Week 9 Tutorial Activity
ECON1246 / ECON1273Macroeconomics 1
Assessment 2 Part 2
MACROECONOMICS 1 (ECON1246 ECON1273)
Assessment 2 Part 2
This assignment covers the following topics:
· Inflation – Topic 5
· Labour Force and unemployment – Topic 6
· Foreign exchange rate market – Topic 7
READ THE FOLLOWING FIRST
· Explain your answers, but be succinct (
ief and relevant). Show all of your working in order to get partial credits.
· Show you CULCULATION under each question. To make sure you have a good understanding.
SECTION A
14 marks
The economy of Euphoria has the following economic data.
Yea
2015
2016
2017
Nominal Gross Domestic Product ($ billions)
470
485
545
Real Gross Domestic Product ($ billions)
470
480
505
% change in real Consumption spending
3.00
1.25
1.00
% change in real Investment spending
2.00
-10.00
5.00
Net exports ($ billions)
- 23,000
- 52,000
- 5,000
Unemployment rate (%)
5.3
5.8
6
Natural rate of unemployment
4.8
4.8
5.4
Index of production costs (2015 = 100)
100
105
107
Productivity index (2015 = 100)
100
101
103
Examine the data relating to the economy of Euphoria above and answer the following questions.
Q1
a. Calculate the real growth rate for 2016 and 2017 to two decimal places.
. Calculate the inflation rate for 2016 and 2017 to two decimal places.
c. What phase of the business cycle was the economy in 2016 and 2017? Briefly give two reasons for your answer.
XXXXXXXXXX = 4 marks)
Q2.
What was the likely cause of the change in the unemployment rate in 2017? What type of unemployment is likely to exist in Euphoria in 2017? Explain your answer.
(3 marks)
Q3. Identify and explain the likely cause of inflation in 2017?
(4 marks)
Q4.
Read the article ‘Venezuela Cuts to Fight Inflation (Zeros from Its Cu
ency. That Is)’
a. Identify and
iefly explain the two causes of hyperinflation in Venezuela.
. Illustrate these using the AD-AS diagram clearly showing the increase in the inflation rate.
(3 marks)
1
1
Assessment 2 Part 2Semester 2 2018
Slide 1
Vocational Business Education
Slide 1
Topic 5: Measurements of inflation
Textbook reading:
Chapter 8 pp203-212, pp XXXXXXXXXXCauses of inflation)
Measurements of Inflation
Learning Objectives:
Define inflation, inflation rate, price level and Consumer Price Index (CPI).
Calculate the inflation rate.
Name and
iefly explain the various ways of measuring inflation.
Explain the sources of bias in the CPI
Distinguish between the CPI & the GDP Deflato
Distinguish between nominal and real variables
Calculate the purchasing power of the dollar in different years.
Explain the difference between demand-pull & cost-push inflation
Vocational Business Education
Slide 2
Vocational Business Education
Slide 3
Inflation
Inflation: refers to a sustained increase in the general level of prices in the economy.
Deflation?
…a sustained decrease in price levels.
Price level: a measure of the average prices of goods and services in the economy.
Inflation rate: percentage increase in the price level (price index) from one year to the next.
3
3
Measurements of Inflation
At least 3 ways of measuring inflation:
1. Consumer Price Index (CPI). Measures the inflation rate on common household goods & services.
2. GDP Deflator. It is a
oad measure of the price level; it measures the change in prices of all goods and services that make up the GDP.
3. Producer Price Index (PPI). Measures the inflation rate on producer goods & services.
Vocational Business Education
Slide 4
- Producer Price Index won’t be examined in this course, it is purely mentioned for completeness sense.
- GDP deflator was examined in topic 2 Measurements of Gross Domestic Product
4
Vocational Business Education
Slide 5
Measurements of Inflation – Consumer Price Index
1. Consumer price index (CPI): A measure of changes in retail prices of a basket of goods and services representative of consumption expenditure by typical Australian households in capital cities.
The Market Basket: In Australia, the Australian Bureau of Statistics identifies:
A typical or representative Australian household.
The goods and services purchased by the household – this is the “market basket”.
The prices of goods and services in the market basket are given a weight according to their fraction of a ‘typical’ family budget.
The CPI measures the rate of change in the prices of the goods and services in the market basket.
Most widely used measure inflation
Often mistaken for the only measure of inflation.
What’s in the CPI’s basket?
Copyright©2004 South-Western
6
16th series CPI, June quarter 2011, weighted average of eight capital cities
Vocational Business Education
6
Figure 6.1: The CPI market basket.
Source: Australian Bureau of Statistics (2016), Consumer Price Index 16th Weighting Pattern, Cat. No XXXXXXXXXX, Table 1, Percentage contribution to all groups, CPI, June quarter, eight capital cities.
Goods and services in the CPI market basket are grouped into 11
oad categories. Almost half of the market basket falls into the categories of housing, transportation and food.
How the CPI is calculated
Computing the inflation rate: the inflation rate is the percentage change in the price index from the preceding period.
The inflation rate is calculated as follows:
Vocational Business Education
Slide 7
Vocational Business Education
Slide 8
Calculating the CPI – an example
Assume the consumer price index is based on the change in prices of a given basket of goods consisting only of 4 apples and 2 burgers.
Calculate 1. the cost of the basket for 2014, 2015 and 2016,
2. the CPI for each of the 3 years,
3. inflation rate for 2015 and 2016.
Fixed basket of 4 apples and 2 burgers
Year Price of apples Price of burgers
2014 $1 $5
2015 $1.50 $4.50
2016 $3 $4
Year Cost of basket
2014
2015
2016
Year Consumer price index (2014 is the base year)
2014 PI = cu
ent year cost / base year cost x 100.
2015
2016
8
8
9
Problems in measuring the cost of living
The CPI is an accurate measure of the selected goods that make up the typical bundle, but it is not a perfect measure of the cost of living.
Problems
substitution bias
introduction of new goods
unmeasured quality changes
The substitution bias, introduction of new goods, and unmeasured quality changes cause the CPI to overstate the true cost of living.
The issue is important because many government programs use the CPI to adjust for changes in the overall level of prices.
Vocational Business Education
Slide 9
10
Substitution bias
The basket does not change to reflect consumer reaction to changes in relative prices.
Fixed line vs mobile phones - Consumers substitute toward goods that have become relatively less expensive.
The index overstates the increase in cost of living by not considering consumer substitution.
Vocational Business Education
Slide 10
11
Introduction of new goods
The basket does not reflect the change in purchasing power
ought on by the introduction of new products.
New products result in greater variety, which in turn makes each dollar more valuable - Consumers need fewer dollars to maintain any given standard of living.
Unmeasured quality changes
A new DVD playe
If the quality of a good rises (falls) from
one year to the next, the value of a dollar rises (falls), even if the price of the good stays the same.
Vocational Business Education
Slide 11
12
ABS price indexes
In addition to the consumer price index for the overall economy, the ABS calculates several other price indexes.
GDP Deflator: Measures the change in prices of all goods and services that make up the GDP.
Calculated by dividing nominal GDP by real GDP and multiplying by 100:
Producer price index, which measures the cost of a basket of goods and services bought by firms rather than by consumers.
Vocational Business Education
Slide 12
The GDP deflator versus the CPI
First, the GDP deflator reflects the prices of all goods and services produced domestically, whereas ...
… the consumer price index reflects the prices of all goods and services bought by consumers.
The GDP deflator differs from the CPI because it includes goods and services produced rather than goods and services consumed.
Second, the consumer price index compares the price of a fixed basket of goods and services to the price of the basket in the base year...
… whereas the GDP deflator compares the price of cu
ently produced goods and services to the price of the same goods and services in the base year.
13
Vocational Business Education
13
Vocational Business Education
Slide 14
Measurements of Inflation - Comparison
GDP Deflator Consumer Price Index
All domestic goods and services; includes C, I G1, G2 and X Goods and services bought by consumers; only C & G1
Domestically produced goods and services; includes exports Domestically and internationally produced goods and services; includes imports
Variable quantity of goods and services Fixed quantity of goods and services
14
14
Uses of inflation
CPI is used widely in:
Comparing purchasing power of the dollar between periods, i.e. comparing the cost of supermarket shopping between years.
Deciding on the most profitable investment by using the real rate of interest and not the nominal interest rate.
Negotiating pay rises, i.e. nominal vs real wages. Based on the expected CPI for the next period, employers and employees negotiate pay rises.
Indexing pensions, i.e., Many pensions are indexed to the CPI so that pensions will increase according to the CPI.
Vocational Business Education
Slide 15
Purchasing power of dolla
Price indexes, such as the CPI, allow us to adjust for the effects of inflation so we can compare dollar values of time.
To change dollar values from one year to the next, we can use this formula:
Price indexes are used to co
ect for the effects of inflation when comparing dollar figures from different times.
Phar Lap (a famous horse) had winnings of $19,000 in XXXXXXXXXXHow much is it in 2016 dollars?
Vocational Business Education
Slide 16
17
Co
ecting economic variables / Comparing purchasing power of the dollar
Winnings in 2016 dollars = winnings in 1930 dollars × (price level in 2007/price level in 1930)
From the ABS statistics the CPI in 2016 was 194.4, and in 1930 it was 4.7
$19,000 × (194.4/4.7) = $785,872
Vocational Business Education
Slide 17
Interest represents a payment in the future for a transfer of money in the past.
The nominal interest rate is the interest rate usually reported and not co
ected for inflation. It is the interest rate that a bank pays.
The real interest rate is the nominal interest rate that is co
ected for the effects of inflation.
If the inflation rate is higher than expected, bo
owers may gain and lenders receive a lower real interest rate (on a fixed interest rate loan).
The real interest rate provides a better measure of the true cost