Study Questions Circular Flow Model Definitions Consumption Expenditures - a measure of price changes in consumer goods and services.

. Personal consumption expenditures consist of the actual and imputed expenditures of households; it is essentially a measure of goods and services targeted toward individuals and consumed by individuals. Investment the purchase of final goods by businesses that are used in the production of other goods plus the purchase of new homes by individuals. Private saving the income that households have left after paying for taxes and consumption. Public saving the tax revenue that the government has left after paying for its spending. !ational "aving public savings plus private savings !et #axes taxes minus transfer payments; the net flow of cash from household to government !et Exports the value of exports minus the value of imports Lists #he three uses of income by households private savings$ tax payments$ and consumption expenditures. #he four sectors in the complete circular flow model households$ firms$ government$ and rest of the world. #he four types of expenditures in the complete circular flow model government spending$ investment$ net exports$ consumer. Visual Representation %raw a two sector circular flow model a four sector circular flow model

Househol ds

Firms

Househol ds

Go v.

R.O.W .

Firms

Explanations Why are expenditures and income equal to each other? &hen one receives income$ they either spend it or save it. #he firms do not hold onto any of the money in the economy since all things are owned by the household. #hus$ if money is spent on something in the economy$ that money serves as income for someone else$ not as savings by a firm. #hus$ expenditure always e'uals income. If net taxes increase, must government spending increase? Why or Why not? !ot necessarily; government has two options when net taxes are positive either uses it for expenditure or public savings. #hus$ if net taxes were to increase$ government can either spend the money (expenditure) or use it towards public savings. Study Questions Price Level Definitions Price *evel the change of prices in general Price Index an index allows one to measure changes in a numerical series. + price index shows how prices$ in general$ change from a reference year. Inflation a sustained increase in the general level of prices. %eflation a sustained decrease in the general level of prices. !ominal Price a price expressed in current dollars. ,elative (,eal) Price the relative price of a good is its nominal price ad-usted for changes in the general level of prices. Consumer Price Index (CPI) #he CPI is a type of price index. It measures the change in prices for goods and services fre'uently bought by households. It is reported monthly by the ." government/s 0ureau of *abor "tatistics. Core Consumer Price Index the section of the CPI that measures all items less food and energy; provides a better depiction of the CPI from a consumer point of view. Chained 1%P Price Index measures the value of new stuff produced in economy. Lists #hree price indices 2 #he gross domestic product (1%P) chain-type price indexes measure changes in the ..". economy !nflation

2 #he consumer price index (CPI) measures price changes in consumer purchases 2 #he producer price index (PPI) measures changes in the selling price of material goods #hree differences between the CPI and the chained 1%P price index #he CPI measures only increases in the price of goods paid by consumers. #he CPI includes also goods produced abroad but the 1%P deflator does not. In the CPI the bas3et is held constant in the 1%P deflator is not.

#hree costs of inflation 4) menu (use of resources in one area vs. another; change prices$ ta3es resources to change price of things)$ 5) shoe leather (the time effort put into one thing vs. another; could be doing something more productive)$ 6) brac3et creep (prices set by the government in nominal terms; changing the terms ta3es a lot of effort; doesn/t change$ so behavior changes since real price changes). Calculations

I,78 9 :CPI7;-78 < CPI7; 9 (54=.>6? 54>.676) < 54>.676 9 -.776>@ I,47 9 :CPI78-47 < CPI78 9 .74@= I,44 9 :CPI47-44 < CPI47 9 .764@

PrelativeA48;7 9 !P48;7 < CPI48;7 x (CPI48;5-;=) 9 (4.5=> < ;5.=) x (477) 9 B4.>4 PrelativeA4887 9 B7.;8 PrelativeA5777 9 B7.;; PrelativeA5747 9 B4.5;

I,5747 9 CD(E(P5F5) x E(P5F4)) < (E(P4F4) x E(P4F5))G 9 4.764? I,5747 9 4.74@6 PI78 9 8@.5=; PI47 9 477; PI44 9 474.6=

Explanations When would it be more appropriate to use the CPI for all items and when would it be appropriate to use the CPI for all items less food and energy? It is better to use the CPI for all items when evaluating income or household ability to buy. #his is because households re'uire all items for daily life (usually). If one wanted to evaluate the economy$ one would use the core CPI. #his is because the core CPI measures items that tend to not fluctuate as much (e.g. gas and agricultural products)$ and thus gives a less deviated depiction of the economy as a whole. Explain why a general decline in the purchasing power of income is not a cost of inflation 1eneral decline in purchasing power of income doesn/t leave economy$ changes in distribution; not a cost of inflation since no currency leaves the economy and thus economy as a whole does not lose income. Data *oo3 at #able + in the most recent consumer price index news release (there is a lin3 to this news release on the Hy1ateway site for this course). &hat is the inflation rate for all items for the 45 months ending %ecember 5744I " # &hat is the inflation rate for all items less food and energy for the 45 months ending %ecember 5744I $%$ # (Jou may want to print out a copy of the data table from the Hy1ateway site for this course and add these numbers to this table.) Examine the graph of the inflation rate based on the CPI for all items (there is a lin3 to this graph on the Hy1ateway site for this course). &ould you consider the current inflation rate to be high$ moderate$ or low compared to inflation rates since 48=;I Moderate &hen was the inflation rate highI &hat were the approximate inflation rates during these time periodsI !id"#ate $%&'s ( %)* Early"!id $%+'s ( %)* ,-oughly. $%/' ( 0)* !id $%/'s ( $') 1this inflation fluctuated between +) and $+) through the early 2's3* Early $%%'s ( + +)* ,roughly. 4''2 ( +)

Study Questions &ross Do'estic Product Definitions 1ross %omestic Product #he mar3et value of all final goods and services produced in an economy during a given period. !ominal 1ross %omestic Product - + gross domestic product (1%P) figure that has not been ad-usted for inflation. +lso 3nown as current dollar 1%P or chained dollar 1%P. +ny 1%P figure that does not account for inflation can be misleading because 1%P will appear higher than it actually is. ,eal 1ross %omestic Product ,eal 1%P is calculated by ad-usting nominal 1%P by changes in price level. Lists *ist the = ma-or expenditure categories of 1%P. &hich is the largestI
Consumption expenditures$ Investment expenditures$ 1overnment expenditures$ !et exports;

consumption expenditures (roughly ?4K of all 1%P). &hich of the following items would be included in measuring the ..". 1%P for 5778I + household/s purchase of a new domestic car. o + household/s purchase of a new imported car. o + household/s purchase of a used domestic car. + firmLs purchase of new Hicrosoft word processing software. o + firmLs purchase of 57 reams of paper for their printers. o #he value of teaching services produced by a public school teacher measured using their salary. o #he value of painting services when a homeowner paints a room in their house. #he value of painting services when a homeowner hires a painter to paint a room in their house.

!1%P5778 9 EP78F78 9 4$75>$777 !1%P5747 9 4$7;=$>77 !1%P5744 9 4$46;$777 1,5747 9 CD(E(P47F47) x E(P78F47)) < (E(P78F78) x E(P47F78))G 9 4.75>@ 1,5744 9 4.765> ,1%P5778 9 !1%P47 < 1,5747 9 4$7>?$=67 ,1%P5747 9 4$7;=$>77 ,1%P5744 9 !1%P47 x 1,5747 9 4$455$5@7

,1%P7= 9 !1%P7> < 1,7> 9 =$64>$55>$;7@.=> ,1%P7= 9 !1%P7> 9 46$6??$577$777 ,1%P7= 9 !1%P7> x 1,7>-7@ 9 44$@>4$478$@??.=4

Explanations Explain the difference between nominal 56P and real 56P !ominal 1%P is the sum value of all produced goods and services at current prices #his is the 1%P that is explained in the sections above. !ominal 1%P is more useful than real 1%P when comparing sheer output$ rather than the value of output$ over time. ,eal 1%P is the sum value of all produced goods and services at constant prices #he prices used in the computation of real 1%P are gleaned from a specified base year. 0y 3eeping the prices constant in the computation of real 1%P$ it is possible to compare the economic growth from one year to the next in terms of production of goods and services rather than the mar3et value of these goods and services. In this way$ real 1%P frees year-to-year comparisons of output from the effects of changes in the price level. Explain why real 56P in preferred when comparing 56P across time
!ominal 1%P uses current prices and thus may over-or under-state true changes in output. ,eal 1%P ta3es into account the inflation rate and thus is more accurate at recording the actual increase in production activities. ,eal 1%P is a better measure of economic well-being. 0ecause ,eal 1%P is not affected by changes in prices$ changes in real 1%P reflects only changes in the amount being produced.

Data &hat is the average growth rate of real 1%P since &orld &ar II (48=?). "%$ # *oo3 at the most recent gross domestic product news release (there is a lin3 to this news release on the Hy1ateway site for this course). &hat is the advance estimate of the seasonally ad-usted annualiMed growth rate of real 1%PI $%( # (Jou may want to add this number to the data table from the Hy1ateway site for this course.) .sing nominal 1%P for 5744 (available on #able 6 of the news release)$ what percentage of 1%P is consumption (personal consumption expenditures)I )*%+)# .sing nominal 1%P for 5744$ what percentage of 1%P is investment (gross private domestic investment)I *$%,(# .sing nominal 1%P for 5744$ what percentage of 1%P is government spending (government consumption expenditures and gross investment)I $+%+(# .sing nominal 1%P for 5744$ what percentage of 1%P is net exports (net exports of goods and services)I -"%("# Study Questions .ne'ploy'ent Definitions .nemployment ,ate measures the percent of the labor force that is not employed. *abor Norce Participation ,ate the percent of the wor3ing-age population (4@ years and older) in the labor force. Employment-Population ,atio the ratio of those individuals employed to the wor3ing-age populations. Nrictional .nemployment unemployment that occurs because individuals are constantly moving between -obs. "tructural .nemployment the type of unemployment that occurs due to a mismatch between wor3ers/ s3ills and those demanded by employers. Cyclical .nemployment the rise and fall of the unemployment rate that occurs due to changes in business activity. !atural ,ate of .nemployment an estimate of what the unemployment rate would be if the economy were operating at its potential (on the PPN).

Potential Output<1%P (Null Employment Output<1%P) an estimate of what real 1%P would be if the economy were operating at full production (on the PPN). Lists *ist the 6 types of unemployment Nrictional$ "tructural$ and Cyclical. S/ort 0nswer Nor each of the following$ indicate the type of unemployment that best describes the situation + store cler3 loses their -ob in the !ew Orleans because the store was destroyed in the flooding following Purricane Qatrina. Cyclical, 7tructural + movie theatre wor3er loses their -ob due to decreased demand for movies because of a recession. Cyclical + movie theatre wor3er loses their -ob due to people substituting watching movies at home on %R%s for watching movies in theatres. Cyclical + sales person losses their -ob when the mall store where they wor3ed closes due to a change in consumers/ preferences. Cyclical

*N 9 4>6.@4@ million *Nc 9 ;@.775 million ., 9 8.;6K *NP, 9 @=.45K E-P-, 9 >;.6?K

Explanations Explain the natural rate of unemployment changes over time

Post-&orld &ar II historical data show that while the unemployment rate rises in recessions and falls during expansions$ it also has a significant noncyclical component that has varied over time$ rising in the late 48@7s and throughout the 48?7s and declining after the early 48;7s. Cyclical trends occur during the 87s up to the recession in 577;. #his caused a significant -ump in the rate; however$ the rate has recently steadily fallen from its pea3 of roughly 47K.

Data *oo3 at the most recent employment situation news release (there is a lin3 to this news release on the Hy1ateway site for this course). &hat is the seasonally ad-usted civilian unemployment rate for Sanuary 5745I (%" # (Jou may want to add this number to the data table from the Hy1ateway site for this course.) &hat is the seasonally ad-usted civilian labor force participation rate for Sanuary 5745I ,"%) # &hat is the seasonally ad-usted employment-population ratio for Sanuary 5745I 1(%1 # +ccording to what I said in class$ the natural rate of unemployment is currently in what rangeI #he natural rate of unemployment is in the 1%1-,%+# range; In the ..".$ some mainstream economists have placed the natural rate of unemployment in the 1# to ,# range$ though other economists have placed it as low as 2# and as /i3/ as )#. 8his variability and lac9 of precision in the natural rate of unemployment represents a source of uncertainty with which policy ma9ers must deal Is the current unemployment rate above$ near$ or below the current natural rate of unemploymentI 04ove Examine the graph of the civilian unemployment rate Nor the past two years$ has the unemployment rate been rising$ falling$ or staying about the sameI Fallin3 Examine the graph of the civilian labor force participation rate Nor the past 47 years$ has the labor force participation rate been rising$ falling$ or staying about the sameI Fallin3 Examine the graph of the civilian employment-population ratio Nor the past two years$ has the employment-population ratio been rising$ falling$ or staying about the sameI Stayin3 t/e sa'e