price of Gasoline ($/gal)
September 2014 3.40September 2015 2.40
Elderly
2.4%
$3 Net Increase of Purchasing Power
$5 of
Interest
Inflation and Interest Rates: Nominal and Real Interest Rates
The Effects of Inflation: Purchasing Power
Real NominalInterest = Interest Rate (r) Rate (i)
InflationRate ()
Save $100 for a year
Nominal Interest Rate = 5%
InflationRate = 2%
Real Interest Rate = 3%
$2 Erosion of
Purchasing Power
Year20072008
Nominal Interest Rate (i)
5.2%3.1%
InflationRate ()
2.8%3.8%
Real Interest Rate (r)
0.7%
Nominal Interest Rates: The interest rate that the bank advertises.
Question: What is the opportunity cost of holding cash? Answer: Nominal interest rate.
2014 0.1% 1.6% 1.5%
Question: What does opportunity cost refer to?
Equilibrium:Quantity Demanded = Quantity Supplied
Aggregate Demand (AD) CurveP
QD
S
P*
Q*Market demand curve: How many cans of beer would consumers purchase (the quantity demanded), if the price of beer were _____,
given that everything else relevant to the demand for beer remains the same?
Market supply curve: How many cans of beer would firms produce (the quantity
supplied), if the price of beer were _____, given that everything else relevant to the
supply of beer remains the same?P
Q
SP
QD
If P = .50
If P = 1.00
If P = 1.50
If P = 2.00
If P = .50
If P = 1.00
If P = 1.50
If P = 2.00
2.001.501.00.50 2.001.501.00.50
Review: Market for a Good
Question: Why is the demand curve downward sloping?
Question: Why is the supply curve downward sloping?
Equilibrium:Goods and Services Purchased
EqualsGoods and Services Produced
(%)
G&SAD
AS
AD Question: How many final goods and services would be purchased if the inflation rate () were _______ percent, given that all other factors relevant to demand remained
the same?
AS Question: How many final goods and services would be produced if the inflation
rate () were _______ percent, given that all other factors relevant to supply remained the
same? (%)
G&S
AS (%)
G&SAD
If = 1.0
If = 2.0
If = 3.0
If = 4.0
If = 1.0
If = 2.0
If = 3.0
If = 4.0
4.03.02.01.0 4.03.02.01.0
Aggregate Demand/Aggregate Supply Model
Aggregate Demand/Aggregate Supply Equilibrium
Goods and services (G&S) purchased
Goods and services (G&S) produced=
AD
AS=
(%)
G&SAD
AS
Goods and services (G&S) purchased
AD
Goods and services purchased by households
C
Goods and services purchased by
firms
I
Goods and services purchased by governments
G= + +
= + +
C + I + G =
GDP
Real GDP for 2014 = Sum of the market values of all final goods and services produced in the United States during 2014 evaluated at base year (2009) prices
NB: To keep our analysis more straightforward we are ignoring net exports
for now.
(%)
G&SAD
ASAD Question: How many final goods and services
would be purchased if the inflation rate () were
_______ percent, given that all other factors relevant to demand remained the same?
AS Question: How many final goods and services would be produced if the
inflation rate () were _______ percent, given
that all other factors relevant to supply
remained the same?
Summary: Aggregate Demand/Aggregate Supply Model
Goods and services (G&S) purchased
Goods and services (G&S) produced
AD
AS
C + I + G
GDP
Equilibrium
AD Question: How many final goods and services would be purchased if the inflation rate () were _______ percent, given that all other factors relevant to demand remained
the same? (%)
G&SAD
If = 1.0
If = 2.0
If = 3.0
If = 4.0
4.03.02.01.0
Aggregate Demand Curve
Question: Why is the aggregate demand (AD) curve downward
sloping?
Inflation rate () increases
Fewer goods and services purchased
The aggregate demand (AD) curve
is downward sloping.
The Federal Reserve Board (Fed)
The Real Interest Rate: The Federal Reserve Board’s (Fed’s) Throttle on the Economy
Real interest rate (r) increases
Loans become more costly
Households and firm purchase fewer goods and services
In the entire economy fewer goods
and services (G&S) purchased
Real interest rate (r) decreases
Loans become less costly
Households and firm purchase more goods and services
In the entire economy more goods
and services (G&S) purchased
Economy “slows down”
Economy “speeds up”
Fed’s Goal: Use its throttle, the real interest rate, to stabilize the economy.
When the inflation rate () increases the Fed “slows down” the economy by increasing the real interest rate (r).
When the inflation rate () decreases the Fed “speeds up” the economy by decreasing the real interest rate (r).
Taylor Principle
The Federal Reserve Board and the Taylor Principle
When the inflation rate () increases the Fed “slows down” the economy by increasing the real interest rate (r).
When the inflation rate () decreases the Fed “speeds up” the economy by decreasing the real interest rate (r).
Inflation rate () increases
Real interest rate (r) increases
Loans become more costly
Households and firm purchase fewer goods and services
Economy “slows down”
Inflation rate () decreases
Real interest rate (r) decreases
Loans become less costly
Households and firm purchase more goods and services
Economy “speeds up”
Taylor principle
Economy stabilizes
Taylor Principle
Fed’s Goal: Use its throttle, the real interest rate, to stabilize the economy.
In the entire economy fewer goods
and services (G&S) purchased
In the entire economy more goods
and services (G&S) purchased
When the inflation rate () increases the Fed “slows down” the economy by increasing the real interest rate (r).
If =
If =
When the inflation rate () decreases the Fed “speeds up” the economy by decreasing the real interest rate (r).
FP
(%)
r (%)1.0 3.0 5.0
Taylor Principle and the Fed Policy (FP) Curve
If = 2.0
3.0
1.0
FP Question: What would the real interest rate (r) equal, if the inflation rate () were _______ percent, given that the Fed does not change its inflation policy?
2.03.0%
3.01.05.0%1.0%4.0
2.0 4.0 6.0
r = 1.0%
Consumption Purchases (C) Investment Purchases (I)
1,530 220
1,300 200
1,070 180
r = 3.0%
r = 5.0%
Taylor Principle
The Fed policy (FP) curve is upward sloping to stabilize
the economy.
If =1.0% If =2.0% If =3.0%
FP
(%)
r (%)AD
(%)
G&S
AD Question: How many final goods and services would be purchased, if the inflation rate () were _______ percent, given that all other factors relevant to demand remained the same?
1.0 3.0 5.0
Deriving the Aggregate Demand (AD) Curve
If =
2,000
2.0
3.0
1.0
1,750 2,250
FP Question: What would the real interest rate (r) equal, if the inflation rate () were _______ percent, given that the Fed does not change its inflation policy?
If =
If =
2.03.0%
2,000
3.01.05.0%1.0%
2.03.01.0
1,7502,2504.0
2.0 4.0 6.0
r = 1.0%
Consumption Purchases (C) Investment Purchases (I)
Government Purchases (G) Goods and Services Purchased (G&S)
1,530 220 500
2,250
1,300 200 500
2,000
1,070 180 500
1,750
r = 3.0%
r = 5.0%
The Fed policy (FP) curve is upward sloping to stabilize the
economy.
The aggregate demand (AD) curve reflects the goods and services
purchased.
The aggregate demand (AD) curve is downward sloping.
If =1.0% If =2.0% If =3.0%
FP
(%)
r (%)AD
(%)
G&S
AD Question: How many final goods and services would be purchased, if the inflation rate () were _______ percent, given that all other factors relevant to demand remained the same?
Summary of the Fed Policy (FP) and the Aggregate Demand (AD) Curves
FP Question: What would the real interest rate (r) equal, if the inflation rate () were _______ percent, given that the Fed does not change its inflation policy?
Inflation rate ()
increases
Real interest rate (r)
increases
Loans become
more costly
Households and firms
purchase less
Fewer goods and services purchased
Taylor principle
(FP curve)
C and I
decrease
AD = C + I + G
decreases