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USC / Economics / ECON 222 / What is the function of consumer price index?

# What is the function of consumer price index? Description

##### Description: Key Information from Lectures 1-10 Examples, Graphs and Charts Glossary of Terms
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Exam Date: Tuesday, September 29, 2015

## What is the consumer price index?

Macroeconomics Exam One Study Guide

Lecture One____________________________________________________________________

- Slope = Rise/Run

- Rate of Growth Formula: V1= Value 1 V2 = Value 2

[(V2-V1)/ V1] x 100% (yields a percentage)

EXAMPLE: In 2010 Runnels County, Texas had a population of 2,358. AS of 2015 the  population jumped to 3,764. What is the Rate of Growth?

3,764 – 2,358 x 100% = 59.63%

2,358

- Macroeconomics vs. Microeconomics

o Macroeconomics- the study of the economy as a whole

o Microeconomics - study of how households and firms make choices (such as) ▪ Quantity, Marketing, Management, Price

## What are the four economic resources?

▪ How they interact in the market (buyers and sellers interact to exchange a good  or service)

▪ How the government attempts to influence their choices

▪ How specific industries operate

- Consumer Price Index: the overall price level or average of all prices (CPI)

o Increase in CPI means inflation

o Decrease in CPI means deflation

- Four Economic Resources

1. Land: all natural resources (as well as what comes with land)

2. Labor: workers physical and mental abilities (quality) as well of number of workers  (quantity)

3. Physical Capital: tools, machines, factories, building, produced factors of production 4. Entrepreneur: Organizes resources for production, innovation and risk taking - Opportunity Cost

## What are the three ways to calculate gdp?

o Economics is the study of those choices people make as far as what they want/need vs  what they can afford

▪ Process called opportunity cost (What you give up to get something you want)

EXAMPLE: Kelsey wants to can either eat her friend’s fresh baked cookies and  gain weight or refrain from eating and meet her weight loss goals.

a) Eat Cookies Cost: Gains weight, does not match weight loss goal Benefit: Gets to enjoy sweet treats

b) Do not eat cookies Cost: Does not get to enjoy the sugary goodness

Benefit: Will lose weight and get closer to meeting goal

- Steps of building an Economic Model

1. Decide on assumptions to use

2. Formulate a testable hypothesis

3. Use economic data to test the hypothesis

4. Revise model

5. Retain the revised model

- Important Features of Economic Models

1. Assumptions and Simplifications

2. Good models generate testable predictions, which can be proven or disproven using data 3. Economic Variable is something measurable that can have different values

Lecture Two____________________________________________________________________

- Three Key Economic Ideas

1. People are rational

2. Optimal decisions are made at the margin

3. People respond to economic incentives

- Three Economic Questions We also discuss several other topics like What did the new york sun favor?

1. What goods will be produced? Don't forget about the age old question of What relative dating method is tested using gravestone data?

2. How will the goods be produced?

3. Who will receive the goods and services? If you want to learn more check out Define universal listeners.

- Key Relationships

Demand Increases Price increases

Demand Decreases Price decreases

Supply Decreases Price Increases

Supply Increases Price Decreases

- Types of Economies

Centrally Planned Economies: governments decide what to produce, how to produce it and who  received the goods and services

Example: Soviet Union (USSR), North Korea and Cuba

Market Economies: Result when the decisions of households and firms determine what is  produced, how it’s produced and who receives the goods and services

Mixed Economies: features of both the previous economies

Example: United States of America and China  We also discuss several other topics like Who is clara rockmore?

Lecture Three___________________________________________________________________ Don't forget about the age old question of What is popular sovereignty?

- Adam Smith – Writer of the “Wealth of Nations” (1776), promoted market economies, catalyst  for early capitalism

- Efficiencies (Market economies promote these forms of efficiencies)

Productive Efficiency- Where goods or services are produced at the lowest possible cost

Allocative Efficiency- Where production is consistent with consumer preferences, the  marginal benefit of production is equal to its marginal cost

- Marginal Cost and Benefit

o Marginal Cost- how much firms are currently spending producing the good

o Marginal Benefit- how much competitors value the good

- Market Failure

1. Externality- the impact of one person’s actions on the well-being of a bystander o Positive Externality: Impose external benefits

EXAMPLE: Finding a lottery ticket on street, it wins jackpot

o Negative Externality: Impose external costs

EXAMPLE: Dumping toxic waste into a public river, smoking in a crowded

classroom

2. Excessive Market Power

3. Equity: Free markets are efficient but not equitable

4. Government: Provides goods and services that a private market will not provide (called  public goods)

o Public good- Nonexcludable (Cannot prevent a person from using) and Nonrival  (One person’s using will not diminish another person’s use)

o Private Good- excludable (Can prevent a person from using) and rival(One person’s  use will diminish another person’s use)

▪ For a private market to produce a good it needs to be excludable

5. Enforce Laws, Contracts and Property Rights: The rights individuals or firms have to the  exclusive use of their property

- Market Power Types

o Monopoly: One seller of a good or service, price maker

o Oligopoly: A few sellers of a good or service

o Natural Monopoly: Happens naturally due to high startup costs

EXAMPLE: utility companies, electricity

- Analysis Types

o Positive- the study of “what is.” Factual and can be supported by evidence,  describes world as it is

o Normative- Study of “what ought to be.” How you think the world should be,  prescriptive, personal values, views and judgements, cannot be tested in order to be  proven true or false

EXAMPLES:

Diana has 9 cats. - Positive

Kourtney is not my favorite Kardashian. - Normative

Mason Plumlee has a subpar jumpshot. - Normative

Clarence is from Houston, Texas. - Positive

Lecture Four___________________________________________________________________

- Entrepreneurs are a virtual part of economy because

1. Respond to consumer demand

2. Introduce new products

- Circular Flow Diagram Assumptions

1. Two economic Agents- Households and firms (does not factor in government) 2. No savings

3. Closed Economy: no foreign trade

No imports: goods produced abroad and sold domestically

No exports: goods produced domestically and sold abroad

4. Households own all resources/ factors of production and inputs

5. Firms employ resources in the production of output (good or service) i. Market for goods and services

-or

ii. Market for output/ product market

- Circular Flow Diagram

Factors of Production

Land Labor Physical Capital Entrepreneurs

Rent Wages Loans Interest

Profit s

Sedans

Firms Firms Firms Firms  Blue arrow= Input to firms

Red Arrow = Output of firms (Back to household/consumer)

- Modern Economy Groups (Two)

1. Households: consists of individuals who provide the factors of production

2. Firms

- Markets

o Product Market- markets where goods like computers and services such as medical  treatment are offered (Firms are sellers and households are buyers)

o Factor Markets- Markets where Factors of Production such as land, labor, capital  etc. are traded

- Basic Circular Flow Diagram

Lecture Five____________________________________________________________________

- Production Possibilities Frontier (PPF)

Productivity

80 40

A

C

(80,0)

(40,40)

G Not possible production

1 hour = 2 sedans

1 hour = 2 SUV’s

40 work hours available

0

40

E

80

(0,80)

SUVs

A) 80 sedans and 0 SUVs C) 40 sedans and 40 SUVs E) 0 sedans and 80 SUVs

- Opportunity Cost (OC)

o The highest valued alternative that must be given up in order to engage in an activity/  what you give up to get something

o Opportunity costs are normally increasing (shown in chart below)

o The more resources already devoted to an activity, the smaller the payoff to devoting  additional resources to that activity

o Further, Marginal Opportunity cost is increasing

▪ Because resources are not equally proficient in the production of both goods

Example: Columbia can only produce a limited number of soda cans and gameday towels, the  chart shows the opportunity cost of producing less tanks in return for more automobiles.

Plotted Points

Soda Cans

Gameday Towels

Opportunity Cost

A

400

0

-

B

350

200

50 soda cans

C

200

400

150 soda cans

D

0

500

200 soda cans

- Shifts in the PPF on One- Axis

o New technology or an additional resource that is limited to the production of an item on  ONE axis

o PPF will also shift when the country has experienced economic growth

- Shifts in the PPF on BOTH axes

o Caused by general technological breakthrough

EXAMPLE: assembly line or better machinery

Lecture Six_____________________________________________________________________

- How humans supply wants/needs

o Economically Self- Sufficient: Consuming only goods that you produce (no trade) o Economically Interdependent: Specialize in the production of one good and trade with  others for other goods (trade allows us to consume more)

- Marginal Opportunity Cost

o Again, Marginal Opportunity Cost is increasing

B

A

∙ Increasing Marginal Opportunity Cost is the reason PPF is curved, not  straight

∙ As more economic resources become available, production moves from  Curve A to B

Gigi can produce 1 cherry in 8 hours Bubba can produce 1 cherry in 4 hours  1 apple in 1 hour 1 apple in 2 hours 40 work hours available for both the girl and the boy

40

20

A

A) 40 apples and 0 cherries

B) 20 apples and 2.5 cherries

C) 0 apples and 5 cherries

*B= the production point and consumption point

B

2.5

5

AA) 20 apples and 0 cherries 20

B) 10 apples and 5 cherries

C) 0 apples and 10 cherries

*B= the production point and the

10

5

B

10

C

Gigi

Bubba

Production Point

20 apples and 2.5 cherries

10 apples and 5 cherries

Consumption Point

20 apples and 2.5 cherries

10 apples and 5 cherries

Gigi

Bubba

Production Point

40 apples and 0 cherries

0 apples and 10 cherries

Consumption Point

20 apples and 5 cherries

20 apples and 5 cherries

Lecture Seven__________________________________________________________________

o Lowest opportunity cost of producing a good

Gigi 1 apple = 1 hour Bubba 1 apple = 20 hours

1 cherry = 8 hours 1 cherry = 10 hours

o Gigi has absolute advantage in both apples and cherries

Gigi

Production Point

20 apples and 2.5 cherries

40 apples and 0 cherries

Consumption Point

20 apples and 2.5 cherries

30 apples and 3 cherries

Bubba

Production Point

1 apple and 2 cherries

0 apples and 4 cherries

Consumption Point

1 apple and 2 cherries

10 apples and 1 cherry

*40 work hours available for both*

Gigi Bubba

8 hours = 1 cherry 10 hours = 1 cherry

1 hour = 1 apple 20 hours = 1 apple

____________________Equalize hours_____________________________

1 cherry = 8 hours 1 cherry = 10 hours

1 apple = 1 apple 1 apple= 20 hours

_____________________Find Opportunity Costs_____________________

1 cherry = 8 apples 1 cherry = ½ apple

1 apple = 1/8 cherry 1 apple = 2 cherries

o Gigi has comparative advantage apples

o Bubba has comparative advantage in cherries

Step One: If a graph is provided, look at the axis. If a table is provided, carefully read the table.

Item

Labor hours needed to

produce 1 unit

5 hours

6 hours

Sweets

8 hours

12 hours

US 5 hours = 1 Basket Venezuela 6 hours = 1 Basket

8 hours = 1 Sweet 12 hours = 1 Sweet

Pounds Production

Item

Pound(s) Production per hour

Sweets

8 Sweets

12 Sweets

- Who produces more in the same amount of time ~or~

- Whoever takes less time to produce the same amount of the good

- If one producer has an absolute advantage in both goods calculate opportunity cost  - The lower opportunity cost producer of a good has comparative advantage in that good - If one producer has an absolute advantage in one good the other producer has an absolute  advantage in the other good

o Then that is what they will have their comparative advantage in

Step Four: Compare consumption point before and after trade to calculate the gains from trade

- Economists

o David Ricardo “Principles of Political Economy and Taxation” (1817)

o Adam Smith “Wealth of nations” (1776)

o Generally, all economists agree upon the massive benefit that is free trade Lecture Eight___________________________________________________________________ - Comparative v Absolute Advantage Review

Carlos 1 quilt = 90 hours Hilda 3 quilts = 90 hours 2 dresses = 90 hours 9 dresses = 90 hours

Who has an absolute advantage in quilts? Hilda

Who has an absolute advantage in dresses? Hilda

Carlos 1 quilt = 2 dresses Hilda 1 quilt = 3 dresses 1 dress = ½ quilt 1 dress = 1/3 quilt

Who has a comparative Advantage in quilts? Carlos

Who has a comparative advantage in dresses? Hilda

- Types of Goods

o Normal goods

▪ Demand for normal goods increases as income increases

o Complement Goods

▪ Increase in price of complement good makes demand for normal goods go  down

o Substitute Goods

▪ Increase in price of a normal good makes the demand for a substitute good  increase

- Law of Supply- an increase in price causes an increase in the quantity supplied and a decrease in  price causes a decrease in the quantity supplied

Lecture Nine___________________________________________________________________

- Gross Domestic Product (GDP)- Reported by the bureau of economic analysis (BEA), part of the  department of commerce, measured quarterly, total market value of all final goods and services  produced in a country during a specific period of time

- Inflation Rate- The percentage increase in the price level, consumer price index (CPI) The Bureau  of Labor Statistics (BLS) which is part of the US Labor Department measures on a monthly basis o Increase in CPI = inflation

o Decrease in CPI = deflation

- Business Cycles (Short Run GDP)

Peak (high point) Peak of a business cycle= top of a curve Trough (low point)

- Final Goods vs Intermediate Goods

o Final Good- Good or service purchased by the final user (at it’s end use)

o Intermediate Goods- goods used up in the production of another good

EXAMPLE: Katy buys sugar cookie mix at the grocery store for \$5. She then goes to her  friend Randy’s house and they bake them and proceed to sell them at a bake sale for \$7.  Intermediate Good: Raw Cookie Dough (\$5)

How much does this add to the GDP?

\$7

▪ (Not \$12 because that would be double counting)

- Requirements to be included in GDP

1. Produced in the boundaries of our county (Includes exports)

2. Newly produced

3. Sold legally in markets

4. Rent and estimated Rental Value of owner- occupied houses

5. Final goods services: household buys things for consumption, physical capital final - Value – Added Method- the value added at each stage of production. Difference between the  price the firm sells the good for and the price paid to other firms for the intermediate good

EXAMPLE: Farmer grows peaches for \$0.50

Grocer sells for \$1

Baker buys peaches, and bakes into peach cobbler, sells for \$2

Lecture Ten____________________________________________________________________

- Final Goods and Physical Capital Calculation Excludes:

1. Value of intermediate goods

2. Second- hand goods

3. Illegal production

4. Items produced at home and never enters the market

5. Transfer payments (Social Security Check)

- GDP Calculation methods

1. Resource Cost or Income Approach:

Wage + Rent + Profits + Interest

2. Expenditure Method:

Y = C + I + G + NX

(GDP = Consumption + Investment + Government Purchases + Net Exports)

3. Output Method: total dollar value of output produced

P x Q = GDP

- Circular Flow Model and the Measurement of GDP

Households

Expenditure on

goods and

services

Firms

Wages, Rent and  Interest Profits

- Circular Flow Model adding government, Rest of the World Households

Payment = payment of wages (I.e.  social security and transfer  payments)

Tax

Expenditure on

goods and

Payment

Wages, Rent and

servicesGovernment es

Interest Profits

Expenditure  on G&S

Firms

Tax es

Rest of  World

- Circular Flow Model adding Financial Systems

Households -

Rest of

-

World Banks’  Financial

System

Firms

Borrowing

Key Terms

Microeconomics- the study of how households and firms make choices

Macroeconomics- the study of the economy as a whole

Consumer Price Index- (CPI) the overall price level or average of all prices

Technology- the processes a firm uses for turning inputs into outputs of goods and services

Scarcity- a situation in which unlimited wants exceed the limited resources available to fulfill those  wants

Centrally Planned Economies- governments decide what to produce, how to produce it and who  received the goods and services (Examples include Soviet Union (USSR), North Korea and Cuba)

Market Economies- Result when the decisions of households and firms determine what is produced,  how it’s produced and who receives the goods and services

Mixed Economies- Features of both a centrally planned economy and a market economy (mix of two) Productive Efficiency- where goods or services are produced at the lowest possible cost

Allocative Efficiency- Where production is consistent with consumer preferences: the marginal benefit  of production is equal to its marginal cost

Marginal Cost- how much firms are currently spending producing the good

Marginal Benefit- how much competitors value the good

Market Failure: Market does not reach the best outcome on its own, government intervention can  improve a market’s outcomes

Externality- the impact of one person’s actions on the well-being of a bystander Monopoly- One seller of a good or service in a market, Price maker

Oligopoly- a few large firms control a market

Public good- Nonexcludable (Cannot prevent a person from using) and Nonrival (One person’s using will  not diminish another person’s use)

Private Good- excludable (Can prevent a person from using) and rival (One person’s use will diminish another person’s use)

Positive Analysis- the study of “what is.” Factual and can be supported by evidence, describes world as  it is (Example- Clothes protect humans from the cold)

Normative Analysis- Study of “what ought to be.” How you think the world should be, prescriptive,  personal values, views and judgements, cannot be tested in order to be proven true or false,

Free market- one with few government restrictions on how a good or service can be produced or sold,  or on how a factor of production can be employed

Entrepreneur- Someone who brings together the factors of production (land, labor and capital) to  produce goods and services

Closed Economy: no foreign trade, markets do not allow importing/exporting

Product Market- markets where goods like computers and services such as medical treatment are  offered (Firms are sellers and households are buyers)

Factor Markets- Markets where Factors of Production such as land, labor, capital etc. are traded Circular Flow Diagram- (CFD) Model that illustrates how participants in markets are linked

Opportunity Cost- (OC) the highest valued alternative that must be given up in order to engage in an  activity/ what you give up to get something

Economically Self- Sufficient- Consuming only goods that you produce (no trade)

Economically Interdependent- Specialize in the production of one good and trade with others for other  goods

Law of Supply- an increase in price causes an increase in the quantity supplied and a decrease in price  causes a decrease in the quantity supplied

Ceteris paribus- “all else equal,” is literal translation, Latin phrase

Inflation Rate- The percentage increase in the price level, consumer price index (CPI) The Bureau of  Labor Statistics (BLS) which is part of the US Labor Department measures on a monthly basis

Gross Domestic Product- (GDP) total market value of all final goods and services produced in a country  during a specific period of time, typically a quarter or a year. Reported by the Bureau of Economic  Analysis (BEA) which is a part of the US Department of Commerce

Final Good- Good or service purchased by the final user (at its end use)

Intermediate Goods- goods used up in the production of another good

Value - Added Method- the value added at each stage of production. Difference between the price the  firm sells the good for and the price paid to other firms for the intermediate good

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