Final Review
Review
For Test 2
Introduction to Macroeconomics
Neetu Kaushik, Ph.D., M.B.A
Assistant Professor of Economics
At LaGuardia Community College, CUNY
Long Island City, New York
Chapter 11
Measuring the Cost of Living
Consumer Price Index: The Consumer Price Index is a measure of the cost of living. The CPI tracks the cost of the typical consumer’s “basket” of goods & services.
Problems in computing CPI: Unmeasured quality change, introduction of new goods, Substitution Bias.
Producer Price Index: The average change over time in the selling prices received by domestic producers for their output.
Imported consumer goods:
included in CPI
excluded from GDP deflato
Contrasting the CPI and GDP Deflato
The basket:
CPI uses fixed basket
GDP deflator uses basket of
cu
ently produced goods & services
Capital goods:
excluded from CPI
included in GDP deflator (if produced domestically)
0
3
3
Source: Cengage learning.
Co
ecting Variables for Inflation:
Real vs. Nominal Interest Rates
The nominal interest rate:
the interest rate not co
ected for inflation
the rate of growth in the dollar value of a
deposit or debt
The real interest rate:
co
ected for inflation
the rate of growth in the purchasing power of a deposit or debt
Real interest rate
= (nominal interest rate) – (inflation rate)
0
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Chapter 12
Production and Growth
Productivity : The amount of goods and services a worker produce in each hour of work.
How Productivity is determined? (Y/L)
Physical Capital per worker (K/L)
Human capital per worker (H/L)
Natural resources per worker (N/L)
Technological Knowledge (A)
The Production Function
A production function describes the relationship between the quantity of input used in production and the quantity of output from production.
The production function generally is written as:
Y = AF (L,K,H,N)
Where;
Y is output
L is quantity of labo
K is quantity of physical capital
H is quantity of human capital
N is quantity of natural resources
A is the available production technology and
F is a function that shows how inputs are combined to produce output.
Economic Growth and Public Policy
It is dependent on the following:
Saving and Investment
Diminishing Returns and the catch up effect
Investment from a
oad (FDI and FPI)
Education
Health and Nutrition
Property rights and political Stability
Free Trade
Research and Development
Population Growth
Chapter 15
Unemployment
Unemployment can be divided into two categories:
The economy’s natural rate of unemployment. It is the unemployment which the economy normally experiences.
Cyclical Unemployment: It is the year to year fluctuations in unemployment around its natural rate.
Note: Natural rate of unemployment is further causes by two reasons:
Frictional Unemployment
Structural Unemployment
How unemployment is measured?
It is measured by the data collected by BLS.
BLS surveys 60000 households every month.
BlS places each adult in to one of the three categories :
employed,
unemployed or
not in the labor force
Labor force = Number of employed + Number of unemployed
Unemployment Rate: The percentage of the labor force that is unemployed.
Unemployment Rate: Number of unemployed x 100
XXXXXXXXXXLabor force
Labor force Participation rate: The percentage of the adult population that is in the labor force.
LFPR = Labor Force x 100
Adult Population
Discouraged Workers: Individuals who would like to work but have given up looking for a job. Thus these individuals will not be a part of labor force.
Why are there always some people unemployed?
Because of :
Frictional Unemployment
Structural Unemployment
Notes:
Job Search: The process by which workers find appropriate jobs given the tastes and skills.
Why some frictional unemployment is inevitable?
Many reasons as some firms may close resulting in lay offs etc.
Public policy and job search
It is policies made to boost up the job search, employment opportunities, training etc.
Unemployment insurance: It is a government program that partially protects workers incomes when they become unemployed.
Minimum wage laws
Unions and collective bargaining
The theory of efficiency wages : It is the wage paid above equili
ium wage to increase workers productivity.
Chapter 16
The Monetary System
Functions of Money:
Medium of exchange,
Unit of account, and
Store of value
Types of Money:
Commodity Money
Fiat Money
Money Supply:
Cu
ency
Demand Deposits
Measures of Money Supply
M1
M2
In a fractional reserve banking system, banks create money when they make loans.
Bank reserves have a multiplier effect on the money supply.
Money multiplier: the amount of money the banking system generates with each dollar of reserves.
The money multiplier equals 1/R.
The Federal Reserve is the central bank of the U.S., is responsible for regulating the monetary system.
The Fed controls the money supply mainly through open-market operations, discount rate and reserve requirements.
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Chapter 17
The Money Growth and Inflation
Quantity Theory of Money. According to this theory, the price level depends on the quantity of money, and the inflation rate depends on the money growth rate.
The classical dichotomy :
is the division of variables
into real and nominal.
The neutrality of money is the idea that changes in the money supply affect nominal variables but not real ones.
Most economists believe these ideas describe the economy in the long run.
The inflation tax is the loss in the real value of people’s money holdings when the government causes inflation by printing money.
The Fisher effect is the one-for-one relation between changes in the inflation rate and changes in the nominal interest rate.
The costs of inflation include menu costs, shoeleather costs, confusion and inconvenience, distortions in relative prices and the allocation of resources, tax distortions, and a
itrary redistributions of wealth.
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Week 4 Discussion Board Answers
Question 1: In an economy a typical consumer purchases 4 notebooks and 5 pens. The price of these products is given in the table below for three years.
Yea
Price of Notebook
Price of Pen
2017
$4
$3
2018
$5
$3
2019
$6
$5
From the information given in the table above (assuming 2017 as the base year) calculate:
· CPI for 2017
· CPI for 2018
· CPI for 2019
· Inflation rate for 2018
· Inflation rate for 2019
Answer: Consumer Price Index (CPI) = (Cost of the basket cu
ent yea
cost of the basket base year) x 100
As per the formula to calculate CPI we must first calculate cost of the basket which is the product of price and quantity given in the fixed basket. Quantity is given above the table i.e., 4 notebooks and 5 pens. Note that here the quantity will NOT change no matter what the year is. Only the price changes depending on the year. This the reason we call it a fixed basket.
Cost of the basket 2017 = (4 notebooks x $ XXXXXXXXXXpens x $3) = $31
Cost of the basket 2018 = (4 notebooks x $ XXXXXXXXXXpens x $3) = $35
Cost of the basket 2019 = (4 notebooks x $ XXXXXXXXXXpens x $5) = $49
Now since we have cost of the basket information, we can plug this information in the CPI formula.
Again Consumer Price Index (CPI) = (Cost of the basket cu
ent yea
cost of the basket base year) x 100
Here base year is 2017 as given in the question. If the question is silent on base year then always take the first year as the base year.
CPI for 2017 = ($31/$31) x 100 = 100
CPI for 2018 = ($35/$31) x 100 = 112.90
CPI for 2019 = ($49/$31) x 100 = 158.06
Inflation rate = [(CPI for cu
ent yea
CPI for previous year)/CPI for previous year] x 100
Inflation rate 2018 = [ XXXXXXXXXX)/100] x 100 = 12.90%
Inflation rate 2019 = [ XXXXXXXXXX)/112.90] x 100 = 40%
Note: Make sure in the denominator of inflation rate formula you take the information of previous year NOT the base year. Base year is used in CPI formula.
Question 2: How much of the following items would be worth in today's dollars if today's CPI is 260?
· Popcorn that was sold for $7 in 2009 and the CPI in 2009 was 214
· A cup that was sold for $15 in 2015 and the CPI in 2015 was 237
Answer: To answer such questions, you can use the following formula and plug the numbers you have and find the missing value. Please note that question can ask you any value given in the formula so be careful while plugging.
Amount in today’s dollar = [Amount in year T x (CPI Today/CPI in year T)]
Note: Today is the most recent year and year T is the old year.
First part: Amount in today’s dollar = [Amount in year T x (CPI Today/CPI in year T)]
= [$7 x (260/214)] = $8.50
Second part: Using the same formula, plugging the information as given in the question.
= [15 x (260/237)] = $16.45
Question 3: Refer to the table below for an imaginary economy of Flowerland.
Year
Real GDP
Population
2015
60 million
45 million
2016
70 million
50 million
Based on the information given in the table calculate;
· Real GDP Per Person (or capita)
· Percentage increase in the real GDP per person over the time period given and analyze.
Answer: Real GDP Per Person = Real GDP/Population
2015 = 60 million/45 million = 1.33
2016 = 70 million/50 million = 1.4
Percentage Increase in Real GDP Per Person = [(Real GDP Per Person in Cu
ent Year / Real GDP Per Person in Previous Year)/ Real GDP Per Person in Previous Year)] x 100
= [(1.4 – 1.33)/1.33] x 100 = 5.26%
Question 4: In an imaginary economy of Cotton Land, 190,000 tons of cotton were produced in a day. The number of people who were involved in this production was 4500 and each of them worked for 8 hours. Further, there are 50 companies that employed these people in their processing plants. Calculate the productivity of this economy.
Answer: Productivity = Output / Number of Labor Hours
Note: It is important to take total labor hours not just number of labors. For that multiply the number of labors and numbers of hours each labor worked for. Ignore the number of companies as it is i
elevant to answer this question