NCSU Econ 205 - SS1 - Test 3

Consumer Price Index (CPI)

** How we measure inflation ** A measure of the price level based on the consumption pattern of a typical consumer Goal is to measure the cost of living of the average consumer

Usefulness of GDP

- Allows us to estimate living standards across time/countries - We can measure economic growth - We can see if the economy is expanding or contracting

Trade Model

- Examines specialization, trade, gains to trade & comparative advantage - Two countries, two goods - Demonstrate how trade creates value

Length of Frictional Unemployement

- Internet makes it easier to search for jobs... decreases time & cost of job searching - Government regulations that make it hard to fire people increases the length of frictional unemployment

Unemployment Timeline

- Unemployment rate tends to lag behind economic activity - When recovery happens & people reenter the labor force, the unemployment rate increases - We don't know who is unemployed. We don't know how long.. ** Short-run unemployment not a problem, long-run is a big deal **

Reasons for Trade Barriers

-- Why are trade barriers so common? 1. Special interest groups, lobbying, irrational ignorance 2. National Security: we want to produce in times of war... produce weapons 3. Infant Industry Argument: firm just starting out needs protection... Protections rarely removed 4. Economic Diversification: if a country is too dependent on a single industry, a problem in that industry affects the whole economy 5. Anti-dumping: "dumping" is when a country sells a good for less than their domestic price --> Goal of dumping: entry into a new market often the result of foreign subsidies... Counter is tariff on good

What can structurally unemployed people do?

--> Undesirable to "save" obsolete/inefficient jobs 1. workers have to retrain, reeducate, relocate or change expectations about wages 2. retire 3. government sometimes help with training programs

Shortages of the Unemployment Rate

1. Discouraged Workers: workers that give up looking for work... Not considered unemployed 2. Underemployed Workers: part time workers who want full-time jobs. Includes workers who are overqualified for their job... Considered employed

Parts of Business Cycle

1. Expansion 2. Contraction 3. Peak 4. Trough

Finding Real GDP

1. Filter out nominal prices from Nominal GDP by dividing it by price level of that year 2. Multiply by the price level of the base year Real GDP = (Nominal GDP_t / Price_t) x P_base

Two Conditions must be met for successful Price Discrimination

1. Firms must be able to distinguish/discriminate between groups of buyers with different demand elasticities 2. Firms must be able to prevent resale **

Costs of Inflation

1. Future Price Level Uncertainty 2. Shoe-leather Costs 3. Money Illusion 4. Wealth Redistribution 5. Price Confusion 6. Tax Distortions

Shortcomings of GDP

1. Non-market goods: goods/services produced but never sold though they add value to society Ex. cooking, cleaning, childcare In less developed countries, GDP may be a poor measure of output as people make their own thins 2. Underground Economy (aka Black Markets): hidden & uncounted transactions... sometimes illegal Size of underground economy is estimated ~10% of GDP in US... ~45% in developing countries 3. Environmental Quality: GDP doesn't distinguish how goods/services are produced High enviro quality, lower GDP --> more taxes/restrictions.. 4. Leisure Time: GDP does not capture how long it took to make the goods 5. Distribution of Wealth: per capita GDP does not take into account the distribution of wealth

How to prevent resale?

1. Require identification 2. Tend to see PD with services/Utilities (can't resell the item)

Types of Unemployment

1. Structural 2. Frictional 3. Cyclical STRUCTURAL & FRICTIONAL ARE NORMAL CYCLICAL IS BAD

Concerns with CPI

1. Substitution --> price of good A rises, we buy more of good B.... 1999 BLS has incorporated this into model 2. Changes in Quality --> prices may rise when quality improves... 1999 BLS has incorporated this into model 3. New Products/Locations --> BLS added new goods to the CPI after long delays... New products often drop in price after a few years so the CPI should keep track of these price drops.... BLS created the "chained CPI" in 2000 to attempt to correct for this bias.

Biggest Problems with Inflation

1. Uncertainty about price changes causes problems for firms & workers 2. Long-term wage contracts are difficult to agree to 3. Consumers may change buying habits due to uncertainty

Other measures of wellbeing

1. life expectancy 2. education levels 3. access to healthcare 4. crime rates 5. environmental quality Reality: in most countries, GDP is strongly correlated with these things

US trades with

238 countries, but 60% of imports come from just 7 countries 1. China 2/3. Canada & Mexico

Shoe-leather Costs

As prices increase, the cost of hold cash increases (buy now, not tomorrow) These are the resources people waste trying to avoid holding money... ex. time, effort, fuel costs, worn out shoes

Unemployment Insurance

Benefits workers by reducing the consequences of getting laid off --> Unintended consequences: workers tend to not search as hard for new jobs as they are getting money.... increases frictional unemployment

Finding Price Index

CPI = (Basket Price_t / Basket Price base year) * 100%

Tax Distortions

Capital Gains Taxes are taxes paid on gains realized from selling an asset for more than its purchase price... Price rises due to inflation not the good naturally becoming more valuable Ex. Bough house for 80K in 1980.. Sells in 2012 for 230K Capital Gain: 150K However reale value of the house has not changed.

Government Purchases

Capital for the government --> Includes government employee salaries, government buildings & equipment produced, public works project, national defense, schools, etc... NOT included: wealth redistribution (medicare, medicaid, social security)

Modern Trade Increases

Caused by: Reduction in shipping costs Increased specialization

Pricing Strategy General Rule

Charge high price for groups with inelastic demand, Charge low prices for groups with elastic demand How --> let customers self select into a group

BLS Survey

Collect prices for ~8000 goods/services in 211 categories, at 38 geographic locations --> For the average consumer: 41% of consumer budget is housing, 17% is transportation, 15% is food....

Where do gains to trade come from?

Countries produce the goods they can make at the lowest opportunity cost, and then trade for goods and services which have a high opportunity costs Lower costs, increase output

Business Cycle affects international trade

During recessions, imports and exports drop... We tend to see trade deficits shrink during recessions

Net Exports

Exports - Imports If imports > exports, negative Net Exports

Consumption

Final purchase of goods & services by households Everything except new housing

Future Price Level Uncertainty

Firms make long-run contracts for salaries & loans on capital... The uncertainty of inflation makes long-run contracts riskier. If long-run contracts aren't formed, GDP goes down.

World Trade Organization (WTO)

Forum that facilitates agreements Settles disputes

Is structural unemployment bad?

From an efficiency perspective, this is not a bad thing.

Nominal GDP

GDP measured with market prices ****not adjusted for inflation****

Real GDP

GDP with prices held constant over time ****adjusted for inflation****

Why do we include both goods/services in GDP?

Goods - tangible Services - intangible Composition of US industries has changed a lot in the last 50 years... Switching to a service based economy as our technology is high enough where we don't need people workers

Bureau of Labor Statistics

Gov. agency that reports unemployment rates & the consumer price index --> determine "weight" of various prices

Calculate Inflation Rate

IR = (CPI new - CPI old)/CPI old * 100%

Inflation Rate

IR = (Pnew - Pold)/Pold * 100%

When would the US trade with another country, if completely free trade existed

If the domestic price is higher than the world price, we tend to import that good.

Implications of Free Trade

Increase in supply for goods we can import Total Supply = Domestic Supply + Imports --> Would lower the price --> Local producers will sell less.. may go out of business

Price Level

Index that measures the average price of goods and services

Cause of Inflation

Inflation is caused by expansions in the money supply

Labor Force Participation Rate

LFPR = (labor force / population) * 100% Tells us what percent of the population is in the labor force (working / looking for work) People tend to leave the labor force in bad times & reenter in good.. At the same time, baby boomer generation is retiring --> driving LFPR down

Natural Rate of Unemployment

Level of unemployment we see in a healthy economy Denoted by u*

Arbitrage

Low demand group reselling the good to people in the high demand group --> Price discrimination doesn't work if this can occur

NAFTA

North America Free Trade Agreement Signed in 1992 Eliminated nearly all trade restrictions between the US, Canada, & Mexico

Why does GDP count the "market value" of goods/services?

Not all goods are worth the same... We need to account for the value of goods/services produced

Money Illusion

People misinterpret nominal prices changes as real changes... Most common with wages --> If you get a 3% rise & the inflation rate is 5%, you're getting a real wage cut of 2% Nominal Wage: wage in current dollars Real Wage: inflation adjusted Menu Costs: costs of changing prices --> to change prices at a restaurant, you print new menus... $$

Price Discrimination Summary

Perfect competition & monopolies are fairly rare Very common for services --> Distinguish between groups of buyers & prevent resale Creates a more efficient outcome than a monopoly (total surplus increases, dead weight loss decreases)

Institutions & Laws affect International Trade by:

Positive aspect of trade --> it gives countries an incentive to improve institutions Stable institutions & laws are good for trade --> rule of law, property rights, low inflation ---> Products must meet standards... Nations with stable currency & low corruption are better trading partners... Firms want to trade where the law is followed

Comparing Prices Across Time

Price Today = (Price Earlier) * (CPI today / CPI earlier)

Investments

Private spending on capital (tools, factories, things that help us make stuff) Also includes purchases by businesses that add to inventory Also includes new houses... NEVER STOCK/BONDS

Market Value

Quantity * Price

Wealth Redistribution

Redistributes wealth between borrowers & lenders Ex. You borrow 50K today. Agree to pay back 60K in 5 years. If unexpected inflation occurs, the bank is worse off.

Macroeconomics

Study of economy wide issues --> "aggregate"

Examples

Suppose a pizza shop charges $8 for a cheese pizza & $16 for a meat lovers pizza --> Not PD as it is based on cost to make the pizza Bob pays $100 for a 2nd class ticket while Joe pays $200 for a 2nd class ticket --> PD as there is a price difference for same good

Price Confusion

The difficulty in determining whether price changes are caused by demand shifts, or inflation... If demand increases, produce more. If inflation increases, you don't change quantity

Perfect Price Discrimination

The firm can charge a unique price for every consumer equal to their maximum willingness to pay --> If occurs, consumer surplus = 0... Impossible to implement b/c can't know everyone's max willingness On curve --> everything is producer surplus... no consumer surplus & no deadweight loss

Per Capita GDP

Total GDP/population GDP per person... measures the average standard of living

Trends in Globalization

Total world exports make up 1/4 of world GDP. Many goods purchased in the US are imported... Ex. Iphones designed in Cali assembled in China

Structural Unemployment

Unemployment caused by changes in the industrial structure of the economy "Creative Destruction" --> as new jobs are created, old jobs become obsolete Ex. horse carriages replaced by cars Ex. workers at steel mills replaced by capital

Frictional Unemployment

Unemployment caused by delays in matching jobs to workers People don't always take the first job they are offered and firms don't always hire the first applicant Ex. College graduates, spouses of someone who moved to get a new job

% Change Formula

Used to calculate Growth Rates %change = (new-old)/old x 100%

Comparative Advantage

You have a comparative advantage in the production of a good/service if you can produce it at a lower opportunity cost than anyone else

Price Discrimination

a firm sells the same good to different consumers at different prices, for reasons unrelated to cost ex. college tuition, airline tickets, movie tickets --> selected discounts... senior, military, employee

Durable Goods

a good consumed over a long period of time; subject to cylcical fluctuations Ex. cars, computers, appliances

GDP Deflator

a measures of the price level that includes prices of final goods & services in GDP

Bureau of Economic Analysis

calculates official GDP estimates GDP = Consumption + Investments + Government Purchases + Net Exports

Cyclical Unemployment

caused by economic downturns... "worst" type of unemployment occurs for unknown periods of time

Lagging Indicator

changes after the economy changes ex. unemployment rate, consumer price index

Labor Force

consists of people who are employed or actively seeking work

Inflation

continuing rise in the general price level --> measured as the growth rate in the average prices --> negative inflation = deflation

Trade Surplus

exports > imports; positive trade balance

Competition

foreign competition diminishes domestic market power & increases consumer choice

Nondurable Goods

good consumed over a short period of time; not affected much by business cycle Ex. food, medicine, newspaper

Final Good

goods that are sold to end users

Leading Indicator

helps us predict a future event & changes before the economy changes Ex. Building permit for microeconomics

Trade Deficit

imports < exports; negative trade balance

Who is not in the labor force?

jobless people NOT looking for work retirees students (usually) institutionalized

Import Quota

limit on the quantity that can be imported US has quotas on many agricultural products: milk, tea, olives, peanuts, cotton, sugar Import Quotas often times upset countries less than tarrifs

Tariffs

local producers maybe harmed by international trade... Could impose a tariff or import quota to help PROTECT the industry A tax on an imported good.. It raises the prices of the import by the amount of the tariff

Full employment output

output in an economy with no cyclical unemployment Denoted by y* Full employment output = Real GDP

Intermediate Good

raw materials/components --> not counted as it would be double counted in the final good

Business Cycle

short run fluctuations in economic activity that cause output to be above or below the long run trend

Microeconomics

study of the individual units that comprise the economy

Growth Rates

tell us how fast our economy is growing

Gross Domestic Product (GDP)

the total value of all new final goods & services produced and sold in an economy over a certain length of time --> gives us a measure of economic growth --> used to compare regions/countries Output & income are essentially the same thing --> Used as a measure of economic health

Total GDP

total amount of all goods/services not always the best standard for comparing countries

Trade Balance

total exports - total imports

Economies of Scale

trade gives small countries access to goods such as cars - Small countries produce goods that they produce cheapest & they trade for other goods

Super Normal Expansion

u < u* y > y* Cyclical unemployment < 0

Unemployment Rate Calculation

u = (# unemployed / # in labor force) * 100%

Healthy Economy

u = u* y = y* Cyclical unemployment = 0

Recession

u > u* y < y* Cyclical unemployment > 0

Foreign Producers

worse off b/c tariff reduces demand for imports; reduces amount of US dollars abroad, isolates the protectionist country

Consumers

worse off by tariff b/c it increases prices, reducing quantity demanded & reduces consumer surplus