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ASU / Economics / ECN 211 / etsu housing rates

etsu housing rates

etsu housing rates

Description

School: Arizona State University
Department: Economics
Course: Macroeconomic Principles
Professor: Pereira
Term: Fall 2016
Tags: exam and 2
Cost: 25
Name: Exam 2 Notes
Description: Everything on the 2nd Exam
Uploaded: 11/01/2016
75 Pages 195 Views 0 Unlocks
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N. Gregory Mankiw Economics Principles of Sixth Edition 26 Saving, Investment,  and the Financial System Premium  PowerPoint  Slides by  Ron Cronovich In this chapter,  look for the answers to these questions: • What are the main types of financial institutions  in the U.S. economy, and what is their function?  • What are the three kinds of saving?  • What’s the difference between saving and  investment?  • How does the financial system coordinate saving  and investment?  • How do govt policies affect saving, investment,  and the interest rate? 1 Financial Institutions ▪ The financial system:  ▪ Financial markets:  Examples: ▪ The Bond Market.  A bond is ▪ The Stock Market.  A stock is2 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Financial Institutions ▪ Financial intermediaries:  Examples: ▪ Banks  ▪ Mutual funds 3 The Financial Crisis of 2008–2009 ▪ A financial crisis led to a deep recession in the U.S.  and around the world. A few unemployment rates: 11 10 9 e crofr obalf o8 7 6 5 USA France U.K. % 4 3 Canada Sweden 7 002-218 002-108 002-208 002-308 002-408 002-508 002-608 002-708 002-708 002-808 002-908 002-018 002-118 002-219 002-109 002-209 002-309 002-409 002-509 002-609 002-709 002-809 002-909 002-019 002-119 002-21FYI: Elements of Financial Crises ▪ ▪ 2008–2009: Housing prices fell 30%. ▪ ▪ 2008–2009:  Banks and other institutions failed when many  homeowners stopped paying their mortgages.  ▪ ▪ 2008–2009:  Customers with uninsured deposits began  pulling their funds out of financial institutions.5 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. FYI: Elements of Financial Crises ▪ ▪ 2008–2009: Borrowers unable to get loans  because troubled lenders not confident in  borrowers’ credit-worthiness. ▪ ▪ 2008–2009: Failing financial institutions and a  fall in investment caused GDP to fall and  unemployment to rise.  ▪ ▪ 2008–2009: The downturn reduced profits and  asset values, which worsened the crisis.  6 Different Kinds of Saving Private saving  Public saving 7 National Saving National saving  = private saving + public saving8 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Saving and Investment Recall the national income accounting identity: Y = C + I + G + NX For the rest of this chapter, focus on the closed  economy case: Y = C + I + G Solve for I: 9 Budget Deficits and Surpluses Budget surplus Budget deficit 10 ACT IVE L E A RNING 1 A. Calculations ▪ Suppose GDP equals $10 trillion,  consumption equals $6.5 trillion,  the government spends $2 trillion  and has a budget deficit of $300 billion.  ▪ Find public saving, taxes, private saving,  national saving, and investment. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. ACT IVE L E A RNING 1 Answers, part A ACT IVE L E A RNING 1 B. How a tax cut affects saving ▪ Use the numbers from the preceding exercise,  but suppose now that the government cuts taxes  by $200 billion.  ▪ In each of the following two scenarios,  determine what happens to public saving,  private saving, national saving, and investment.  1. Consumers save the full proceeds of the  tax cut.  2. Consumers save 1/4 of the tax cut and spend  the other 3/4.  ACT IVE L E A RNING 1 Answers, part B© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. ACT IVE L E A RNING 1 C. Discussion questions The two scenarios from this exercise were: 1. Consumers save the full proceeds of the  tax cut.  2. Consumers save 1/4 of the tax cut and spend  the other 3/4.  ▪ Which of these two scenarios do you think is  more realistic? ▪ Why is this question important? The Meaning of Saving and Investment ▪ Private saving is the income remaining after  households pay their taxes and pay for  consumption.  ▪ Examples of what households do with saving: ▪ Buy corporate bonds or equities ▪ Purchase a certificate of deposit at the bank ▪ Buy shares of a mutual fund ▪ Let accumulate in saving or checking accounts 16 The Meaning of Saving and Investment ▪ Investment is the purchase of new capital.  ▪ Examples of investment: ▪ General Motors spends $250 million to build  a new factory in Flint, Michigan.  ▪ You buy $5000 worth of computer equipment  for your business.  ▪ Your parents spend $300,000 to have a new  house built.  Remember:17 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Market for Loanable Funds ▪ A supply–demand model of the financial system ▪ Helps us understand 18 The Market for Loanable Funds Assume: only one financial market ▪ All savers deposit their saving in this market. ▪ All borrowers take out loans from this market. ▪ There is one interest rate, which is both the  return to saving and the cost of borrowing. 19 The Market for Loanable Funds The supply of loanable funds comes20 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Slope of the Supply Curve Interest Rate Loanable Funds  ($billions) 21 The Market for Loanable Funds The demand for loanable funds comes from 22 The Slope of the Demand Curve Interest Rate Loanable Funds  ($billions)23 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Equilibrium Interest Rate The interest rate  The interest rate  adjusts to equate  adjusts to equate  Supply supply and demand.  supply and demand.  Demand Loanable Funds  ($billions) 24 Policy 1: Saving Incentives Interest Rate 5% S1 


economy, and what is their function?



We also discuss several other topics like lial(otbu)3h

60 D1 Loanable Funds  ($billions) 25 Policy 2: Investment Incentives Interest Rate 5% S1 

60D1 Loanable Funds  ($billions) 26 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. ACT IVE L E A RNING 2 Budget deficits ▪ Use the loanable funds model to analyze  the effects of a government budget deficit: ▪ Draw the diagram showing the initial  equilibrium. ▪ Determine which curve shifts when the  government runs a budget deficit.  ▪ Draw the new curve on your diagram.  ▪ What happens to the equilibrium values of the  interest rate and investment? ACT IVE L E A RNING 2 Answers Budget Deficits, Crowding Out,  and Long-Run Growth ▪ Our analysis: Increase in budget deficit causes  fall in investment.  ▪ This is called crowding out.  ▪ Recall from the preceding chapter:29 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. The U.S. Government Debt ▪ The government finances deficits by borrowing  (selling government bonds).  ▪ Persistent deficits  ▪ The ratio of govt debt to GDP is a useful  measure of the government’s indebtedness  relative to its ability to raise tax revenue.  ▪ Historically, the debt-GDP ratio  30 U.S. Government Debt  as a Percentage of GDP, 1970–2010 120% 100% 80% 60% Revolutionary  WarCivil  WW2 63.6% in  2010 War WW1 40% 20% 0% 1790 1810 1830 1850 1870 1890 1910 1930 1950 1970 1990 2010 CONCLUSION ▪ Like many other markets, financial markets are  governed by the forces of supply and demand. ▪ One of the Ten Principles from Chapter 1:  Markets are usually a good way  to organize economic activity. Financial markets help allocate the economy’s  scarce resources to their most efficient uses. ▪ Financial markets also link the present to the future:32 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. N. Gregory Mankiw Economics Principles of Sixth Edition 25 Production and Growth Premium  PowerPoint  Slides by  Ron Cronovich In this chapter,  look for the answers to these questions: • What are the facts about living standards and  growth rates around the world? • Why does productivity matter for living  standards? • What determines productivity and its growth  rate?  • How can public policy affect growth and living  standards? 1 Incomes  and Growth  Around the  World

GDP per  capita, 2009 Growth rate,  1970–2009 China $6,828 7.4% Singapore $50,633 4.7% India $3,296 3.3% Japan $32,418 2.2% Spain $32,150 2.1% Israel $27,656 2.1% Colombia $8,959 1.9% United States $45,989 1.8% Canada $37,808 1.7% Philippines $3,542 1.3% Rwanda $1,136 1.1% New Zealand $28,993 1.1% Argentina $14,538 1.0% Saudi Arabia $23,480 0.6% Chad $1,300 0.4%5


• What are the three kinds of saving?



Don't forget about the age old question of What are the steps to do a stimulation?

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Incomes and Growth Around the World Since growth rates vary, the country rankings can  change over time: ▪ Poor countries are not necessarily doomed to  poverty forever, e.g. Singapore incomes were  low in 1960 and are quite high now.  ▪ Rich countries can’t take their status for  granted: They may be overtaken by poorer but  faster-growing countries.  7 Incomes and Growth Around the World Questions: ▪ Why are some countries richer than others? ▪ Why do some countries grow quickly while  others seem stuck in a poverty trap? ▪ What policies may help raise growth rates and  long-run living standards? 8 Productivity ▪ Recall one of the Ten Principles from Chap. 1: A country’s standard of living depends on its ability to produce g&s. ▪ This ability depends on productivity,  ▪ Y = real GDP = quantity of output produced L = quantity of labor  so productivity = 9 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Why Productivity Is So Important ▪ When a nation’s workers are very productive,  ▪ When productivity grows rapidly,  ▪ What, then, determines productivity and its  growth rate?  10 Physical Capital Per Worker ▪ Recall: The stock of equipment and structures  used to produce g&s is called [physical] capital,  denoted K.  ▪ ▪ Productivity is higher when the average worker  has more capital (machines, equipment, etc.). ▪ i.e.,  11 Human Capital Per Worker ▪ Human capital (H):  ▪ H/L = the average worker’s human capital ▪ Productivity is higher when the average worker  has more human capital (education, skills, etc.). ▪ i.e., 12 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Natural Resources Per Worker ▪ Natural resources (N):  ▪ Other things equal,  more N allows a country to produce more Y.  In per-worker terms,  ▪ Some countries are rich because they have  abundant natural resources  (e.g., Saudi Arabia has lots of oil).  ▪ But countries need not have much N to be rich  (e.g., Japan imports the N it needs).  13 Technological Knowledge ▪ Technological knowledge:  ▪ Technological progress does not only mean  a faster computer, a higher-definition TV,  or a smaller cell phone.  ▪ It means 14 Tech. Knowledge vs. Human Capital ▪ Technological knowledge  ▪ Human capital  ▪ Both are important for productivity. 15 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Production Function ▪ The production function  F( ) is a function that shows how inputs are  combined to produce output  “A”  ▪ “A” multiplies the function F( ),  so improvements in technology (increases in “A”) 16 The Production Function Y = A F(L, K, H, N) ▪ The production function has the property  constant returns to scale:  ▪ For example, doubling all inputs (multiplying each  by 2) causes output to double: 2Y = A F(2L, 2K, 2H, 2N) 17 The Production Function Y = A F(L, K, H, N)▪ If we multiply each input by 1/L, then  ▪ This equation shows that productivity  (output per worker) depends on:  18 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. ACT IVE L E A RNING 1 Discussion Question Which of the following policies do you think would  be most effective at boosting growth and living  standards in a poor country over the long run? a. Offer tax incentives for investment by local firms b. ” ” ” ” ” by foreign firms c. Give cash payments for good school attendance d. Crack down on govt corruption e. Restrict imports to protect domestic industries f. Allow free trade g. Give away condoms ECONOMIC GROWTH  AND PUBLIC POLICY Next, we look at the ways  Next, we look at the ways  public policy can affect  public policy can affect  long-run growth in productivity  long-run growth in productivity  and living standards. and living standards. 20 Saving and Investment ▪ ▪ Since resources scarce, producing more capital  requires producing fewer consumption goods.  ▪ Reducing consumption = increasing saving.  This extra saving funds the production of  investment goods. (More details in the next chapter.) ▪ Hence, a tradeoff between current and future  consumption. 21 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Diminishing Returns and the Catch-Up  Effect ▪ The govt can implement policies that raise  saving and investment. (Details in next chapter.) Then K will rise, causing productivity and living  standards to rise.  ▪ But 22 The Production Function & Diminishing Returns Y/L K/L 23 The catch-up effect: Y/L


• What’s the difference between saving and investment?



Don't forget about the age old question of Where does the standard error of the mean depend on?

Poor country  K/L starts here Rich country starts here24 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Example of the Catch-Up Effect ▪ Over 1960–1990, the U.S. and S. Korea devoted  a similar share of GDP to investment, so you  might expect they would have similar growth  performance.  ▪ But growth was >6% in Korea and only 2% in  the U.S.  ▪ Explanation: 25 Investment from Abroad ▪ To raise K/L and hence productivity, wages, and  living standards, the govt can also encourage ▪ foreign direct investment:  ▪ foreign portfolio investment:  ▪ Some of the returns from these investments  26 Investment from Abroad ▪ Especially beneficial in poor countries that cannot  generate enough saving to fund investment  projects themselves.  ▪ Also27 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Education ▪ Govt can increase productivity by  ▪ Education has significant effects: In the U.S.,  ▪ But investing in H also involves a tradeoff  between the present & future:  Spending a year in school requires sacrificing  a year’s wages now to have higher wages later.  28 Health and Nutrition ▪ ▪ In countries with significant malnourishment,  raising workers’ caloric intake raises productivity: ▪ Over 1962–95, caloric consumption rose 44% in  S. Korea, and economic growth was spectacular. ▪ Nobel winner Robert Fogel:  30% of Great Britain’s growth from 1790–1980  was due to improved nutrition. 29 Property Rights and Political Stability ▪ Recall:  Markets are usually a good  way to organize economic activity. The price system allocates resources  to their most efficient uses.  ▪ This requires30 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Property Rights and Political Stability ▪ In many poor countries, the justice system  doesn’t work very well: ▪ Contracts aren’t always enforced ▪ Fraud, corruption often go unpunished ▪ In some, firms must bribe govt officials for  permits ▪ Political instability (e.g., frequent coups) creates  uncertainty over whether property rights will be  protected in the future.  31 Property Rights and Political Stability ▪ When people fear their capital may be stolen by  criminals or confiscated by a corrupt govt,  Result:  ▪ Economic stability, efficiency, and healthy growth  require 32 Free Trade ▪ Inward-oriented policies ▪ Outward-oriented policies33 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Free Trade ▪ Recall: Trade can make everyone better off. ▪ ▪ Countries with inward-oriented policies have  generally failed to create growth. ▪ e.g., Argentina during the 20th century. ▪ Countries with outward-oriented policies have  often succeeded.  ▪ e.g., South Korea, Singapore, Taiwan after 1960. 34 Research and Development ▪ ▪ One reason is that knowledge is a public good:  Ideas can be shared freely, increasing the  productivity of many.  ▪ Policies to promote tech. progress: 35 Population Growth …may affect living standards in 3 different ways: 1. Stretching natural resources ▪ 200 years ago, Malthus argued  ▪ Since then, the world population has increased  sixfold. If Malthus was right, living standards  would have fallen. Instead, they’ve risen.  ▪ Malthus failed to account for 36 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Population Growth 2. Diluting the capital stock ▪ ▪ This applies to H as well as K:  ▪ Countries with fast pop. growth tend to have lower  educational attainment.  37 Population Growth 2. Diluting the capital stock To combat this, many developing countries 38 Population Growth 3. Promoting tech. progress ▪ ▪ Evidence from Michael Kremer:  Over the course of human history, ▪ growth rates increased as the world’s  population increased ▪ more populated regions grew faster than  less populated ones39 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. ACT IVE L E A RNING 2 Review productivity concepts ▪ List the determinants of productivity.  ▪ List three policies that attempt to raise living  standards by increasing one of the determinants  of productivity. Are Natural Resources a Limit to  Growth? ▪ Some argue that population growth is depleting the  Earth’s non-renewable resources, and thus will limit  growth in living standards.  ▪ But  ▪ Hybrid cars use less gas. ▪ Better insulation in homes reduces the energy  required to heat or cool them. ▪ As a resource becomes scarcer,  43 CONCLUSION ▪ In the long run, living standards are determined by  productivity.  ▪ Policies that affect the determinants of productivity  will therefore affect the next generation’s living  standards.  ▪ One of these determinants is saving and  investment.  ▪ In the next chapter, we will learn how saving and  investment are determined, and how policies can  affect them. 44 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. N. Gregory Mankiw Economics Principles of Sixth Edition 28 Unemployment Premium  PowerPoint  Slides by  Ron Cronovich In this chapter,  look for the answers to these questions: • How is unemployment measured? • What is the “natural rate of unemployment”?  • Why are there always some people  unemployed? • How is unemployment affected by unions and  minimum wage laws? • What is the theory of efficiency wages, and how  does it help explain unemployment? 1 Labor Force Statistics ▪ Produced by Bureau of Labor Statistics (BLS),  in the U.S. Dept. of Labor  ▪ Based on regular survey of 60,000 households ▪ Based on “adult population” (16 yrs or older)2 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Labor Force Statistics BLS divides population into 3 groups: ▪ Employed:  ▪ Unemployed:  ▪ Not in the labor force: The labor force 3 Labor Force Statistics Unemployment rate (“u-rate”):  Labor force participation rate:  4 ACT IVE L E A RNING 1 Calculate labor force statistics Compute the labor force, u-rate, adult population,  and labor force participation rate using this data: Adult population of the U.S. by group, April 2011 # of employed 139.7 million # of unemployed 13.7 million not in labor force 85.7 million

We also discuss several other topics like How is an interval estimate defined?

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. ACT IVE L E A RNING 1 Answers Labor Force Statistics for Different Groups ▪ The BLS publishes these statistics for  demographic groups within the population.  ▪ These data reveal widely different labor market  experiences for different groups.  8 Labor Force Statistics for Whites & Blacks,  April 2011 Adults (20 yrs & older)

u-rate LF part. rate White, male 7.9% 73.9% White, female 7.0 59.8 Black, male 17.0 68.6 Black, female 13.4 62.0

9 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Labor Force Statistics for Whites & Blacks, April 2011 Teens (16–19 yrs)

u-rate LF part. rate White 22.3% 36.2% Black 41.6% 26.2%

Don't forget about the age old question of What is the formula for double integral?

10 Labor Force Statistics for Other Groups, April 2011 All ages

u-rate LF part. rate Asian 6.4% 64.1% Hispanic 11.8 66.6

11 Labor Force Statistics by Education Level,  April 2011 Adults (25 yrs & older)

u-rate LF part. rate less than h.s. 14.6% 45.5% h.s. diploma 9.7 60.4 some college or assoc degree 7.5 69.7 bachelor’s  degree or more 4.5 77.0

12 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. LF Participation Rates by Sex, 1950–2009 90 80 Men male 70 t necrep60 50 40 30 20 Women female 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 ACT IVE L E A RNING 2 Limitations of the u-rate In each of the following, what happens to the u-rate?  Does the u-rate give an accurate impression of what’s  happening in the labor market? A. Sue lost her job and begins looking for a new one.  B. Jon, a steelworker who has been out of work since  his mill closed last year, becomes discouraged and  gives up looking for work.  C. Sam, the sole earner in his family of 5, just lost his  $80,000 job as a research scientist. Immediately,  he takes a part-time job at McDonald’s until he can  find another job in his field.  ACT IVE L E A RNING 2 Answers© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. What Does the U-Rate Really Measure? ▪ The u-rate is not a perfect indicator of joblessness  or the health of the labor market: ▪ Despite these issues, the u-rate is still a very  useful barometer of the labor market & economy. 18 The Duration of Unemployment ▪ Typically 1/3 of the unemployed  have been unemployed under 5 weeks,  2/3 have been unemployed under 14 weeks. ▪ Only 20% have been unemployed over 6 months.  ▪ The small group of long-term unemployed persons  has fairly little turnover, so it accounts for most of  the unemployment observed over time. Knowing these facts helps policymakers design  better policies to help the unemployed.  19 Cyclical Unemployment vs. the Natural Rate There’s always some unemployment, though the  u-rate fluctuates from year to year.  Natural rate of unemployment Cyclical unemployment20 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. U.S. Unemployment, 1960–2011 12 Unemployment rate 10 e crofr obalf oe gatnecrep8 6 4 2 0 Natural rate of  unemployment 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Explaining the Natural Rate: An Overview Even when the economy is doing well, there is  always some unemployment, including: Frictional unemployment Structural unemployment 22 Job Search ▪ Workers have different tastes & skills, and  jobs have different requirements.  ▪ Job search ▪ Sectoral shifts ▪ Such shifts displace some workers,  who must search for new jobs appropriate  for their skills & tastes.  ▪ The economy is always changing, so 23 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Public Policy and Job Search ▪ Govt employment agencies ▪ Public training programs 24 Unemployment Insurance ▪ Unemployment insurance (UI):  ▪ UI  To see why, recall one of the  Ten Principles of Economics:  People respond to incentives. UI benefits end when a worker takes a job,  25 Unemployment Insurance Benefits of UI:26 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Explaining Structural Unemployment Structural  unemployment  occurs when There are three  reasons for this… W S D L 27 1. Minimum-Wage Laws ▪ ▪ But this group is a small part of the labor force,  28 2. Unions ▪ Union: a worker association that bargains with  employers over wages, benefits, and working  conditions  ▪ ▪ The typical union worker earns 20% higher  wages and gets more benefits than a nonunion  worker for the same type of work. 29 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. 2. Unions ▪ When unions raise the wage above eq’m,  quantity of labor demanded falls and  unemployment results.  ▪ “Insiders”  ▪ “Outsiders”  ▪ Some outsiders go to non-unionized labor  markets,  30 2. Unions Are unions good or bad? Economists disagree.  ▪ Critics:  Unions are cartels. They raise wages above eq’m,  which causes unemployment and/or depresses  wages in non-union labor markets.  ▪ Advocates:  31 3. Efficiency Wages ▪ The theory of efficiency wages:  ▪ Different versions of efficiency wage theory  suggest different reasons why firms pay high  wages.32 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. 3. Efficiency Wages Four reasons why firms might pay efficiency wages: 1. In less developed countries, poor nutrition is a  common problem.  2. Worker turnover 33 3. Efficiency Wages Four reasons why firms might pay efficiency wages: 3. Worker quality Offering higher wages  4. Worker effort Workers can work hard or shirk. Shirkers are fired  if caught. Is being fired a good deterrent? 34 ACT IVE L E A RNING 3 Applying the concepts Which of the following would be most likely to reduce  frictional unemployment? A. The govt eliminates the minimum wage. B. The govt increases unemployment insurance  benefits.  C. A new law bans labor unions.  D. More workers post their resumes at Monster.com,  and more employers use Monster.com to find  suitable workers to hire. E. Sectoral shifts become more frequent. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Explaining the Natural Rate of  Unemployment: A Summary The natural rate of unemployment consists of  ▪ frictional unemployment ▪ structural unemployment In later chapters, we will learn about cyclical  unemployment, the short-term fluctuations in  unemployment associated with business cycles.39 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. N. Gregory Mankiw Economics Principles of Sixth Edition 30 Money Growth and  Inflation Premium  PowerPoint  Slides by  Ron Cronovich In this chapter,  look for the answers to these questions: • How does the money supply affect inflation and  nominal interest rates? • Does the money supply affect real variables like  real GDP or the real interest rate?  • How is inflation like a tax? • What are the costs of inflation? How serious are  they? 1 Introduction ▪ This chapter introduces the quantity theory of  money to explain one of the Ten Principles of  Economics from Chapter 1: Prices rise when the govt prints  too much money. ▪ Most economists believe the quantity theory 2 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Value of Money ▪ P = the price level  (e.g., the CPI or GDP deflator) ▪ ▪ Example: basket contains one candy bar. ▪ If P = $2, value of $1 is 1/2 candy bar ▪ If P = $3, value of $1 is 1/3 candy bar ▪ Inflation drives up prices  3 The Quantity Theory of Money ▪ Developed by 18th century philosopher  David Hume and the classical economists ▪ Advocated more recently by Nobel Prize Laureate  Milton Friedman  ▪ ▪ We study this theory using two approaches: 1. A supply-demand diagram  2. An equation 4 Money Supply (MS) ▪ In real world, determined by Federal Reserve,  the banking system, consumers.  ▪ In this model, we assume5 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Money Demand (MD) ▪ Refers to ▪ Depends on  ▪ Thus, quantity of money demanded is ____________ related to the value of money  and __________ related to P, other things equal.  (These “other things” include real income, interest  rates, availability of ATMs.)  6 The Money Supply-Demand Diagram Value of  Money, 1/P 1 ¾ ½ ¼ MS1 The Fed sets MS at some fixed value,  regardless of P. Price  Level, P 1 1.33 2 4 $1000 Quantity  of Money 8 The Money Supply-Demand Diagram Value of  Money, 1/P 1 ¾ ½ ¼ A fall in value of money  (or increase in P)  increases the quantity  of money demanded:MD1 Quantity  of Money Price  Level, P 1 1.33 2 4 9 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Money Supply-Demand Diagram Value of  Money, 1/P 1 ¾ ½ ¼ MS1 $1000 MD1 Quantity  of Money Price  Level, P 1 1.33 2 4 10 The Effects of a Monetary Injection Value of  Money, 1/P 1 ¾ ½ MS1 A Suppose the Fed  increases the  money supply. Price  Level, P 1 1.33 2

MD1

We also discuss several other topics like traits of metalloids

¼ 4 $1000 Quantity  of Money 11 A Brief Look at the Adjustment Process Result from graph: Increasing MS causes P to rise. How does this work? Short version:  ▪ At the initial P, an increase in MS causes  ▪ People get rid of their excess money by spending  it on g&s or by loaning it to others, who spend it.  Result:  ▪ But supply of goods  (Other things happen in the short run, which we will  study in later chapters.)  12 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Real vs. Nominal Variables ▪ Nominal variables Examples: nominal GDP,  nominal interest rate (rate of return measured in $) nominal wage ($ per hour worked) ▪ Real variables Examples: real GDP,  real interest rate (measured in output) real wage (measured in output) 13 Real vs. Nominal Variables Prices are normally measured in terms of money.  ▪ Price of a compact disc: $15/cd ▪ Price of a pepperoni pizza: $10/pizza A relative price  ▪ Relative price of CDs in terms of pizza: Relative prices are measured in ________________,  so they are real variables.  14 Real vs. Nominal Wage An important relative price is the real wage: W = nominal wage = price of labor, e.g., $15/hour P = price level = price of g&s, e.g., $5/unit of output Real wage is the price of labor relative to the price  of output:15 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Classical Dichotomy ▪ Classical dichotomy:  ▪ Hume and the classical economists suggested  ▪ If central bank doubles the money supply,  Hume & classical thinkers contend ▪ all nominal variables  ▪ all real variables 16 The Neutrality of Money ▪ Monetary neutrality:  ▪ Doubling money supply causes all nominal prices  to double; what happens to relative prices? ▪ Initially, relative price of cd in terms of pizza is price of pizza= 1.5 pizzas per cd $15/cd price of cd $10/pizza = ▪ After nominal prices double,  price of pizza= ____ pizzas per cd /cd price of cd /pizza = 17 The Neutrality of Money ▪ Similarly, the real wage W/P ▪ quantity of labor supplied  ▪ quantity of labor demanded  ▪ total employment of labor  ▪ The same applies to employment of capital and  other resources.  ▪ Since employment of all resources is ____________,  total output is also unchanged by the money supply.18 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Neutrality of Money ▪ Most economists believe the classical dichotomy  and neutrality of money describe the economy in  the long run.  ▪ In later chapters, we will see that monetary  changes can have important short-run effects  on real variables.  19 The Velocity of Money ▪ Velocity of money:  ▪ Notation: P x Y = nominal GDP = (price level) x (real GDP) M = money supply V = velocity ▪ Velocity formula: 20 The Velocity of Money Example with one good: pizza.  In 2012,  Y = real GDP = 3000 pizzas  P = price level = price of pizza = $10 P x Y = nominal GDP = value of pizzas = $30,000 M = money supply = $10,000 V = velocity =21 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. ACT IVE L E A RNING 1 Exercise One good: corn.  The economy has enough labor, capital, and land  to produce Y = 800 bushels of corn.  V is constant.  In 2008, MS = $2000, P = $5/bushel.  Compute nominal GDP and velocity in 2008. ACT IVE L E A RNING 1 Answers U.S. Nominal GDP, M2, and Velocity 1960–2011 3,000 Velocity is fairly  Velocity is fairly  stable over the  001=06912,500 2,000 1,500 1,000 500 0 stable over the  long run. long run. Nominal GDP M2 Velocity 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Quantity Equation Velocity formula: V =P x Y M ▪ Multiply both sides of formula by M: ▪ Called the quantity equation 25 The Quantity Theory in 5 Steps Start with quantity equation: M x V = P x Y 1. V is stable.  2. So, a change in M causes  3. A change in M money is neutral, Y is determined by  4. So, P changes by  5. Rapid money supply growth causes rapid inflation.  26 ACT IVE L E A RNING 2 Exercise One good: corn. The economy has enough labor,  capital, and land to produce Y = 800 bushels of corn.  V is constant. In 2008, MS = $2000, P = $5/bushel.  For 2009, the Fed increases MS by 5%, to $2100.  a. Compute the 2009 values of nominal GDP and P.  Compute the inflation rate for 2008–2009. b. Suppose tech. progress causes Y to increase to  824 in 2009. Compute 2008–2009 inflation rate. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. ACT IVE L E A RNING 2 Answers ACT IVE L E A RNING 2 Summary and Lessons about the  Quantity Theory of Money ▪ If real GDP is constant, then  ▪ If real GDP is growing, then ▪ The bottom line:  ▪ Economic growth increases # of transactions. ▪ Hyperinflation ▪ Hyperinflation is generally defined as  ▪ Recall one of the Ten Principles from Chapter 1: Prices rise when the government  prints too much money.  ▪31 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Hyperinflation in Zimbabwe Large govt budget deficits  led to the creation of  large quantities of money  and high inflation rates. The Inflation Tax date Zim$ per US$ Aug 2007 245 Apr 2008 29,401 May 2008 207,209,688 June 2008 4,470,828,401 July 2008 26,421,447,043 Feb 2009 37,410,030 Sept 2009 355

Sign posted in  public restroom 32 ▪ When tax revenue is inadequate and ability to  borrow is limited, govt may print money to pay  for its spending.  ▪ Almost all hyperinflations start this way.  ▪ inflation tax:  ▪ In the U.S., the inflation tax today accounts for  less than 3% of total revenue.  33 The Fisher Effect ▪ Rearrange the definition of the real interest rate: ▪ The real interest rate is determined by saving &  investment in the loanable funds market.  ▪ ▪ So, this equation shows how the nominal interest  rate is determined. 34 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Fisher Effect ▪ In the long run, money is neutral,  so a change in the money growth rate affects  the inflation rate but not the real interest rate.  ▪ So, the nominal interest rate  ▪ This relationship is called the Fisher effect after Irving Fisher, who studied it.  35 U.S. Nominal Interest & Inflation Rates, 1960–2011 18% 15% 12% 9% 6% 3% 0% -3% Inflation rate Nominal  interest rate 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 The Fisher Effect & the Inflation Tax Nominal  interest rate Inflation  rate = +Real  interest rate ▪ The inflation tax applies to people’s holdings of  money, not their holdings of wealth.  ▪ The Fisher effect: an increase in inflation causes  an equal increase in the nominal interest rate,  so the real interest rate (on wealth) is unchanged.  37 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Costs of Inflation ▪ The inflation fallacy:  ▪ But inflation is a general increase in prices  of the things people buy and ▪ In the long run,  38 U.S. Average Hourly Earnings & the CPI 250 200 150 100 50 0 CPI  (left scale) Nominal wage  (right scale) $20 $18 $16 $14 $12 $10 $8 $6 $4 $2 $0 1965 1970 1975 1980 1985 1990 1995 2000 2005 39 The Costs of Inflation ▪ Shoeleather costs: the resources wasted when  inflation encourages people to reduce their  money holdings  ▪ Menu costs:40 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Costs of Inflation ▪ Misallocation of resources from relative-price  variability: Firms don’t all raise prices at the  same time, so relative prices can vary… which distorts the allocation of resources.  ▪ Confusion & inconvenience: Inflation changes  the yardstick we use to measure transactions.  Complicates long-range planning and the  comparison of dollar amounts over time.  41 The Costs of Inflation ▪ Tax distortions:  42 ACT IVE L E A RNING 3 Tax distortions You deposit $1000 in the bank for one year. CASE 1: inflation = 0%, nom. interest rate = 10% CASE 2: inflation = 10%, nom. interest rate = 20% a. In which case does the real value of your deposit  grow the most?  Assume the tax rate is 25%.  b. In which case do you pay the most taxes? c. Compute the after-tax nominal interest rate,  then subtract inflation to get the  after-tax real interest rate for both cases. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. ACT IVE L E A RNING 3 Answers A Special Cost of Unexpected Inflation ▪ Arbitrary redistributions of wealth Higher-than-expected inflation  Debtors get to repay their debt with dollars that  aren’t worth as much.  Lower-than-expected inflation  High inflation  So, these arbitrary redistributions are frequent  when inflation is high.  48 The Costs of Inflation ▪ All these costs are quite high for economies  experiencing hyperinflation.  ▪ For economies with low inflation (< 10% per year),  these costs are probably much smaller,  though their exact size is open to debate. 49 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. CONCLUSION ▪ This chapter explains one of the Ten Principles  of economics: Prices rise when the govt prints  too much money. ▪ We saw that  ▪ In later chapters, we will see that money has  important effects in the short run on real  variables like output and employment. 50 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. N. Gregory Mankiw Economics Principles of Sixth Edition 24 Measuring the Cost of  Living Premium  PowerPoint  Slides by  Ron Cronovich In this chapter,  look for the answers to these questions: • What is the Consumer Price Index (CPI)?  How is it calculated? What’s it used for? • What are the problems with the CPI? How  serious are they? • How does the CPI differ from the GDP deflator?  • How can we use the CPI to compare dollar  amounts from different years? Why would we  want to do this, anyway? • How can we correct interest rates for inflation? 1 The Consumer Price Index (CPI) ▪ measures  ▪ the basis of2 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. How the CPI Is Calculated 1. The Bureau of Labor Statistics (BLS) surveys  consumers to determine what’s in the typical  consumer’s “shopping basket.” 2. The BLS collects data on the prices of all the  goods in the basket.  3. Use the prices to compute the total cost of the  basket.  3 How the CPI Is Calculated 4. Choose a base year and compute the index. The CPI in any year equals 5. Compute the inflation rate. The percentage change in the CPI from the  preceding period.  4 EXAMPLE basket: {4 pizzas, 10 lattes} year price of  pizza price of  latte cost of basket 2010 $10 $2.00

2011 $11 $2.50

2012 $12 $3.00

Compute CPI in each year 2010: 2011: 2012: using 2010 base year:5 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. ACT IVE L E A RNING 1 Calculate the CPI CPI basket:  {10 lbs beef,  20 lbs chicken} The CPI basket cost $120  in 2010, the base year.

price  of beef price of  chicken 2010 $4 $4 2011 $5 $5 2012 $9 $6

A. Compute the CPI in 2011. B. What was the CPI inflation rate from 2011–2012? ACT IVE L E A RNING 1 Answers What’s in the CPI’s Basket? 4% 3% Housing 6% Transportation 6% Food & Beverages 6% 15% 43% 17% Medical care Recreation Education and communication Apparel Other9 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. ACT IVE L E A RNING 2 Substitution bias CPI basket: {10# beef,  20# chicken} 2010–11:  Households  bought CPI basket.

beef chicken cost of CPI  basket 2010 $4 $4 $120 2011 $5 $5 $150 2012 $9 $6 $210

2012: Households bought {5 lbs beef, 25 lbs chicken}. A. Compute cost of the 2012 household basket. B. Compute % increase in cost of household basket  over 2011–12, compare to CPI inflation rate. ACT IVE L E A RNING 2 Answers Problems with the CPI:  Substitution Bias ▪ Over time, some prices rise faster than others.  ▪ Thus, the CPI overstates increases in the cost of  living. 13 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Problems with the CPI:  Introduction of New Goods ▪ The introduction of new goods ▪ The CPI misses this effect because  ▪ Thus,  14 Problems with the CPI:  Unmeasured Quality Change ▪ ▪ The BLS tries to account for quality changes  but probably misses some, as quality is hard to  measure.  ▪ Thus, the CPI overstates increases in the cost of  living.  15 Problems with the CPI ▪ Each of these problems causes ▪ The BLS has made technical adjustments,  but the CPI probably still overstates inflation  by about  ▪ This is important because16 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Two Measures of Inflation, 1950–2010 15 10 r aeyr e5 pt necre0 P-5 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 CPI GDP deflator Contrasting the CPI and GDP Deflator 18 ACT IVE L E A RNING 3 CPI vs. GDP deflator In each scenario, determine the effects on the  CPI and the GDP deflator.  A. Starbucks raises the price of Frappuccinos. B. Caterpillar raises the price of the industrial  tractors it manufactures at its Illinois factory. C. Armani raises the price of the Italian jeans it  sells in the U.S.© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. ACT IVE L E A RNING 3 Answers Correcting Variables for Inflation: Comparing Dollar Figures from Different Times ▪ Inflation makes it harder to compare dollar  amounts from different times. ▪ Example: the minimum wage ▪ $1.15 in Dec 1964 ▪ $7.25 in Dec 2010 ▪ Did min wage have more purchasing power in  Dec 1964 or Dec 2010?  ▪ To compare,  21 Correcting Variables for Inflation: Comparing Dollar Figures from Different Times Amount  in today’s  dollars =▪ In our example,  ▪ “year T” is 12/1964, “today” is 12/2010 ▪ Min wage was $1.15 in year T ▪ CPI = 31.3 in year T, CPI = 220.3 today 22 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Correcting Variables for Inflation: Comparing Dollar Figures from Different Times ▪ Researchers, business analysts, and policymakers  often use this technique to convert a time series of  current-dollar (nominal) figures into constant-dollar  (real) figures.  ▪ They can then see how a variable has changed  over time after correcting for inflation.  ▪ Example: the minimum wage, from Jan 1960 to  Dec 2010… 23 The U.S. Minimum Wage in Current Dollars and Today’s Dollars, 1960–2010 $12.00 2010 dollars $10.00 r uohr eps ralloD$8.00 $6.00 $4.00 $2.00 $0.00 current dollars 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 ACT IVE L E A RNING 4 Comparing tuition increases Tuition and Fees at U.S. Colleges and Universities

1990 2010 Private non-profit 4-year $9,340 $27,293 Public 4-year $1,908 $7,605 Public 2-year $906 $2,713 CPI 130.7 218.1

Instructions: Express the 1990 tuition figures in 2010  Instructions: Express the 1990 tuition figures in 2010  dollars, then compute the percentage increase for all  dollars, then compute the percentage increase for all  three types of schools. Which type experienced the  three types of schools. Which type experienced the  largest increase in real tuition costs?  largest increase in real tuition costs? © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. ACT IVE L E A RNING 4 Answers

1990 2010 % change CPI 130.7 218.1

Private non-profit 4-year  (current $) $9,340 $27,293

Private non-profit 4-year  (2010 $)

Public 4-year (current $) $1,908 $7,605

Public 4-year (2010 $)

Public 2-year (current $) $906 $2,713

Public 2-year (2010 $)

Correcting Variables for Inflation: Indexation For example, the increase in the CPI automatically  determines 27 Correcting Variables for Inflation: Real vs. Nominal Interest Rates The nominal interest rate:  The real interest rate: Real interest rate 28 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Correcting Variables for Inflation: Real vs. Nominal Interest Rates Example: ▪ Deposit $1,000 for one year. ▪ Nominal interest rate is 9%.  ▪ During that year, inflation is 3.5%. ▪ Real interest rate  29 Real and Nominal Interest Rates in the U.S., 1950–2010© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. N. Gregory Mankiw Economics Principles of Sixth Edition 23 Measuring a Nation’s  Income Premium  PowerPoint  Slides by  Ron Cronovich In this chapter,  look for the answers to these questions: • What is Gross Domestic Product (GDP)?  • How is GDP related to a nation’s total income  and spending?  • What are the components of GDP?  • How is GDP corrected for inflation? • Does GDP measure society’s well-being? 1 Micro vs. Macro ▪ Microeconomics:  ▪ Macroeconomics: 2 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Income and Expenditure ▪ Gross Domestic Product (GDP) ▪ GDP also measures  For the economy as a whole,  3 The Circular-Flow Diagram ▪ a simple depiction of the macroeconomy ▪ illustrates GDP as spending, revenue,  factor payments, and income ▪ Preliminaries: ▪ Factors of production ▪ Factor payments 4 The Circular-Flow Diagram Markets for  Markets for  Markets for  Goods &  Goods &  Goods &  ServicesServices Services Firms Households Markets for  Markets for  Markets for  Factors of  Factors of  Factors of  Production Production Production 6 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. What This Diagram Omits ▪ The government ▪ collects taxes, buys g&s ▪ The financial system ▪ matches savers’ supply of funds with  borrowers’ demand for loans ▪ The foreign sector ▪ trades g&s, financial assets, and currencies  with the country’s residents 7 Gross Domestic Product (GDP) Is… …the market value of all final goods &  services produced within a country  in a given period of time. 8 Gross Domestic Product (GDP) Is… …the market value of all final goods &  services produced within a country  in a given period of time. Final goods: Intermediate goods:  GDP only includes9 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Gross Domestic Product (GDP) Is… …the market value of all final goods &  services produced within a country  in a given period of time. 10 Gross Domestic Product (GDP) Is… …the market value of all final goods &  services produced within a country  in a given period of time. 11 Gross Domestic Product (GDP) Is……the market value of all final goods &  services produced within a country in a given period of time. 12 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Gross Domestic Product (GDP) Is… …the market value of all final goods &  services produced within a country  in a given period of time. Usually a year or a quarter (3 months)  13 The Components of GDP ▪ Recall: GDP is total spending.  ▪ Four components: ▪ These components add up to GDP (denoted Y): 14 Consumption (C) ▪ ▪ Note on housing costs:  ▪ For renters, consumption includes  ▪ For homeowners, consumption includes15 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. Investment (I) ▪ ▪ includes spending on 16 Government Purchases (G) ▪ ▪ G excludes transfer payments,  17 Net Exports (NX) ▪ NX = ▪ Exports represent  ▪ Imports are ▪ Adding up all the components of GDP gives:18 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. U.S. GDP and Its Components, 2010

billions % of GDP per capita Y $14,745 100.0 $47,459 C 10,366 70.3 33,365 I 1,907 12.9 6,139 G 3,022 20.5 9,727 NX –550 –3.7 –1,772

19 ACT IVE L E A RNING 1 GDP and its components In each of the following cases, determine how much  GDP and each of its components is affected (if at all). A. Debbie spends $200 to buy her husband dinner  at the finest restaurant in Boston. B. Sarah spends $1800 on a new laptop to use in her  publishing business. The laptop was built in China.  C. Jane spends $1200 on a computer to use in her  editing business. She got last year’s model on sale  for a great price from a local manufacturer.  D. General Motors builds $500 million worth of cars,  but consumers only buy $470 million worth of them. ACT IVE L E A RNING 1 Answers A. B.© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. ACT IVE L E A RNING 1 Answers C. D. Real versus Nominal GDP ▪ Inflation can distort economic variables like GDP,  so we have two versions of GDP:  ▪ Nominal GDP ▪ Real GDP 23 EXAMPLE:

Pizza Latte year P Q P Q 2011 $10 400 $2.00 1000 2012 $11 500 $2.50 1100 2013 $12 600 $3.00 1200

Compute nominal GDP in each year: 2011: 2012: 2013: Increase:24 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. EXAMPLE:

Pizza Latte year P Q P Q 2011 $10 400 $2.00 1000 2012 $11 500 $2.50 1100 2013 $12 600 $3.00 1200

Compute real GDP in each year,  using 2011 as the base year:Increase: 2011: 2012: 2013: 25 EXAMPLE: year 2011 2012 2013 Nominal  GDP Real  GDP 26 Nominal and Real GDP in the U.S.,  1965–2010 $16,000 $14,000 $12,000 snoillib$10,000 $8,000 $6,000 $4,000 $2,000 $0 Real GDP  (base year  2005) Nominal  GDP 1960 1970 1980 1990 2000 2010 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. The GDP Deflator ▪ The GDP deflator is a measure of the overall  level of prices.  ▪ Definition: ▪ One way to measure the economy’s inflation  rate is 29 EXAMPLE: year Nominal  GDP Real  GDP GDP  Deflator 2011 $6000 $6000 2012 $8250 $7200 2013 $10,800 $8400 Compute the GDP deflator in each year: 2011: 2012: 2013: 30 ACT IVE L E A RNING 2 Computing GDP

2011 (base yr) 2012 2013

P Q P Q P Q Good A $30 900 $31 1000 $36 1050 Good B $100 192 $102 200 $100 205

Use the above data to solve these problems: A. Compute nominal GDP in 2011. B. Compute real GDP in 2012.  C. Compute the GDP deflator in 2013. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. ACT IVE L E A RNING 2 Answers GDP and Economic Well-Being ▪ ▪ But GDP is not a perfect measure of  well-being.  ▪ Robert Kennedy issued a very eloquent  yet harsh criticism of GDP:  34 Gross Domestic Product… “… does not allow for the health of our  children, the quality of their education,  or the joy of their play. It does not  include the beauty of our poetry or  the strength of our marriages, the  intelligence of our public debate or  the integrity of our public officials.  It measures neither our courage, nor our wisdom,  nor our devotion to our country. It measures everything,  in short, except that which makes life worthwhile, and it  can tell us everything about America except why we are  proud that we are Americans.” - Senator Robert Kennedy, 1968© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. GDP Does Not Value: 36 Then Why Do We Care About GDP? ▪ Having a large GDP enables a country to afford  better schools, a cleaner environment,  health care, etc.  ▪ Many indicators of the quality of life are  positively correlated with GDP. For example… 37 GDP and Life Expectancy in 12 countries ) sraeIndonesia China Mexico Japan Germany U.S. y( ycnatcepxee fiLBrazil Pakistan Russia India Bangladesh NigeriaReal GDP per capita 38 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use. GDP and Literacy in 12 countries   China ) nRussia Mexico Brazil U.S. Germany Japan ycaretiLt ludAoitalupop fo% (Indonesia Nigeria India Pakistan Bangladesh Real GDP per capita 39 GDP and Internet Usage in 12 countries   egasUt enretnI) noitalupop fo% (Indonesia Brazil Mexico Japan Germany U.S. PakistanNigeria Russia China India Bangladesh Real GDP per capita 40 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license  distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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