EVERY MACROECONOMIC WORD YOU EVER HEARD: GROSS DOMESTIC PRODUCT, INFLATION, UNEMPLOYMENT, RECESSION, AND DEPRESSION

________________________________________________________________________

CHAPTER OUTLINEMeasuring the EconomyReal Gross Domestic Product and Why It Is Not Synonymous with Social WelfareMeasuring and Describing UnemploymentBusiness CyclesKick It Up a Notch: National Income and Product AccountingSummary

LEARNING OBJECTIVESLO1: Define the basic vocabulary of macroeconomics.

LO2: Describe how the economy is measured.

LO3: Describe how gross domestic product, our national measure of output, is calculated.

LO4: Calculate inflation using a price index.

LO5: Describe real gross domestic product as the inflation-adjusted value of economic activity and judge its use as the measure of the economy’s health.

LO6: Describe how unemployment is measured and enumerate the types of unemployment that economists recognize.

LO7: Define and apply the vocabulary of the business cycle.

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KEY TERMSMicroeconomics- the part of the discipline of economics that deals with individual markets and firms.

Macroeconomics- the part of the discipline of economics that deals with the economy as a whole.

Gross domestic product (GDP) - the dollar value of all of the goods and services produced for final sale in the United States in a year.

Market basket- goods that average people buy and they quantities they buy them in.

Base year- year to which all other prices are compared.

Price of the market basket in the base year- National average of the total cost of the market basket.

Price index- a device that centers the price of the market basket around 100.

Consumer price index (CPI) - the price index based on what average consumers buy.

Inflation rate- the percentage increase in the consumer price index.

Cost-of-living adjustment (COLA) - a device that compensates people for the fact that changes in inflation change the spending power of their income.

Chain-based index- a price index based on an annually adjusted market basket.

GDP deflator (GDPDEF) - the price index used to adjust GDP for inflation, including all goods rather than a market basket.

Real gross domestic product (RGDP) – an inflation-adjusted measure of GDP.

Work force- all those nonmilitary personnel who are over 16 and are employed or are unemployed and actively seeking employment.

Unemployment rate- the percentage of people in the work force who do not have jobs and are actively seeking them.

Underemployment- the state of working significantly below skill level or working fewer hours than desired.

Discouraged-worker effect- bad news induces people to stop looking for work, causing the unemployment rate to fall.

Encouraged-worker effect- good news induces people to start looking for work, causing the unemployment rate to rise (until they succeed in finding work).

Cyclical unemployment- state that exists when people lose their jobs because of a temporary downturn in the economy.

Seasonal unemployment- state that exists when people lose their jobs predictably every year at the same time.

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Every Macroeconomic Word You Have Ever Heard

Structural unemployment- state that exists when people lose their jobs because of a change in the economy that makes their particular skill obsolete.

Frictional unemployment- short-term unemployment during a transition to an equal or better job.

Business cycle- regular pattern of ups and downs in the economy.

Trough- the lowest point in the business cycle.

Recovery- the part of the growth period of the business cycle from the trough to the previous peak.

Expansion- the part of the growth period of the business cycle from the previous peak to the new peak.

Peak- the highest point in the business cycle.

Recession- the declining period of at least two consecutive quarters in the business cycle.

Depression- severe recession typically resulting in a financial panic and bank closures, unemployment rates exceeding 20 percent, prolonged retrenchment in RGDP on the magnitude of 10 percent or more, and significant deflation.

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PROBLEMS

1. A country has the following labor statistics:

_______________________________________________________________________________

Military Personnel ……………………………………………………………. 1.5 millionPopulation under 16 years old who are working part time …………………… 0.3 millionPopulation over 16 years old who are working part time …………………….. 4.2 millionPopulation over 16 years old who are working full time ……………………... 14.3 millionThose without jobs and who are actively seeking jobs ……………………….. 1.5 million

_______________________________________________________________________________

Calculate the following:

a. the workforce _________________________________________________________________________

________________________________________________________________________________________

b. the unemployment rate

________________________________________________________________________________________

2. The data for the average annual tuition are listed in the table on the next page.

a. Use the tuition cost in 1990–91 of $3,016 as your base year cost. Estimate a price index for undergraduate tuition costs at American institutions of higher education.

b. How have tuition costs changed between 1990–91 and 2005–2006?

c. How have tuition costs changed since 1976–77?

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Every Macroeconomic Word You Have Ever Heard

AVERAGE ANNUAL UNDERGRADUATE TUITIONPAID BY FULL-TIME-EQUIVALENT STUDENTS IN U.S. DEGREE-GRANTING

INSTITUTIONS

Selected Years 1980-81 to 2007–2008

Year Tuition and Required Fees (in-State)

Tuition and FeePrice Index

at All Institutions 1990–91 = 100

1980–81 1,289 ____________1982–83 1,626 ____________1984–85 1,985 ____________1986–87 2,312 ____________1988–89 2,658 ____________1990–91 3,016 ____________1992–93 3,517 ____________1994–95 4,044 ____________

1996–97 4,564 ____________1997–98 4,755 ____________1998–99 5,013 ____________1999–00 5,238 ____________2000–01 5,377 ____________2001–02 5,646 ____________2002–03 6,002 ____________2003–04 6,608 ____________2004-05 7,122 ____________2005-06 7,601 ____________2006-07 8,092 ____________2007-08 8,505 ____________

Note: Data are average charges paid by students for the entire academic year. Tuition and fees were weighted by the number of full-time-equivalent undergraduates.The data have not been adjusted for changes in the purchasing power of the dollar over time.

Source: Table 331, U.S. Department of Education, National Center for Education Statistics, http://nces.ed.gov/programs/digest/d08/tables/dt08_331.asp.

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3. During the 1970s, there were two oil crises. As the price of energy increased, production and transportation costs increased throughout the United States. The higher costs were passed onto the consumers in higher consumer prices. The CPI data from the 1970s and early 1980s are listed in the table below. Calculate the inflation rates for this turbulent time in our economic history.

CONSUMER PRICE INDEXAll Urban Consumers

Base Year: 1982–1984 =100CPI Inflation

Year At End of Year Rate

1971 41.1 3.3%

1972 42.5 ____________

1973 46.2 ____________

1974 51.9 ____________

1975 55.5 ____________

1976 58.2 ____________

1977 62.1 ____________

1978 67.7 ____________

1979 76.7 ____________

1980 86.3 ____________

1981 94.0 ____________

1982 97.6 ____________

1983 101.3 ____________

Source: Consumer Price Index, All Urban Consumers (CPI-U), U.S. City Average, All Items,1982–84 = 100, Bureau of Labor Statistics, U.S. Department of Labor, (ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt).

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Every Macroeconomic Word You Have Ever Heard

4. Answer the following based on the following data:

____________________________________________________________________________________ Year Nominal GDP GDP Deflator Real GDP

1 $4,500 billion 100 _______ 2 4,950 105 _______ 3 5,260 108 _______ 4 5,390 112 ___________________________________________________________________________________________

a. What is the base year? __________________________________________________________________

b. Explain. _____________________________________________________________________________

c. Calculate real GDP for years one through four.

d. In what year did real GDP decline?________________________________________________________

5. Name the two techniques that the BLS uses to correct for some of the problems that the CPI has in measuring the true rate of inflation.

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Chapter 6

SELF TEST --- MULTIPLE-CHOICE QUESTIONS

1. The cost of a market basket was $200 in the base year of 1990, and the cost of the same market basket was $350 in the year 2001. The price index for the year 2001 equals

a. 350.b. 175.c. 57.d. 700.

2. As the post-war period following World War II began, the CPI rose from 18.2 at the end of 1945 to 21.5 at the end of 1946. (Base year: Average 1982–1984 = 100) Estimate the inflation rate in 1946.

a. 1.53%b. 15.3%c. 1.81%d. 18.1%

3. In the midst of the Great Depression, the CPI fell from 14.6 at the end of 1931 to 13.1 at the end of 1932. (Base year: Average 1982–1984 = 100) Estimate the deflation rate in 1932.

a. -1.15%b. -11.5%c. -10.3%d. -1.03%

4. The CPI is considered by many to overstate the cost of living and the inflation rate. Which of the following is not considered a reason for this problem?

a. The CPI market basket changes frequently and immediately includes new products.b. Over time when products are cheaper elsewhere, people change where they buy them.c. Quality changes as older products disappear, and better quality goods replace them.d. Product substitutions take place following price changes.

5. Select the correct formula for estimating Real GDP. a. Real GDP = (GDP GDPDEF) 100b. Real GDP = (GDP/ GDPDEF) 100c. Real GDP = (GDP + GDPDEF) 100d. Real GDP = (GDP GDPDEF) / 100

6. The Real GDP does not completely measure the value of all the goods and services which are produced and consumed in the United States. Which of the following is not considered a reason for this problem?

a. Illegal workb. Government spending on educationc. Unpaid work done at home d. Work that is “off the books,” for which the income goes unreported

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Every Macroeconomic Word You Have Ever Heard

7. In the first quarter of 1982, the nominal GDP (at an annual level) was $3,193.8 billion and the GDP Implicit Price Deflator was 64.99 (1996 = 100). Estimate the Real GDP in 1996 constant dollars.

a. $2075.7 billionb. $3258.8 billionc. $2034.9 billiond. $4,914.3 billion

8. In the first quarter of 1971, the nominal GDP (at an annual level) was $1,099.9 billion and the Real GDP in constant 1996 dollars was $3,666.1 billion. Use the relationship between the Real GDP, nominal GDP, and the GDP Deflator to estimate the GDP Implicit Price Deflator (1996 = 100).

a. 70.00b. 333.31c. 30.00d. 33.33

9. Assume that the price level increases at the same time that the economy goes into recession, and the actual level of output declines. Given this information, we know that

a. the GDP Price Deflator will rise, the Real GDP will fall, and the nominal GDP may or may not increase.

b. the GDP Price Deflator will rise, the Real GDP will fall, and the nominal GDP will definitely fall. c. the GDP Price Deflator will rise, the Real GDP will fall, and the nominal GDP will definitely

increase.d. the GDP Price Deflator will rise, the Real GDP will rise, and the nominal GDP will definitely

fall.

10. The Real GDP is not considered a perfect measure of social welfare in the United States. Which of the following is not considered a reason for this problem?

a. The Real GDP ignores the composition of the output, and it gives equal weight to spending on military equipment and to spending on health and education.

b. The Real GDP ignores the quality of the environment, which is often affected by production.c. The Real GDP ignores the value of leisure.d. The Real GDP ignores production outside the geographic boundaries of the United States.

11. Which of the following is not a reason why depressions are less likely to occur in the modern economies of the twenty-first century?

a. Governments have policies to alter interest rates.b. Governments have safety nets in the form of unemployment insurance.c. Governments can increase their regulation of industry.d. Governments have spending policies.

12. Carol is 15 years of age and works in her father’s firm 15 hours a week. Carol is considered to bea. underemployed.b. part of the workforce.c. subject to the encouraged worker effect.d. not part of the workforce.

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13. All of the following are part of the workforce, except a. military workers.b. civilian workers who are 50 years of age and who are employed.c. civilian workers who are 25 years of age and who are unemployed.d. civilian workers who are over 16 years of age and who are actively seeking employment.

14. All of the following are reasons that the consumer price index can estimate inflation inaccurately, except a. the market basket changes frequently.b. quality improvements in electronics are not captured.c. people have significantly changed the places in which they buy goods.d. it assumes that people buy the same amount of everything, regardless of price and do not look for

substitutes.

15. All of the following are flaws in measuring the unemployment rate, except that a. it counts as unemployed those people who are (correctly or incorrectly) encouraged by positive

economic news to look for work before there really is any work.b. it fails to recognize the plight of workers who are working significantly below their skill level.c. it only counts people who are over 16 years of age. d. it does not count as unemployed any people who are so discouraged that they stop looking for

work.

16. James lost his job at his plant when robots were engaged to do the manufacturing. He is currently unemployed and will have to learn a new trade. James can be considered

a. seasonally unemployed.b. structurally unemployed.c. frictionally unemployed.d. cyclically unemployed.

17. People who are unemployed for a short time in the transition to an equal or better job are said to be a. seasonally unemployed.b. structurally unemployed.c. frictionally unemployed.d. cyclically unemployed.

18. Which of the following is not a phase in the business cycle? a. unemploymentb. peakc. troughd. recession

19. All of the following are characteristics of a recession, except a. a moderation in the inflation rate.b. a strong increase in the employment level.c. a declining period of at least two consecutive quarters in the business cycle.d. a reduction in real gross domestic product in the range of 2% to 3 %.

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Every Macroeconomic Word You Have Ever Heard

20. Which is not considered a characteristic of a depression?a. A severe recession usually characterized by financial panic and bank closures.b. Unemployment rates exceeding 20%.c. Prolonged retrenchment in real GDP of 10% or more.d. Significant inflation.

21. Which of the following is a chain-based price index that adjusts for the substitution problem?a. CPIb. Core CPIc. PCE deflatord. PPI

22. What does the traditional CPI include that the Core CPI excludes?a. Substitution effectsb. New goodsc. Tuition and textbooksd. Food and energy

23. Which Federal agency determines the beginning and ending dates of recessions?a. Federal Reserve Bankb. Business Cycle Dating Committeec. Bureau of Labor Statisticsd. Recession Dating Committee

24. When did the worst recession (excluding the 2007-2009 recession), since World War II occur?a. 2000-2001b. 1990c. 1981-1982d. 1972-1974

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Chapter 6

SELF TEST --- TRUE / FALSE QUESTIONS

T F 1. Microeconomics is the part of the discipline of economics that deals with national issues and the economy as a whole.

T F 2. The CPI is thought to be a very accurate measure of the cost of living and inflation.

T F 3. The Real GDP has been adjusted for inflation.

T F 4. If the price level increases, and the output level stays the same, the nominal GDP will increase, but the Real GDP will remain the same.

T F 5. The expenditure approach to the GDP measures the GDP by tallying all the income earned from the production.

T F 6. The discouraged worker effect, which induces people to stop looking for work because of bad economic news, can cause the unemployment rate to rise.

T F 7. Tom has a degree in nursing and is employed as a nurse’s aid. Tom can be considered underemployed.

T F 8. Chain-based versions of the CPI reestablish the market basket every year; so new goods enter the market basket much more quickly.

T F 9. The unemployment rate is the percentage of the people in the total economy that do not have jobs and are actively seeking them.

T F 10. Efforts to solve the inaccuracies of the CPI still leave large errors, so that over 30 years, tax brackets and CPI-adjusted benefits will be over adjusted by 27 percent.

T F 11. The Core CPI is the CPI with the impact of food and energy costs removed.

T F 12. The PPI is the PCE deflator minus the Core CPI.

T F 13.The expenditure approach is the only approach to calculating GDP.

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Every Macroeconomic Word You Have Ever Heard

ANSWERS TO STUDY QUESTIONS

PROBLEMS

1 a. The workforce: those over 16 and working part time ……….…………………… 4.2 millionthose over 16 and working full time ……………………………. 14.3 millionthose without jobs and actively seeking jobs……………………. 1.5 millionTotal Workforce 20.0 million

b. The unemployment rate is the percentage of people in the workforce that do not have jobs but are actively seeking employment. The unemployment rate = (1.5 million/ 20.0 million) 100 = 7.5 %

2. a. The data for the price index are listed on the table on the next page.b. The index of 252.02 for 2005–2006 indicates that between the 2005–2006 academic year and the base year

of 1990–91, tuition costs have increased by 152.02%.c. Tuition costs in 2005–2006 are over 8.2 times the 1976–77 level, since $7601/ $924 = 8.23 and

252.02/ 30.64 = 8.23. During this time period, tuition costs increased by 722.52%, since the percentage change in tuition equals [(7601 - 924)/ 924] 100 = 722.52%.

3. The inflation rate data are reported in the table on page 80. Note the high “double-digit” rates of inflation in 1974, 1979, and 1980.

_________________________________________________________________________________ 4. Year Nominal GDP GDP Deflator Real GDP Calculation Real GDP

1 $4,500 bil. 100 ($4,500/100) ∙ 100 = $4,500.00 bil. 2 4,950 105 (4,950/105) ∙ 100 = 4,714.29 3 5,260 108 (5,260/108) ∙ 100 = 4,870.37 4 5,390 112 (5,390/112) ∙ 100 = 4,812.50_______________________________________________________________________________________________________________

a. Year 1b. Year 1 is the base year, because the price index (the GDP Deflator) is equal to 100.c. See results listed in the table above.d. Real GDP in year 3 was $4,870.37 billion and in year 4, Real GDP declined to $4,812.5 billion.

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Chapter 6

AVERAGE ANNUAL UNDERGRADUATE TUITIONPAID BY FULL-TIME-EQUIVALENT STUDENTS IN U.S. DEGREE-GRANTING

INSTITUTIONSSelected Years 1976-77 to 2005-06

Year Tuition and Required Fees (in-State)

Tuition and FeePrice Index

at All Institutions 1990–91 = 100

1976–77 $924 30.641978–79 1,073 35.581980–81 1,289 42.741982–83 1,626 53.911984–85 1,985 65.821986–87 2,312 76.661988–89 2,658 88.131990–91 3,016 100.001992–93 3,517 116.611994–95 4,044 134.08

1996–97 4,564 151.331997–98 4,755 157.661998–99 5,013 166.211999–00 5,238 173.672000–01 5,377 178.282001–02 5,646 187.202002–03 6,002 199.012003–04 6,608 218.072004-05 7,122 234.582005-06 7,601 252.022006-07 8,092 268.302007-08 8,505 281.00

The data have not been adjusted for changes in the purchasing power of the dollar over time.

Source: Table 330, U.S. Department of Education, National Center for Education Statistics, http://nces.ed.gov/programs/digest/d08/tables/dt08_331.asp.

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Every Macroeconomic Word You Have Ever Heard

CONSUMER PRICE INDEXAll Urban Consumers

Base Year: 1982–1984 = 100CPI Inflation

Year At End of Year Rate

1971 41.1 3.3%1972 42.5 3.41973 46.2 8.71974 51.9 12.31975 55.5 6.91976 58.2 4.91977 62.1 6.71978 67.7 9.01979 76.7 13.31980 86.3 12.51981 94.0 8.91982 97.6 3.81983 101.3 3.8

Source: Consumer Price Index, All Urban Consumers (CPI-U), U.S. City Average, All Items,1982-84 = 100, Bureau of Labor Statistics, U.S. Department of Labor, (ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt).

5. a. The BLS constructs a hedonic price for goods whose quality changes rapidly, such as electronics, in order to adjust the observed price for changes in the quality of the good.b. The BLS reestablishes the contests of the market basket every two years rather than every ten years, producing a chain-based index.

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Chapter 6

MULTIPLE-CHOICE QUESTIONS

1. B 6. B 11. C 16. B 21. B2. D 7. D 12. D 17. C 22. D3. C 8. C 13. A 18. A 23. B4. A 9. A 14. A 19. B 24. C5. B 10. D 15. C 20. D

TRUE / FALSE QUESTIONS

1. F 6. F 11. T2. F 7. T 12. F3. T 8. T 13. F4. T 9. F5. F 10. T

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