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Chapter 10: Business cycles, Unemployment, GDP, and

Inflation

Diya Mazumder
November 7, 2012
Focus of Macroeconomics

• What is Macroeconomics?
• Focus:
–Monitors performance of economy
as a whole
–Role of Government
Business Cycles
• What are Business Cycles?
–Depression
–Recession
–Expansions

Since WW2, there have been 10 recessions,


lasting an average of 10 Months. Typical
expansion lasts an average of 5 years
(approx).
The Great Depression

What does all this mean for human lives?


Gross Domestic Product (GDP)
• What is it?
–Market value of all final
goods and services produced
within a country in a given
period of time
What is GDP used for?
• Measure the size of an economy
• Comparing to performance of
other countries
–Issues
• Comparing the performance of
one country over time
–Issues
Nominal GDP

• Production of goods and


services valued at CURRENT
prices
Numerical Example of Nominal GDP
YEAR Price of Quantity Price of Quantity
Hot Dogs of Hot Burgers of
Dogs Burgers
2008 $1 100 $2 50
2009 $2 150 $3 100
2010 $3 200 $4 150
Real GDP
• Real GDP
–Production of goods and services
valued at CONSTANT prices
–Calculate Real GDP (base year
2008)
Real Vs Nominal GDP
Year Nominal GDP Real GDP
(billions of (billions of
current dollars) 2000 dollars)
1996 $7,817 $8,329

2000 9,817 9,817

2004 11,734 10,842


What Real GDP doesn’t measure?
• Cross country comparisons need to control for
population differences
– Ex: In 2004:
• US GDP = $11,734 billion
• Japan’s GDP = $4,665 billion
• Real GDP per capita
Real GDP in the US
Is GDP a good measure of economic well-
being?
Real GDP per capita and living standards
Country Real GDP Life Adult Internet
per Person Expectancy Literacy Usage (% of
(2005) (% of Population)
Population)
USA $41,890 78 years 99% 63%
Japan 31,267 82 99 67
Russia 10,845 65 99 15
Mexico 10,751 76 92 18
Brazil 8,402 72 89 19
China 6,757 72 91 9
India 3,452 64 61 3
Pakistan 2,053 65 50 7
Nigeria 1,128 47 69 4
What’s left out?
• All activities that take place outside of a
market
• Distribution of Income
• Quality of the Environment
Unemployment
• Labor Force?
– Equals the number of employed workers +
number of unemployed workers above 16 years of
age
– Whose left out?
• Unemployment rate = (Number of
Unemployed/Labor Force)*100
Breakdown of the Population in 2007

Adult Employed
Population (146 Million)
(231.8)
million Unemployed (7.1 Million)
Distribution of the Unemployed
by Duration of Unemployment, 2007
Nature of Unemployment
• Seasonal Unemployment
• Frictional Unemployment
– What is it?
– Why is a certain amount of frictional
unemployment inevitable?
Nature of Unemployment
• Structural Unemployment
• Natural Rate of Unemployment
• Cyclical Unemployment
– Unemployment that occurs due to business
cycles
Inflation, Hyperinflation and Deflation
• Inflation: Average level of prices are rising
• Hyperinflation: Extreme case
– Case Study: Zimbabwe, Germany, Argentina
– http://www.youtube.com/watch?v=mM3_z2RB3YU&N
R=1
• Deflation:
– Average Price Levels are falling
– Case study: Japan
– Effects: Incentive to postpone consumption
Inflation Vs Relative Prices
• Relative price of a good rises when the price of a
single good rises
– Role is to adapt behavior to adjust to scarcity
• Inflation occurs when the average level of prices rises
• Price Stability:
– Occurs when aggregate price level is changing
slowly
Measure of Inflation rate
• Consumer Price Index (CPI)
– Annual Changes in CPI
– Measures how cost of an average basket of
goods and services changes over time
Computing Inflation Rate
• Fix a Basket: 4 hot dogs, 2 hamburgers
• Find the price of basket in each year
Year Price of Hot Dots Price of Burgers
2008 $1 $2
2009 2 3
2010 3 4

• Compute inflation rate relative to the previous


year
The Makeup of the Consumer Price Index in
2007
Inflation and deflation since 1929
Real Income Vs Nominal Income
• Nominal Income is wages not adjusted for
changes in prices
• Real Income is your wages after adjusting for
inflation
– Reflects the purchasing power of your income
• To calculate:
– Calculate percentage change in Nominal wages
– Calculate percentage change in aggregate price level
– Real wage percentage change = Percentage Change in
nominal wages – Percentage change in Aggregate Price
level
Real Income Vs Nominal Income
• Suppose your nominal wages rose by 10%
over the past year. In each of the following
cases, determine whether you are better or
worse off in comparison to the year before
(calculate Real wage changes). Explain.
– The yearly inflation rate was 5%
– The yearly inflation rate was 15%
– The economy experienced deflation, with
prices falling at a rate of 2% per year
Problems with CPI
• Quality Improvements
– If not included, might overestimate inflation rate
• New Products
– If not included, might not accurately measure the
effect of the inflation rate on people’s living
standards
Effects of Inflation
• Redistributive effects
– Price Effect
• If the prices of the goods you purchase rises faster than
inflation rate, and cannot substitute away from them, then
inflation imposes a higher burden
– Income effects
• If nominal wage is adjusted at a lower rate as inflation, then
you bear a higher burden of inflation
– Wealth effects
• If the value of the assets you’ve purchased rise slower than
inflation, then inflation places a higher burden

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