1. Why in microeconomics can we measure production in terms of quantity, but in macroeconomics we measure production in terms of market value?

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1 Study Plan Ch. 7: GDP: Measuring Total Production and Income 7.1 Gross Domestic Product Measures Total Production 1. Why in microeconomics can we measure production in terms of quantity, but in macroeconomics we measure production in terms of market value? All of the above: If, in macroeconomics, we measured production using quantities, we would add tons of wheat grown by U. S. farmers to the number of ipods produced by Apple, to gallons of milk, and so on. When we measure total production, we can t just add together the quantities of every good and service because the result would be meaningless. Measuring production using market value in dollar terms allows us to add together many different goods and services. Both A and C. 2. If the U.S. Bureau of Economic Analysis (BEA) added up the values of every good and service sold during the year, would the total be larger or smaller than measured gross domestic product (GDP)? Larger: The value of all goods and services sold would include intermediate goods. 3. In the circular flow of expenditure and income, why must the total value of production in an economy equal the total value of income? Every penny spent on a good or service must end up as someone s income. 4. Which equation represents the relationship between GDP and the four major expenditure components? Y=C+I+G+NX What are the four major components of expenditures in GDP? Consumption, investment, government purchases, and net exports. 5. What is the difference between the value of a firm s final product and the value added by the firm to the final product? The value of a firm s final product is the sale price; value added is the difference between the sale price and the price of intermediate goods. 6. Is the value of intermediate goods and services produced during the year included in Gross Domestic Product (GDP)? For example, is cotton used to produce a new shirt included in GDP?

2 Yes. The value of the cotton is not directly counted in GDP, but the production of cotton is included in the value-added method of measuring GDP. 7. Indicate whether each of the following transactions represents the purchase of a final good. The purchase of steel from a steel mill by an automobile manufacturer. Is no the purchase of a final good. The purchase of an aircraft carrier by the federal government. Is the purchase of a final good. The purchase of domestic wine by a French consumer. Is the purchase of a final good. The purchase of a new machine tool by the Ford Motor Company. Is the purchase of a final good. 8. Indicate whether you agree or disagree with the following statement: In years when people buy few shares of stock, investment will be low and, therefore, so will gross domestic product (GDP). Disagree: Investment as a component of GDP refers to the purchase of physical and human capital and inventory, not stock purchases. 9. Indicate which component of GDP will be affected by each of the following transactions involving the Ford Motor Company. You purchase a new Ford Escape Hybrid from a Ford dealer. Consumption Expenditure You purchase a 2008 (pre-owned) Ford Escape Hybrid from a friend. Not included in GDP calculation. Ford purchases door handles for the Escape from an auto parts manufacturer in Indiana. Not included in GDP calculation. Ford produces 1,000 Escapes in a factory in Missouri and ships them to a car dealer in Shanghai, China. Not Export Expenditure Ford purchases new machine tools to use in its Missouri Escape factory. Investment Expenditure The state of Missouri builds a new highway to help improve access to the Ford Escape plant. Government Expenditure 10. Suppose a house is built and sold in the year If the house is resold in the year 2011, is the value of the house included in Gross Domestic Product (GDP) for 2011?

3 No. GDP for 2011 includes only production that occurs during Would the services of a real estate agent who helped sell (or helped buy) the house be included in GDP for 2011? Yes. GDP for 2011 includes the market value of final goods and services. This includes real estate services. 11. An article in the Wall Street Journal observed: Plenty of companies, both in the U. S. and abroad, came to depend on U.S. consumers for their growth. They may have to peddle their wares elsewhere. U.S. and foreign firms will need to depend less on U.S. consumers in the future because U.S. consumers are saving more and spending less. 12. Suppose that a simple economy produces only the following four goods and services: textbooks, hamburgers, shirts, and cotton. Further, assume that all of the cotton used in the production of shirts. Use the information in the following table to calculate Nominal Gross Domestic Product (NGDP) for Production and Price Statistics for 2011 The NGDP for the year 2011 is $7, For the total value of expenditures on final goods and services to equal the total value of income generated from producing those final goods and services, all the money that a business receives form the sale of its product must be paid out as income to the owners of the factors of production. How can a business make a profit if it pays out as income all the money it receives? Profit is the income that remains after a firm has paid wages, rent, and interest. 14. Review the following events: 1. A farmer sells $200 worth of wheat to an agricultural products distributor. 2. The distributor trims, packages, and sells the wheat to a stateowned bakery for $ The state-owned bkaery uses all of the wheat to make bread and then sells it for $250. If, for simplicity, we ignore the value of inputs used to grow the wheat-such as seeds, labor, and fertilizer, then the farmer s value added is $200. (Enter your response as an integer and include a minus sign if necessary.) The value added for the distributor is $100.

4 The value added for the state-owned bakery is $-50. Would a state-owned firm that adds a negative value added to its products operate differently than a free market firm that adds negative value added to its products? Yes. Under the circumstances, the private, free-market firm would quickly shut down, the state-owned could continue operating, ceteris paribus. 15. An artist buys scrap metal from a local steel mill as a raw material for her sculptures. Last year, she purchased $6,000 worth of scrap metal. With the steel she produced 10 authentic sculptures that she sold for $900 each to a local art dealer. The art dealer then sold all of the sculptures to art collectors for an average of $1,100 each. The total value added of the artist is $3,000. (Enter your response as an integer.) 7.2 Does GDP measure what we want it to measure? 1. How does the size of a country s GDP affect the quality of life of the country s people? Generally, the more goods and services people have, the better off they are. 2. GDP is an imperfect measure of economic well-being because it fails to measure what types of production? Household production and the underground economy. Even if GDP included these types of production, why would it still be an imperfect measure of economic well-being? All of the above: The value of leisure is not included in GDP. GDP is not adjusted for crime or other social problems. GDP is not adjusted for pollution and it does not account for unequal income distribution. 3. Which of the following are likely to increase the measured level of GDP and which are likely to reduce it? When the number of people working outside the home decreases, the measured level of GDP decreases. When there is a sharp increase in the crime rate, the measured level of GDP may increase or decrease. If higher tax rates cause more people to hide the income they earn, the measured GDP decreases. 4. Michael Burda of Humboldt University in Germany and Daniel Hamermesh of the University of Texas examined how workers in the United States who lost their jobs

5 between 2003 and 2006 spent their time. They discovered that during the period when they were unemployed, the reduction in the number of hours paid work was almost completely replaced by an increase in the number of hours spend on household production. Based on these findings, what can we predict about total production-whether or not that production is included in the calculation of GDP-in the economy when these workers became unemployed? If the workers had been paying other people to perform the household activities prior to unemployment, then total production will fall. 5. We often use real GDP per capita as a measure of a country s well-being. Review the definition of real GDP per capita before answering the following questions. Today, the typical American works fewer than 40 hours per week. In 1890, the typical American worked 60 hours per week. Would the difference between the real GDP per capita in 1890 and the real GDP per capita today understate or overstate the difference in the population s economic well-being? The increase in real GDP per capita between 1890 and today understates wellbeing because the value of leisure is not included in GDP. 6. A report of the World Bank, an international organization devoted to increasing economic growth in developing countries, includes the following statement: Informal economic activities pose a particular measurement problem [in calculating GDP], especially in developing countries, where much economic activity may go unrecorded. What does the World Bank mean by informal economic activities? In many developing countries, informal economic activities refer to activities in the underground economy. Why do these activities make it harder to measure GDP and, as a result, the standard of living? If a large portion of an economy s production is done in the underground economy, measured GDP will underestimate production and economic well-being. 7. Each year, the United Nations publishes the Human Development Report, which provides information on the standard of living in nearly every country in the world. The report includes data on real GDP per capita and also contains a broader measure of the standard of living called the Human Development Index (HDI). The HDI combines data on real GDP per capita with data on life expectancy at birth, adult literacy, and school enrollment. The table below shows values for real GDP per capita and the HDI for several countries. 1) Rank each country from highest real GDP per capita to lowest real GDP per capita (1 for highest, 2 for next highest, etc.). 2) Next, rank each country from

6 highest HDI to lowest HDI. Why are there differences between the two lists? All of the above: The value of leisure is not included in GDP. GDP is not adjusted for crime or other social problems. GDP does not account for income distribution. GDP is not adjusted for pollution or other negative effects of production. 8. Think about the increase in spending for the Department of Homeland Security and the wars in Afghanistan and Iraq. These all represent government expenditures that have increased GDP yet the typical person might not necessarily be better off as a result. Why? All of the above: GDP is not adjusted for pollution or other negative effects of production. The value of leisure is not included in GDP. GDP is not adjusted for crime or other social problems. GDP does not account for income distribution. 7.3 Real GDP versus Nominal GDP 1. Why does inflation make nominal GDP a poor measure of the increase in total production from one year to the next? When nominal GDP increase from year to year, the increase is due partly to changes in prices and partly to changes in quantities. How does real GDP deal with the problem inflation causes with nominal GDP?

7 All of the above: Real GDP uses the prices of goods and services in the base year to calculate the value of goods in all other years. Real GDP separates prices changes from quantity changes. By keeping prices constant, we know that changes in real GDP represent changes in the quantity of output produced. 2. How is the GDP deflator calculated? 3. Suppose the information in the following table is for a simple economy that produces only the following four goods: textbooks, hamburgers, shirts, and cotton. Further, assume that all of the cotton is used to produce shirts. If the base year is the year 2005, then real GDP for 2010 equals $ (round your answer to the nearest penny). and the real GDP for 2011 equals $ (round your answer to the nearest penny). What is the (annual) growth rate of real GDP in 2011? 5.82% (enter your response as a percentage rounded to two decimal places). 4. Assuming that inflation has occurred over time, what is the relatioinship between nominal GDP and real GDP in each of the following situations? In years after the base year, nominal GDP is greater than real GDP. In the base year, nominal GDP is equal to real GDP. In years prior to the base year, nominal GDP is less than real GDP. 5. Indicate whether you agree or disagree with the following statements. Whenever real GDP declines, nominal GDP must also decline. Disagree. Real GDP falls if output falls. Nominal GDP can increase if output fall and prices rise. If a recession is so severe that the price level declines, then we know that both real GDP and nominal GDP must decline.

8 Agree. If both output and prices are falling, then both real GDP and nominal GDP will fall. 6. Use the data in the following table to calculate the GDP deflator for each year (values are in billions of dollars, enter your response rounded to 1 decimal place remember to multiply by 100). Which year from 1998 to 2001 saw the largest percentage increase in the price level, as measured by changes in the GDP deflator? 2001 (enter a 4-digit year: 1998, 1999, 2000, or 2001.) 7.4 Other Measures of Total Production and Total Income 1. U.S. Gross National Product (GNP) differs from U.S. Gross Domestic Product (GDP) in which of the following ways? (Mark all that apply.) GNP considers production that occurs outside the U.S. GNP is the value of final goods and services produced by residents of the U.S. In the United States, the difference between GNP and GDP is smaller than that of many other countries. 2. Consider the following table: National income (NI) equals $11,680 billion. (Enter your response as an integer.) Personal income (PI) equals $11,180 billion. Disposable personal income (DPI) equals $9,930 billion. 3. In the U.S., gross domestic product (GDP) and gross national product (GNP) are close in value. Under what circumstances would GNP be much longer than GDP?

9 All of the above would push GNP above GDP: Few foreign firms maintain facilities in the U.S. while many U.S. firms are currently opeating abroad. Many U.S. citizens currently work in foreign countries while few foreign citizens currently work in the U.S. Few foreign citizens currently work in the U.S. and foreign firms maintain facilities in the U.S. 4. Suppose the amount the federal government collects in personal income taxes decreases, while the level of GDP remains the same. What will happen to the values of national income, personal income, and disposable personal income? National income will remain the same. Personal income will remain the same. Disposable personal income will increase. 5. If you were attempting to forecast the level of consumer spending by households, which measure of total production or total income might be most helpful in making your forecast? Disposable personal income 6. Indicate whether the following statement is correct or incorrect. Corporate profits are much too high: most corporations make profits equal to 50 percent of the price of the products they sell. Incorrect: The largest component of gross domestic income is wages, which are about three times as large as profit. 7. N: Economics in the News 1. Is This Another Great Depression? A depression is defined as a severe recession. But what constitutes severe? Since the Great Depression of the 1930s we have had shortlived and relatively shallow downturns in economic activity. But many forecasters and pundits are throwing the term depression around this time. While economic conditions do appear to be dire they are not yet of the same magnitude as the Great Depression.

10 GDP fell 27 percent bewteen 1929 and IN the current downturn we are only down 2.5 to 3 percent. The stock market lost 90 percent of its value in the Great Depression and we are only down 35 to 40 percent now. One thired of all banks vailed in the Great Depression. And, while the current bank failures are large, they are numbered in the dozens. By any metric we are not in a depression. However, the period leading up to the Great Depression has some similarities that are alarming. A period of prosperity in the 1920s led to asset price bubbles and a faltering banking system. However, the current belief is that we learend from our policy mistakes of the 1930s. The Fed has been aggressive in addressing the liquidity crisis. In addition the government appears to be near additional massive fiscal stimulus. Only time will tell whether we have better tools today to keep this downturn classified as a recession. Analyzing the News. Where are we on the business cycle? Unfortunately we won t know until later. Did the aggressive monetary and fiscal stimulus work? I ll let you know in a few years but until then we will all be speculating. Was it enough? Was it too much? Will it get better or worse? It apperas we have not been able to prevent downturns nor predict their magnitude. Economic interventino is still more art than science. Thinking Critically Questions. What is the business cycle? A period of economic growth followed by decline. HIstoricaly business cycles range from 3 to 15 years long. Why are we concerned about this particular decline? The current rapid deterioration as shown by corporate profitablity failing and layoffs has many wroried we may continue to spiral down. What is the opint of the fiscal and monetary stimulus?

11 To stop the downward trend and revers it, riscal policy will be designed to get consumers spending again and working again. The monetary stimulus is desgined to shore up banks and enable them to lend money again. 2. Made in the USA Still Means Something. The news media paints a dire picture of U.S. manufacturing. We often hear that most goods are now manufactured overseas using cheaper sources of labor and more modern facilities. While this may be true for many goods the U.S. is still the world s leading manufacturer. However, the mix of goods has changed signifcantly. Instead of dress shirts, microwave ovesn, and boom boxes we now produce chemicals and aircraft. We have shifted production to high-value fields such as medical technologies where we manufacture more than half of the $174 billion of these products purchased annually worldwide. The focus on the jobs lost in manufacturing often overshadows the job gains due to visibility. Many of the more common consumer goods such as clothing are now made outside the U.S. In contrast optimists point out that the U.S. focuses on high value capital goods as Ricardo s comparative advantage predicts. Analyzing the News. Much has been written about the U.S. falling behind in manufacturing. However, it depends on what metric you use to evaluate manufacturing. While we may have lost jobs in this sector it appears that dollars of products produced have increased significantly. According to this metric the U.S. still leads the world in manufacturing. Thinking Critically Questions. Why have we lost some manufacturing jobs? Many labor-intesnive items are much less costly to produce overseas where labor is much less expensive than in the U.S. Why does the U.S. continue to manufacture high-end products? Only A and B: Job-related training is more readily availble in the U.S. than in many foreign countries. Many of these products require a more educated work force. 3. April Retail Sales Fall, Raising Recovery Doubts. Retail Sales were down for the second straight month and would have been substantially lower without the increase in auto sales. Many analysts believe the data points to a more prolonged recession and now believe that second quarter consumption numbers will show a decline. Businesses were hopeful that the stimulus package would begin to entice consumers to spend again. However, with the unemployment rate at 8.9 percent there are many that no longer have an income to spend. The news cast a damper on the stock market and pushed stocks lower overall. While most retailers saw sales fall, the nation s largest retailer Wal-Mart Stores Inc., posted gains of 5 percent. Consumers are flocking to the discount retail giant and shunning high-end stores. Furniture, appliances, and electronics all continue to suffer as consumers postpone those purchases. Analyzing the News. Consumers appear to be continuing their tightfisted ways. Keep in mind that many consumers have lost their jobs, have high levels of debt, or both. Other consumers are saving just in case they find themselves out of work. This recession may be more drawn out than originally

12 forecasted because of these factors. Why is consumer spending critical to recovering from the recession? Consumer spending is by far the largest component of the economy. Consumption typically represents about 70 percent of the GDP. How could the release of falling retail sales impact the length of the recession? Consumers may use this information as additional evidence the recession is lingering and curtail spending even more. Besides consumption, what are the other major components of the gross domestic product? (select all that apply) Net Exports, Business Investment, Government spending. 4. Economy Seems to be stuck in Neutral. National numbers indicate that the economy has moved into a recovery phase, yet many states and metropolitan areas continue to suffer. While the economic free-fall has stopped, the pace of recovery is agonizingly slow. Unemployment remains high and consumers continue to pinch pennies. The anemic recovery has been driven by the government sector and some business inventory rebuilding. The housing market continues to struggle in many regions, but it is picking up slightly in 17 states versus this time last year. About one-third of metro areas are showing signs of economic life, while the remaning two-thirds are still in contraction phase. Those regions still in decline are at least doing so at a moderate pace. The primary challenge for every region remains job creation so that consumers will have the wherewithal to aid the recovery. Analyzing the News. Many economists are predicting unemployment will remain high for several years.

13 The primary reason is that consumers, who represent about 70 percent of our economy, are still not spending. The reliance on consumer ddebt and home equity fueled the previous ten years of consumer spending, and now the party is over. Job loss, declining home values and tighter credit standards all lessen the liklihood of a strong consumer spending rebound for years. Thinking Critically Questions. Which of the following accurately describes the behavior of home values, credit, and consumption over the last decade? Home values were rising, credit was easy, and many homeowners extracted equity from their home sto finance consumption. Even with the economy revocering, there is evidence that firms are reluctant to hire. Which of the following may explain this? Some firms have learened to get by with fewer employees. Which of the following correctlyl defines double dip recession? a situation in which an economy in recession recovers to seom degree but then experiences another downward trend. 5. Housing Real-Estate Recovery Signaled as Fed Unwinds. Economists belive that the housing market has recovered enough to continue growing even after the expiration of the home buyer tax credits and the Fed s withdrawal from the mortgage market. The consensus estimate is that new home sales will contribute around 25 basis points of the expected 3.6 percentage growth. Some are even forecasting a rate increase by the Fed as early as June. The stock market appears to share optimism, with home builder stocks at a five month high on the expectation of new housing starts. Job groth, much of it from the government sector, appears to be the primary drive of the optimism with a little boost from lower home prices. Oddly, home builders do not seem to share this positive sentiment. Most builders view conditions as poor, and prospective buyer traffic also fell to a one-year low. In spite of these negative indicators, many economists maintain that easier credit and the new Senate bill extending unemployment benefits are both positive signs and that the economy is well on the way to recover. Time will tell who is right. Analyzing the News. It s not usually economists who are optimists in any group of people. However, this appears to be the case now, according to the article. Is the recovery strong enough to withstand a gradual withdrawal by the Fed and the expiration of tax credits? We should know in a few months, but there is room for skepticism, given the persistent pessimism of builders and the drop in buyer traffic. Thinking Criticallly Questions. What is the current state of home buyer traffic, and how does this influence the housing market? It is currently low, and home buyer traffic affects the demand for housing. Economists often place special emphasis on the sentiments of home builders, because they deal with the housing market rather intensivelly. Which is true

14 about the information available to home builders and the side of the housing market about which this information gives them insight? Their knowledge of credit conditions and lenders gives them insight into the supply side of the housing market, while their current inventory gives them insight into the demand side of the market. Why might the Fed want to pull out of the mortgage-backed securities market and increase interest rates once the receovery has fully taken root? What type of monetary policy would this be? The Fed would do so to avoid excessive inflation; this would be contractionary monetary policy. 6. U.S. Orders Ex-Transportation Jump by Most Since 07. March durable goods orders, minus transportation, increased by the largest amount since December The 2.8 perecent increase was also four times the consensus forecast of.7 of a percent expected by economists. Analytsts touted the results as evidence that the recovery was gaining strength. Durable goods are those goods expected to last at least three years and are often postponed purchases when economic uncertainty reigns. Last month s increase was particularly good news since the orders included a broad cross section of industries. Computers, machinery, electrical equipment and metals all posted gains. Non-defense industry capital goods were up 4 percent, providing further evidence that the recovery is not soley driven by government spending. Analyzing the News. Durable goods orders are considered a good barometer of economic health since they are often postponable purchases. For example, a consumer may elect to postpone the purchase of a new washer and dryer as long as the old units are still functioning when the economic outlook is uncertain. However, when times are good there is a higher probability of making the purchase even when the old units still have some useful life. Consumers and businesses appear to be finally willing to spend some money. Thinking Critically Questions. Which of the following correctly describes and gives an example of durable good? Durable goods last more than three years; one example is a car. Which of the following is an example of a non-durable good? Fuel Which of the following is most likely to be true about durable and non-durable goods? Non-durable goods purahses are less likely than durable goods to be postponed because of recession.

15 7. Orders for U.S. Durable Goods Likely Climbed, Boosting Growth. U.S. durable goods orders appear to be leading the economic recovery, according to some economists. Bookings for durable goods, those products expected to last more than three years, increased by two percent. Conversely housing sales continue to hover near a record low. Improving sales overseas for companies like Boeing and Intel are pushing profits higher as businesses renew spending on machinery and software. The transportation category was the biggest gainer, with Boeing alone booking orders for 117 aircraft in the past month. The company raised its profit forecast accordingly. Other durable goods saw improvement as well, mobbing up by 0.5 percent. While the Fed expects a less vigorous recovery than desired, the durable goods numbers were a welcome improvement. Analyzing the News. Economic recovery must be driven by something other than government spending. That s why this data on increased business investments is a very positive sign for the economy. Businesses will likely have to add employees to fill orders if the trend continues. Thinking Critically Questions. Which of the following equations would get you the correct figure for an open economy in terms of spending (aggregate demand)? Assume that any government spending does not include spending on transfer payments, so you to not need to consider these in your answer. Consumption + Investment + Government Spending + Exports Imports When businesses start buying durable investment goods after a recession, economists take this as a very positive sign. Which of the following helps explain this? Businesses tend to postpone these purchases as long as possible. Which of the following industries experienced the most growth as described in the article? Transportation 8. Economy in U.S. Grew 1.8% in First Quarter, Less Than Forecast. The U.S. economy posted first quarter growth of only 1.8 percent annualized. According to the article, the primary culprit was a reduction in government spending which fell by the most since Most economists expected a growth rate of about 2.0 percent for the first quarter. The news prompted the Federal Reserve to reiterate that it intends to complete the remainder of the current $600 billion in monetary stimulus. Some experts had speculated the Fed might end the program early due to strength in the economy. However, jobless claims also rose and consumer confidence fell due to higher gas and food prices. In addition, the Fed pared back its forecast of 2011 GDP growth to 3.1 percent. Federal government spending fell by 5.2 percent annually and residential construction was also down by 4.1 percent. Both of these sectors contributed to the lower overall growth but were partially offset by inventory buildups and increases in software and equipment spending. Analyzing the News. The U.S. economy is growing but not fast enough. Higher growth rates will be necessary in order to spur domestic hiring. While some experts are optimistic growth will pick up later in the year, it will be dampened by the

16 higher cost of food and fuel. Consumer budgets are being stretched to pay for increases in food and energy, which reduces their ability to buy other goods and services. Thinking Critically Questions. What is the definition of real gross domestic product or real GDP? The inflation-adjusted market value of all final goods and services produced domestically during a period of time. How is real GDP used to determine the strength of the economy? An increase in the growth rate of real GDP indicates an increase in the level of economic activity. What does the 1.8 percent increase indicate to policymakers? Most policymakers nod analysts would like to see growth exceed 3 percent in order to create the jobs necessary to significantly reduce U.S. unemployment rates. 9. Trade Deficit in U.S. Probably Little Changed in May From Four-Month Low. Most economies expect the trade deficit to remain stable for some time and, in fact, the May 2011 deficit of $44.1 billion was little different from the $43.7 billion trade deficit posted in April While the U.S. continues to import more than it exports, the current weak dollar helped to make U.S. goods more attractive to foreign buyers. In addition, growing economies overseas may keep bolstering demand for American-made goods. The U.S. economy expanded at an annual rate of 1.9 percent for the first quarter of the year according to Commerce Department data. However, the dollar is currently down 9.5 percent over the past 12 months against a market basket of currencies and should continue to contribute to export growth and add a few basis points to overall economic growth. Imports are also lower as U.S. consumers continue to remain tightfisted with their money. Analyzing the News. The U.S. economy remains mired in stagnant growth mode and the current budget battle in Washington DC leaves litter room for fiscal policy action. For now, the Fed remains the primary source of policy designed to stimulate the economy. The falling dollar may be one of the few bright spots in the overall economic recovery. Thinking Critically Questions. How can a weaker dollar help the U.S. economy? U.S. exports become cheaper to the rest of the world. How can a weaker dollar harm U.S. consumers? Imports to the U.S. become more expensive. What is a possible reason for the weaker dollar? Huge national debt. Ch. 8: Unemployment and Inflation

17 8.1 Measuring the Unemployment Rate and the Labor Force Participation Rate 1. The unemployment rate is calculated as follows: Consider the following chocies. Which oen is not accurate? Black teenagers as a group have lower unemployment rates than white teenagers. 2. The labor force particpation rate is calculated by Use the Graph to the right ot help determine which of the following statements regarding the labor force participation rates of adult men and women since 1950 is false.

18 The labor force participation rates of adult men and adult women were equal in Which of the following depicts an accurate description of the household survey and the establishment survey? The household survey interviews households and measures the unemployment rate whereas the establishment survey interviews businesses and measures the employment rate. Many economists prefer The establishment survey because it is determined by actual payroll records than unverified answers. 4. Fill in the missing values in the table of data collected in the household survey for the year 2009 (enter all values rounded to one decimal place). 5. A firm may lay off a substantial number of workers because of A business cycle recession during which the firm cuts back its production in response to a fall in demand for its products. 6. Currently, the Bureau of Labor Statistics does not inlcude homemakers in its employment and labor force totals. What would happen to the unemployment rate and the labor force participation rate if homemakers were included in these numbers? The unemployment rate would decrease and the labor force participation rate would increase. 7. Complete the table below. (Enter your responde rounded to one deciaml place.)

19 Note: The sum of employed and unemployed may not equal the labor force due to rounding. How is it possible for both the number of employed AND the unemployment rate to decline? A and B: A decrease in the labor force. An increase in discouraged workers. 8. During the recession, employment declined sharply in the construction, manufacturing, and financial services sectors. Suppose that employment in these sectors becomse a permanently smaller fraction of total employment in the United States. Thish shift will increase the average unemployment rate of male workers relative to female workers. Would it make a difference if you are considering the situation 2 years from now or 15 years from now? It will make a difference if there is a shift in the proportions of mena dn women in industries that are currently disproportionately male or female. 9. Between December 2001 and January 2002, the total number of people employed and the unemployment rate both fell. How is this possible? It is possible if labor force participation rates also fall. 10. In an article in the New York Times in 2009 on the signs of a potential recovery from the recession, the author makes the following statement: And whenever the economy begins growing again, it won t feel good for a while. The unemployment rate may continue to rise into 2010-and not come down to a healthy level until even later. Why would the unemployment rate continue to rise if the economy has begun to grow again? As firms expand, discouraged workers may enter the labor force but not immediately find jobs. 11. An article published in the Wall Street Journal in December of 2008 remarks that, Employers eliminated nearly two million jobs this year, and no relief is in sight. Is two million likely to be an accurate estimate of the number of jobs eliminated in the United States in 2008-or any other year? No. The U.S. economy creates and destroys millions of jobs every year, so the creation of new jobs offsets many of the jobs eliminated in the economy.

20 12. Real-Time Data Analysis Exercise Click the following link to view unemployment data form FRED*. *Real-time data provided by Federal Reserve Economic Data (FRED), Federal Reserve Bank of Saint Louis. The data in the table below shows employment data for August 01, Using the link above, correctly identify the title for each series listed in the table below. Using FRED, the series above are reported monthly, and the values are in thousands of persons. Use the data in the table above to calculate two different unemployment rates. (Round your responses to two decimal places. The civilian unemployment rate is 9.09 perecent. The civilian unemployment rate including persons who are underemployed (part-time for economic reasons) is percent. 8.2 Types of Unemployment 1. Which of the following accurately describes the relationship between fictional unemployment and job search? People are said to be frictionally unemployed when they are between jobs and searching for new jobs. 2. The natural rate of unemployment is not equal to zero because It is the sum of structural unemployment and frictional unemployment. 3. Macroeconomics conditions affect the decisions firms and families make. After graduation, a college student might enter the job market during an economic expansion but apply for graduate school during a recession because The probability of finding a job is higher during economic expansion and lower during recession. 4. A person who is in between jobs but actively engaged in a job search is considered to be frictionally unemployed.

21 Experts in hand-drawn animation who remain unemployed due to the film industry s switch to computer-generated animation are considered to be structurally unemployed. When a company reduces production and employment during economic recession, those employees who lose their jobs are generally considered to be cyclically unemployed. 5. Recall the definitions of normal and inferior goods. During a recession, a person would prefer to work in an industry that produces An inferior good because the demand for inferior goods should increase with decreases in income during a recession. During an economic expansion, a person would prefer to work in an industry that produces A normal good because the demand for normal goods should increase with increases in income during economic expansion. 6. If Congress eliminated the unemployment insurance system, The level of frictional unemployment would decrease. If Congress eliminated the unemployment insurance system, The level of real GDP will increase as frictionally unemployed individuals will take less time to find jobs. The elimination of unemployment insurance Will reduce the workers incomes and their consumption spending and thus will lower economic well-being. 8.3 Explaining Unemployment 1. Government unemployment insurance tends to Increase the unemployment rate by lowering the opportunity cost of job search. 2. Consider the effect of each of the following on the unemployment rate: The minimum wage law Has only a small effect on the unemployment rate since only a small part of the labor force earns the minimum wage. The effect of labor unions on overall unemployment is small since only a small percentage of the labor force outside the government is unionized.

22 An efficiency wage Increases the unemployment rate since firms pay a higher-than-market wage that increases the quantity of labor supplied. 3. In 2007, Segolene Royal, who was running unsuccessfully for president of France, proposed that workers who lost their jobs would receive unemployment payments equal to 90 percent of their previous wages during the first year of unemployment. If this proposal were enacted, the unemployment rate in France Would have gone up as the opportunity cost of job search would have decreased. 4. Discuss the likely impact of the following event on the unemployment rate. If more companies make information on job openings easily available on Internet job sites, then the unemployment rate will decrease. 5. The government set the minimum wage at $0.25 per hour in This wage was Higher than the equilibrium wage since minimum wages are biding price floors and are usually set above the equilibrium wage rate. 6. An economic consultant studies the labor policies of a firm where it is difficult to monitor workers and recommends an increase in wages. At a meeting of the firm s managers to discuss the report, one manager makes the following argument: I think the wages we are paying are fine. As long as enough people are willing to work here at the wages we are currently paying, why should we raise them? If the firm s managers do not currently face a worker shortage, the consultant should pursue the following argument to justify the wage hike: Efficiency wages are designed to increase worker productivity. 7. If Wal-Mart adopted Costco s compensation policies, the number of workers employed by Wal-Mart Will decrease as efficiency wages always create unemployment when cyclical unemployment is zero. If Wal-Mart adopted Costco s compensation policies, consumers would be Worse off as Wal-Mart increases their prices to pay for the higher wage cost. 8.4 Measuring Inflation 1. Which of the following is not a measure of the price level?

23 Government Price Index: an average of the prices paid by the government for goods and services used only by different government agencies. The most frequently used measure of the price level is: Consumer Price Index. 2. Which of the following is not considered one of the potential biases in calculating the consumer price index? Coverage bias Which of the following steps has not been taken by the Bureau of Labor Statistics (BLS) to reduce the size of the biases in the CPI? The BLS has expanded the number of store from which it collects the price information to reduce the coverage bias. 3. If the Consumer Price Index (CPI) for the year 2008 is 205, does that mean that (the annual rate of) inflation in 2008 was 105%? No. The inflation rate is the percentage increase in the price level from the previous year, not the base year. 4. The following is from an article in the Wall Street Journal: Apple Inc. refreshed its line of Macintosh desktop computers The new models generally offer more features and computing power for the same price as previous models. If Apples new computers offer more features and computing power for the same price as previous modes, how will the consumer price index (CPI) be affected? The CPI does not change. 5. Consider the simple economy that produced only three products. Use the information in the following table to calculate the (annual rate of) inflation for 2010 as measured by the consumer price index (CPI). What is the inflation rate for 2010 as measured by the consumer price index (CPI)? 2.53%. (Enter your response rounded to two decimal places.) 6. The Standard and Poor s?case-shiller Home Price Index is one of the leading indicators of housing price trends in the United States. The base year for the index is January

24 2000. The following table lists index numbers for December 2007 and December 2008 for five cities. Calculate the percentage changes in the price indices during for the following cities (enter all values as percentages rounded to one decimal place and include a minus sign if necessary): most during this year in Phoenix. The rpices of luxury homes changed the Can you determine on the basis of these numbers which city had the most expensive luxury homes in December 2008? It is not possible to determine this with the information provided. 7. Real-Time Data Analysis Exercise. Click the following link to view CPI data from FRED*. Then use that data to answer the following questions. Using the data from FRED, answer the following questions. The series Id for these CPI data is CPIAUCSL. This is monthly data that has been seasonally adjusted. From the FRED website, click on the View Data link to find the values to enter below. The CPI for August of 2010 (shown as in FRED) was The CPI for August of 2011 (shown as in FRED) was (Enter the values exactly as they appear in FRED.) 8. Real-Time Data Analysis Exercise. Click the following like to view the CPI data from FRED*. Then use that data to answer the following questions. This exercise requires you to download data from FRED in an Excel format, and then perform calculations using Excel or some other compatible spreadsheet program such as Openoffice. It is important to follow the instructions carefully. Step 1 Click on the FRED link above. Clicking the link will take you the Consumer Price Index for All Urban Consumers: All Items (CPIAUCSL)

25 page. Step 2 Click on the download data link on that page. From the download data page, change the beginning date to You can leave the ending date as it is. Then click on the download button to download the data and save it on your computer. Finally, open the Excel file. Step 3 Using Excel, calculate the percentage change in CPI from a year ago for each of the observation, beginning with To do so, click on the blank cell next to the observation corresponding to the date , and then enter the following formula: Step 4 Repeat step 3 for the remaining observations. Step 5 Using Excel, create a time series graph of the percentage change from ayear ago. Then, using the spreadsheet, answer the following questions. Looking at the data for March, 2008 (shown as in FRED) to the present, the highest inflation rate, over this period, was 5.53 perecent, which occurred on (Round your numerical response to two decimal places. Enter the data using t he following form: M-YYYY, e.g ) 9. Real-Time Data Analysis Exercise. Click anywehre on the graph to the right. In the diaglog box that appears, select Inflation (CPI) for Y axis1 and Inflation excluding food and energy (CPI) for Y axis2. Then click the plot button. Click the close button to dismiss the dialog box. Click the magnifying glass in the upper right-hand corner of the graph to enlarge the

26 graph. Click the following graph icon to view data that can help you complete the following. By June 2009 inflation, according to the blue line, reached a negative 1.9 percent, while the inflation measured by the red line was approximately 1.75 percent. Which of the following, if true, best explains the data?

27 A significant decrease in the global demand for oil, caused the price of oil to fall, which is reflected on the inflation rate measured using CPI data. 8.5 Using Price Indexes to Adjust for the Effects of Inflation 1. The difference between a nominal variable and a real variable is that 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. 2. Which one of the following choices shows how data on nominal wages for 2002 to 2009 and data on the consumer price index for the same years can be used to calculate the real wage for these years? 3. IN 1924, the famous novelist F. Scott Fitzgerald wrote an article for the Saturday Evening Post titled How to live on $36,000 a Year, in which he wondered how he an d his wife managed to spend all of that very high income without saving any of it. IN 1924, the consumer price index (CPI) was 17, and the CPI in 2008 was 215. The income you would have needed in 2008 to have had the same purchasing that Fitzgerald s $36,000 had in 1924 is $ (Enter your response rounded to the nearest dollar.) 4. Use the information in the following table to determine the percentage changes in the U.S. and French real minimum wages btween 1957 and Calculate the percentage change in U.S. real minimum wages between 1957 and 2008: %. (Enter your response as a percentage rounded to two decimal places). Calculate the precentage chagne in French real minimum wages between 1957 and 2008: %. Based on the above calculations, we can conclude that Although nominal minimum wages increased in the U.S., real minimum wages fell during this period. 5. The Great Depression was the worst economic disaster in U.S. history in terms of declines in real GDP and increases in the unemployment rate. Use the data in the following table to calculate the percentage decline in real GDP between 1929 and 1933.

28 Real GDP changed by -27.2% over the 4 year period between 1929 and (Enter a percentage value rounded to one decimal place. Include a minus sign if necessary.) 6. The following table show the top 10 films of all time through 2008, measured by box office receipts in the United States, as well as several other films farther down the list. The CPI in 2008 was 215. Use this information and the data in the table to calculate the box office receipts for each film in 2008 dollars. Assume that each film generated all of its box office receipts during the year it was released. Use your film results to prepare a new list of the films based on their earnings in 2008 dollars. (Some of the films, such as the first Star Wars film, Gone with the Wind, and Snow White and the Seven Dwarfs, were re-released several times, so their recepits were actually earned during several different years, but we will ignore that comlication.) Choose the move that earned the most in real terms: