ECO202 - Chapter 9

You borrow $1,000 for one year & at the end of the year you repay the $1,000 plus $100 of interest & the inflation rate is 12%.

-2% $100 = 10% of $1000 10-12 = -2%

You borrow $1,000 for one year & at the end of the year you repay the $1,000 plus $100 of interest & the inflation rate is 8%.

2% $100 = 10% of $1000 10 - 8 = 2

Which of the following price indices comes closest to measuring the cost of living of the typical​ household? A.household price index B.producer price index C.consumer price index D.GDP deflator

C. consumer price index

What is the real average hourly wage in​ 2009? A.$17.42 B.$8.61 C.​$8.21 D.​$7.92

C.​$8.21

Types of Unemployment

Frictional Structural Cyclical Define, Causes, & Advice

Unemployment Rates for Demographic Groups

TAKE AWAY Black teenagers highest unemployment rate

Problems with Inflation: Wrong Reason

Wrong reason: Inflation increases the cost of living but not nominal incomes. - Why wrong: Inflation raises, in general, both cost of living & nominal incomes.

Is it possible for the nominal interest rate to be less than the real interest rate?

Yes, but only when the inflation rate is negative (deflation)

Labor Force Participation Rate

percentage of the working age population in the labor force

Calculating the Unemployment Rate

4.3%

During which period did the country experience​ deflation? A. 2005 to 2010. B. 2000 to 2005. C. 1995 to 2000. D. 1990 to 1995.

A. 2005 to 2010.

What can be said about real average hourly earnings and nominal average hourly earnings between 2008 and​ 2010? A.Both real and nominal average hourly earnings increased. B.Real average hourly earnings decreased and nominal average hourly earnings increased. C.Both real and nominal average hourly earnings decreased. D. Real average hourly earnings increased and nominal average hourly earnings decreased.

A.Both real and nominal average hourly earnings increased.

​[Related to the Making the​ Connection] During the late nineteenth century in the United​ States, many farmers borrowed heavily to buy land. During most of the period between 1870 and the​ mid-1890s, the United States experienced mild deflation. Many farmers engaged in political protests during these​ years, and deflation was often a subject of their protests. Why would farmers have felt burdened by deflation during this​ period? A.During deflationary​ periods, the real interest rate exceeds the nominal interest​ rate, and the real cost of borrowing increases. B.During deflationary​ periods, the nominal interest rate exceeds the real interest​ rate, and the real cost of borrowing increases. C.During deflationary​ periods, the nominal interest rate exceeds the real interest​ rate, and the real cost of borrowing falls. D.During deflationary​ periods, the real interest rate exceeds the nominal interest​ rate, and the real cost of borrowing falls.

A.During deflationary​ periods, the real interest rate exceeds the nominal interest​ rate, and the real cost of borrowing increases.

The real interest rate equals A.the nominal interest rate minus the inflation rate. B.the nominal interest rate divided by the CPI for a given year. C.the nominal interest rate plus the inflation rate. D.the inflation rate minus the nominal interest rate.

A.the nominal interest rate minus the inflation rate.

If an economy experiences​ deflation, the real interest rate A.will be greater than the nominal interest rate. B.will be negative when the nominal interest rate is positive. C.will be less than the nominal interest rate. D.will be equal to the deflation​ rate, so long as the nominal interest rate is positive.

A.will be greater than the nominal interest rate.

Producer Price Index (PPI)

An average of the prices received by producer of goods & services at all stages of the production process. i.e.- cotton, buttons, assembly, shirt, not just final shirt

Suppose the consumer price index​ (CPI) of a country follows the path shown in the figure to the right. During which period did the country experience zero​ inflation? A. 2005 to 2010. B. 2000 to 2005. C. 1995 to 2000. D. 1990 to 1995.

B. 2000 to 2005.

The increase in quality bias in the consumer price index refers to the idea that price increases in the CPI reflect pure​ inflation, but​ ______ quality increases. This causes the CPI to​ ______ the cost of the market basket. A. ​also; overstate B. not; overstate C. not; understate D. also; understate

B. not; overstate

Which of the following is true about the consumer price​ index? A.It filters out the part of price increases that occurs because of quality improvements in products. B.It assumes that consumers purchase the same amount of each product in the market basket each month. C.It frequently updates the price changes of new products added to the market​ basket, as these have a tendency to fall. D.It accounts for people switching to goods whose prices have fallen.

B.It assumes that consumers purchase the same amount of each product in the market basket each month.

The Consumer Price Index in December 2012 equaled 231. With a base period of​ 1982-84, the CPI of 231 means that the A.inflation rate in December 2012 for the last twelve months was 131 percent. B.cost of the market basket in December 2012 was 231 percent of the cost of the market basket in the base period. C.inflation rate in December 2012 for the last twelve months was 231 percent. D.cost of the market basket in December 2012 was 131 percent of the cost of the market basket in the base period.

B.cost of the market basket in December 2012 was 231 percent of the cost of the market basket in the base period.

Establishment Survey

Bureau of Labor Statistics (BLS) Samples about 300,000 business & establishments Persons employed on a company payroll

During which period did the country experience a slow down in​ inflation, although the inflation rate remained​ positive? (This situation is called​ "disinflation.") A. 2005 to 2010. B. 2000 to 2005. C. 1995 to 2000. D. 1990 to 1995.

C. 1995 to 2000.

The inflation rate for 1997 was equal to A. 1.2 percent. B. 2.0 percent. C. 2.5 percent. D. 4.0 percent.

C. 2.5 percent.

The substitution bias in the consumer price index refers to the idea that consumers​ ______ the quantity of products they buy in response to​ price, and the CPI does not reflect this and​ ________ the cost of the market basket. A. do not​ change; over−estimates B. change; under−estimates C. change; over−estimates D. do not​ change; under−estimates

C. change; over−estimates

Suppose you borrow​ $1,000 at an interest rate of 12 percent. If the expected real interest rate is 5​ percent, then the rate of inflation over the upcoming year that would be most beneficial to you would be a rate of inflation A. equal to 7 percent. B.less than 7 percent. C.greater than 7 percent. D.equal to 0 percent.

C. greater than 7 percent.

The difference between a nominal variable and a real variable is that A.nominal variables are economic variables that are adjusted for​ inflation, whereas real variables are valued in​ today's dollars. B.real variables are divided by the price index and multiplied by 100 to obtain nominal variables. C.nominal variables are calculated in​ current-year prices and the real variables are measured in dollars of the base year for the price index to correct the effects of inflation. D.real variables are calculated in​ current-year prices and the nominal variables are measured in dollars of the base year to adjust for the effects of inflation.

C.nominal variables are calculated in​ current-year prices and the real variables are measured in dollars of the base year for the price index to correct the effects of inflation.

If inflation is expected to​ increase, A.the nominal interest rate will remain the same. B.the nominal interest rate will decrease. C.the nominal interest rate will increase. D.the real interest rate will increase.

C.the nominal interest rate will increase.

Problems with Deflation

Consumers reduce consumption spending, waiting for even lower prices Increases the burden on borrowers, if the deflation is unexpected, because it increases the real interest rate.

If the inflation rate is 6 percent and the nominal interest rate is 4​ percent, then the real interest rate is A. 2​ percent, which is the inflation rate minus the nominal interest rate. B. 10​ percent, which is the sum of the nominal interest rate and the inflation rate. C. 1.5​ percent, which is the ratio of the nominal interest rate to the inflation rate. D. -2 percent, which is the nominal interest rate minus the inflation rate.

D. -2 percent, which is the nominal interest rate minus the inflation rate.

During which period did the country experience an increasing rate of​ inflation? A. 2005 to 2010. B. 2000 to 2005. C. 1995 to 2000. D. 1990 to 1995.

D. 1990 to 1995.

Indicate whether the following statement is true or false and why. ​"A wage rising slower than the rate of inflation is actually​ falling." A. False. A higher wage increases purchasing power regardless of inflation. B. False. A higher wage decreases purchasing power regardless of inflation. C. True. If wages are increasing slower than the average price of goods and​ services, purchasing power increases. D. True. If wages are increasing slower than the average price of goods and​ services, purchasing power falls.

D. True. If wages are increasing slower than the average price of goods and​ services, purchasing power falls.

Since nominal incomes increase with​ inflation, A.expected inflation increases the purchasing power of the average consumer. B.expected inflation reduces the purchasing power of the average consumer. C. unexpected inflation does not affect the purchasing power of the average consumer. D. expected inflation does not affect the purchasing power of the average consumer.

D. expected inflation does not affect the purchasing power of the average consumer.

Nominal incomes generally increase with inflation because A. when inflation is​ unanticipated, average nominal incomes also increase by the same percentage as inflation. B. even anticipated inflation causes average nominal incomes to fall as prices increase. C. when inflation is​ anticipated, real incomes also increase by the same percentage as inflation. D. when inflation is​ anticipated, average nominal incomes also increase by the same percentage as the rate of inflation.

D. when inflation is​ anticipated, average nominal incomes also increase by the same percentage as the rate of inflation.

Natural Rate of Unemployment

It is not a physical & unchanging law of nature. Instead, it is only the "natural" rate because it is the unemployment rate that would result from the combination of economic, social, & political factors that exist at a time - assuming the economy was neither booming, nor in recession These forces include the usual pattern of companies expanding & contracting their workforces in a dynamic economy, social & economic forces that affect the labor market, or public policies that affect either the eagerness of people to work or willing business to hire

GDP Deflator

Measure of the price level calculated by dividing nominal GDP by real GDP & multiplying by 100. Includes all final goods & services in GDP. i.e. - Final Shirt, not cotton, buttons, or assembly

Personal Consumption Expenditure Price Index (PCE)

Measure of the price level that is similar to the GDP deflator, except it includes only the prices of goods and services in GDP from the consumption category. Federal Reserve uses the % change in the PCE to determine target inflation

Consumer Price Index (CPI)

Measures the Cost of Living A measure of the average change over time in the prices a typical urban family of 4 pays for the goods and services they purchase Ratio of expenditures on market basket in current year to expenditures on market basket in base year times 100 Interpretation: Not actual dollars, but Price Index. Percentage of cost in the base year or percentage increase from the base year. Biases (substitution bias & quality bias) cause CPI to overstate Inflation & overstate the Cost of Living

Measuring Unemployment

Must be actively Looking for a Job in the last 4 weeks to be Counted Unemployed Labor Force = employed + unemployed Creative Destruction (Dynamic Job Market)

At the natural rate of unemployment, does everyone have a job that wants a job?

No, some are in mismatch jobs

Natural Rate of Unemployment - Full‐Employment Rate of Unemployment

Normal rate of unemployment, consisting of frictional unemployment plus structural unemployment - Cyclical Unemployment = 0 Unemployment Rate at Full Employment would be 0%, but due to above not possible Frictional Unemployment + Structural Unemployment

Why is the Employment-Population Ratio Maybe the Best Indicator of the Labor Market?

One drawback to the unemployment data is that workers who drop out of the labor market are no longer counted as unemployed So some economist focus on the employment‐population ratio, because it measures the percentage of the working‐age population (population age 16 and over) that has jobs

CPI - Increase in Quantity Bias

Quantity improvements of goods & services are not filtered out completely & show up as an increase in the cost of living (inflation). dating 'unpopular' to dating popular'

Nominal vs. Real Interest Rates

Real interest rate = nominal interest rate - inflation rate - provides a better measure of the true cost of borrowing & lending i.e. 7% = 2% + 5% Nominal interest rate = real interest rate + inflation rate - stated interest rate on loan i.e. 2% = 7% ‐ 5% The interest rate is the cost of borrowing funds, expressed as a percentage of the amount borrowed

Why Inflation is a Problem: Actual Inflation ≠ Expected Inflation

Redistributes income between borrowers & lenders when actual inflation rate differs from expected inflation rate If actual inflation is greater than expected inflation, borrowers gain by paying lower nominal interest rates than would be required with the higher actual inflation rate. **LENDER LOSE, BORROWERS GAINS** - Real interest rate less than expected real interest rate -suppose actual inflation = 10%, instead of 5% -actual real interest rate= nominal interest rate - actual inflation rate -3% = 7% - 10% ***borrowers gain by paying a nominal interest rate with an expeceted inflation rate (5%) smaller than the actual inflation rate (10%) that occurs; thereby, paying an actual real interest rate (-3%) smaller than the expected real interest rate (2%) If actual inflation less than expected inflation, lenders gain by receiving higher nominal interest rates than would be required with the lower actual inflation rate. - Real interest rate greater than expected real interest rate **LENDER GAINS, BORROWERS LOSE** -suppose actual inflation = 0%, instead of 5% -actual real interest rate= nominal interest rate - actual inflation rate 7% = 7% - 0% ***lender receives & borrowers pays a nominal interest rate (7%0 with an expected inflations rate (5%) larger than the actual inflation rate (0%) that occurs; thereby, lender receives & borrowers pay an actual real interest rate (7%) larger than the expected real interest rate (2%)

Frictional Unemployment

Short-term unemployment arising from the process of matching workers with jobs Key words: search & Qualified Cause - Normal labor market turnover businesses contracting and expanding, - people entering and exiting the labor force - creating the search process of Matching workers with jobs Advice to find job - Encourage to search, try not to be discouraged even if it means moving

CPI - Interpreting Value

The CPI is the cost of the market basket in a specific year as a percentage of the cost of the same market basket in the base year A CPI of 110 indicates that the cost of the market basket is 110% of the cost of the market basket in the base period. In other words, the cost increased from the base period by10% Examples July 2017 = up 114% 1963 = down 69.4%

Household Survey

U.S. Bureau of Census Current Population Survey of 60,000 household employment status of everyone older than 16

Job Creation & Job Destruction

U.S.economy creates & destroys millions of jobs every year. BLS numbers reported each month are net job changes, which greatly understate the gross number of jobs created 2012 - 29.1million created, 26.1million destroyed, net 2.3 million Creation & destruction of jobs results from changes in consumer taste, technological process, & success & failure of entrepreneurs in responding to these changes.

Government Policies Effect the Natural Rate of Unemployment

Unemployment Insurance Payments - allows time to search for a good job match - automatic stabilizer for economy - as long as one is looking for a job in the past 4 weeks Aid Worker Retraining - Trade Adjustment Assistance Program Minimum Wage Laws (Federal, $7.25/hour) - Applies to _______ Heads of Households - _________ Teenage Unemployment - ___________ Effect on Overall Unemployment Rate

Structural Unemployment

Unemployment arising from a persistent mismatch between the skills & attributes of workers & the requirements of jobs Key words: mismatch, could be long term Causes - structural changes in the economy like technological changes and international competition between skill of workers and the jobs prerequisite Advice to find a job - retrain or move

Cyclical Unemployment

Unemployment caused by a business cycle recession Key words: Decrease in total number of jobs Causes - recession causes firms' sales to drop causing laying off of workers Advice to find a job - attempt to move, stick it out

CPI - Substitution Bias

Using a fixed market basket, the CPI assumes that consumers do not buy less of a good whose relative price rises & more of a good whose relative price falls.

Unemployment Rate Measurement Problems

Why Bureau of Labor (BLS) measure understates true degree of unemployment --- Discouraged workers --- Involuntary Part-time Why BLS measure overstates true degree of unemployment --- Claim unemployed to draw gov't payments --- Jobs in informal sector

Briefly explain whether you agree or disagree with the following statement: "I don't believe the government price statistics. The CPI for 2010 was 218, but I know that the inflation rate couldn't have been as high as 118 percent in 2010."

You would need the 2009 CPI as a base year to do the equation in order to determine the inflation rate

Suppose you borrow $1,000 at an interest rate of 5%. If the expected real interest rate is 2%, then the rate of inflation over the upcoming year that would be most beneficial to you would be a rate of inflation a) equal to 2%. b) greater than 3%. c) equal to 0%. d) equal to 3%.

b) greater than 3%. 5 - 2 = 3

The advice to "keep searching, there are jobs here for which you are qualified" best fits which of the following types of unemployment? a) core unemployment b) cyclical unemployment c) frictional unemployment d) structural unemployment

c) frictional unemployment

If cyclical unemployment is eliminated in the economy, then ... a) the unemployment rate is below the natural rate of unemployment. b) the unemployment rate is above the natural rate of unemployment. c) the economy is at less than full employment. d) the economy is considered to be a full employment.

d) the economy is considered to be a full employment.

CPI - Market basket

representative group of goods & services (211 different types) purchased by the typical urban family of four. Bureau of Labor Statistics (BLS) surveys 14,000 households on spending habits. Each month, visits 23,000 stores in 87 cities to record prices of goods & services.