Macroeconomics Chapter 9

Consumer Price Index

An average of the prices of the goods and services purchased by the typical urban family of four. To obtain prices of a representative sample of goods and​ services, the BLS surveys​ 30,000 households to construct a market basket of 211 goods and services and visits​ 23,000 stores in 87 cities. One year is chosen as a​ "base year." For any given​ year, the CPI equals the ratio of the dollar amount necessary to purchase the market basket in the current year to the dollar amount required to purchase the same basket in the base​ year, multiplied by 100. As a​ result, the CPI equals 100 in the base year. StartFraction Cost of the market basket in the current year Over Cost of the market basket in the base year EndFraction times 100Cost of the market basket in the current year cost of the market basket in the base year×100

Producer price index​ (PPI)

An average of the prices received by producers of goods and services at all stages of the production process. The PPI includes intermediate goods. It is often considered an early sign of inflation since increases in the prices of intermediate goods generally translate into higher prices to consumers.

Efficiency​ wage

A​ higher-than-market wage that a firm pays to increase worker productivity. Many studies have shown that higher wages motivate people to work harder. Efficiency wages are set higher than the market equilibrium not because of government regulation or unionization of the​ workforce, but instead as a​ productivity, loyalty, and motivation tool. By paying an efficiency wage to​ workers, the firm raises the cost of losing their jobs because most alternative jobs only pay the market wage. As a​ result, job turnover falls as do the costs associated with hiring and training new employees.

When compared to the Great​ Depression, the typical length of unemployment in the modern​ (post-Great Depression-era) U.S. economy is

During the Great Depression of the​ 1930s, some people were unemployed for years at a time. In the modern U.S.​ economy, a typical unemployed person stays unemployed for a relatively brief period of​ time, although that time lengthens significantly during a severe recession. For​ example, when the economy was expanding in early​ 2007, fewer than 20 percent of the unemployed had been jobless for more than six months. By the end of the​ 2007-2009 recession,​ though, half of the unemployed had been jobless for more than six months.

Economic variables that are calculated in current year prices are referred to as __________ variables, while variables that have been corrected to account for the effects of inflation are __________ variables.

Economic variables that are calculated in current year prices are referred to as nominal variables, while variables that have been corrected to account for the effects of inflation are real variables. Nominal variables simply look at the observed value, but in order to adjust for change that is simply due to a change in price, you need to adjust for inflation. Real values have been adjusted for inflation.

That​ is, if inflation is unexpectedly​ low, then the real interest rate paid or received will be much higher than expected. In this​ case, lenders will benefit since the purchasing power of the payment is unexpectedly higher. If the inflation rate is unexpectedly​ high, then the real interest rate paid or received will be much lower than expected. In this​ case, borrowers will benefit since the real interest rate is much lower​ (possibly negative) than expected.

Households and firms routinely enter into contracts that commit them to make or receive fixed payments for years in the future. Since these payments are made and received in nominal​ dollars, the rate of inflation is very important.

If the CPI was 207 in 2007 and 225 in 2011, what pay raise would someone who earned $50,000 in income in 2007 have to receive in order to keep her purchasing power constant in 2011?

If the CPI was 207 in 2007 and 225 in 2011, someone who earned $50,000 in income in 2007 would have to receive a pay raise of $4,348 in order to keep her purchasing power constant in 2011. To compute the percentage change in prices you use the formula: Inflation rate = [(CPI1 - CPI0) / CPI0] x 100 = [(225 - 207) / 207] x 100 = 8.696. You can then multiply $50,000 x .08696 = $4,348. Her new salary will need to be $54,348 in order to maintain the same level of purchasing power.

In calculating the CPI, the __________.

In calculating the CPI, the market basket does not include large equipment purchased by firms. The CPI is concerned with the impact of changes in prices on consumers, not businesses. However, large equipment purchases are investments in capital that might ultimately impact the CPI in the form of higher production costs that are passed on to consumers. The largest two groups of items in the CPI are housing (43%) and food and beverages (16%). The composition of the market basket of goods and services is updated every two years to reflect changes in purchasing habits of the typical household.

Suppose the fixed interest rate on a loan is​ 5.75% and the rate of inflation is expected to be​ 4.25%. The real interest rate is​ 1.5%. Suppose now that instead of​ 4.25%, the inflation rate unexpectedly reaches​ 5.5%. Who gains and who loses from this unanticipated​ inflation?

Lenders lose from a lower real interest rate. Your answer is correct. Borrowers gain from a lower real interest rate. Your answer is correct.

Even perfectly anticipated inflation imposes costs.​ Why?

Menu costs. Paper money loses its purchasing power by the rate of inflation. Some wages will fail to keep up with anticipated inflation.

Frictional Unemployment

Short-term unemployment that arises from the process of matching workers with jobs. Most workers spend time involved in job​ searches, just as most firms spend at least time searching for the best person for a job opening. Frictional unemployment is​ short-term unemployment that arises from the process of looking for a job. The process takes​ time, so there will always be some workers who are frictionally unemployed because they are between jobs and in the process of finding new ones.

The "normal or natural" underlying level of unemployment in the economy is the __________.

The "normal or natural" underlying level of unemployment in the economy is the full employment rate of unemployment. This is the level of unemployment that exists even when the economy is fully employing its resources. This level is typically between 4 and 5 percent and will contain no cyclical unemployment since that is associated with a recession.

Which market basket specifically targets intermediate goods?

The market basket used by the producer price index specifically targets intermediate goods. The PPI is used to compute inflation rates felt by producers so it uses the prices of intermediate goods to determine price changes. The CPI specifically focuses on consumer products and the GDP deflator evaluates changes in the overall price level of all goods and services included in the GDP.

Real interest rate

The nominal interest rate minus the inflation rate. The real interest rate corrects the nominal interest rate for the effect of inflation on purchasing power. It provides a better measure of the true cost of borrowing and the true return to lending than does the nominal interest rate.

Natural rate of unemployment

The normal rate of​ unemployment, consisting of frictional unemployment plus structural unemployment. When the economy moves through the expansionary phase of the business​ cycle, cyclical unemployment will drop to zero and the economy is said to be in full employment. That​ is, the economy is at full employment when the only remaining unemployment is either frictional or structural. Economists consider frictional and structural unemployment to be the​ normal, underlying level of unemployment in the economy. This normal level of unemployment is called the natural rate of unemployment.

The short-term unemployment that arises from workers, in the process of changing jobs, is called __________.

The short-term unemployment that arises from workers, in the process of changing jobs, is called frictional unemployment. Frictional unemployment will always exist as workers change jobs and are unemployed for a short time. This type of unemployment does not concern policymakers. Cyclical unemployment is due to a recession, or downturn in the business cycle. Structural unemployment deals with long-term permanent (structural) changes in the economy that eliminate the need for a particular skill set. Advances in technology and globalization ensure that the economy always has some structural unemployment.

there is zero inflation, the nominal interest rate is equal to the real interest rate.

This is because the nominal interest rate (also called the stated or quoted interest rate) is equal to the real interest rate plus the rate of inflation. Savers will demand a real return which means some return over and above the rate of inflation, so that they can at least maintain the same level of purchasing power plus a small return.

What is the real average hourly wage ?

To correct for the effects of​ inflation, we can divide a nominal variable by a price index and multiply by 100 to obtain a real variable. The real variable will be measured in dollars of the base year for the price index. To calculate real average hourly earnings for a given​ year, divide the nominal average hourly wage for that year by a price index for that year and multiply by 100.

To obtain prices of a representative group of goods and services, the Bureau of Labor Statistics (BLS) conducts a monthly survey of __________ households nationwide on their spending habits. The results of this survey are used to construct a market basket of __________ types of goods and services purchased by the typical urban family of four.

To obtain prices of a representative group of goods and services, the Bureau of Labor Statistics (BLS) conducts a survey of 14,000 households nationwide on their spending habits. The results of this survey are used to construct a market basket of 211 types of goods and services purchased by the typical urban family of four. The BLS then gathers monthly price information on this market basket of goods and services, and uses this to compute the CPI for that month. To determine the change in price, this CPI is compared to a previous CPI in order to calculate the percentage change in price from one period to the next.

Structural Unemployment

Unemployment arising from a persistent mismatch between the skills and characteristics of workers and the requirements of available jobs. For​ example, many people who were highly skilled at​ hand-drawn animation became unemployed as​ computer-generated, three-dimensional animation became the industry standard. To become employed​ again, these animators either learned the new animation methods or found employment in other industries after lengthy retraining periods. Structural unemployment can last longer than frictional unemployment because workers need time to develop new skills. Next question

How do unemployment insurance paymentsLOADING... in the United States and social insurance programs in other countries increase the unemployment​ rate?

Without these​ payments, the opportunity cost of job search increases more quickly over time. Although there are many reasons unemployment rates differ across​ countries, most economists believe that since the opportunity cost of job search is lower in Western Europe and​ Canada, the unemployment rate tends to be higher than in the U.S.

When the economy is at full​ employment,

all remaining unemployment is either frictional or structural. the unemployment rate is greater than zero. the natural rate of unemployment prevails.

If inflation is anticipated.....

it costs less to society than if unanticipated. Both borrowers and savers can adjust their strategies if they anticipate inflation to minimize the impact. However, inflation erodes the purchasing power of everyone, and is particularly harmful to those on fixed incomes whether it is anticipated or unanticipated. Debtors gain when there is unanticipated inflation since they can pay back loans with cheaper dollars.

Unemployment arising from a persistent mismatch between the skills and characteristics of workers and job requirements is called

structural unemployment