Chapter 8: 1.Market Basket & Price Index Human capital is the set of skills, knowledge, experience, and talent that determine the productivity of workers.
Real values of goods and services are determined by the economy. Nominal price changes, on the other hand, occur when the value Natural resources are production inputs that come from the earth.
of money changes. Market Basket a list of specific goods and services in fixed quantities(change over time/location) Technological improvements (A) are innovations that cause the same inputs to produce more outputs.
Price index is a measure showing how much the cost of a market basket has changed relative to the cost in a base time period or Accounting for growth the growth of a nation decomposes: gY = gA + α gK + (1 - α)gL
location. (base year index always be= 100) Consumer Price Index (CPI) is a measure that tracks changes in the cost of a basket of g = represents growth rates of a variable, measured in percentage change.
goods and services purchased by a typical U.S. household.
α = represents the share of GDP distributed to owners of capital. (0 < α < 1)
Consumer Price Index (CPI) Formula:
1 – α = represents the share of GDP distributed to laborers.
Cost of basket ∈target year gY =growth rate of output gA = growth rate of technology
CPI= ×100 gK = growth rate of capital gL = growth rate of labor
Cost of basket∈base year Convergence Theory (Catch-Up Eff.): Poor countries grow faster and eventually converge to the same growth rate as rich ones.
Savings & Population Growth: Differences in rates of savings and population growth do not prevent countries from converging.
Price indices transform nominal values into real values. Growth Rate vs. Income: Countries may converge in growth rates but not in income levels.
Inflation Rate Formula The inflation rate is the size of the change in the overall price level. Growth Pattern: Poor countries grow rapidly at first but slow as they converge with richer nations.
Inflation Rate = [(CPI Year 2 - CPI Year 1) / CPI Year 1] × 100 Investment in physical capital should increase productivity of workers.
Report inflation: 1)Headline inflation measures price changes for the entire market basket. CPI Less money for consumption: Investment means less spending on current consumption.
2)Core inflation measures price changes with food and energy costs removed. CORE CPI Investment trade-off: Reducing current consumption to fund capital investment for future production.
Producer price index (PPI) measures the prices of goods and services purchased by firms. Sources of Capital Investment: Savings come from domestic or foreign sources.
GDP deflator measures the prices of goods and services produced in the country. Domestic Savings: Funds for capital investment generated within a country.
Deflating nominal variables CPI (or another price index) can be used to deflate nominal values into real values. Compares Three Sources of Domestic Savings Households
purchasing power over time. Any nominal value in year X can be put into year Y value using: (spend less than they earn), corporations (retain profits), and governments (run surpluses).
CPI year Y Domestic savings = domestic income - consumption spending
New CPI
Developing nations tend to save more. - Developed nations tend to save less.
Real value year Y =Nominal value year X × Inflatacion adjustment =Older price × Foreign direct investment (FDI) is when a firm runs part of its operation abroad or invests in another company abroad.
CPI year X Old CPI
Government policy can shape economic growth in many ways.
Government spending: directly contribute to the economy.
Education and Health: high-quality public education to children and good health increases human capital and productivity.
Example: Suppose a worker made $4.25/hour in 1993. How much is this worth today if the CPI in 1993 was 142 and today it
Infrastructure and industrial policy: invest in infrastructure that companies rely on for operations. Governments can focus resources
is 251? Answer: $4.25 in 2016 prices = $4.25 × (251/142) = $7.51
on industries that contribute most to growth.
Indexing the practice of automatically increasing payments in proportion to the cost of living Technological development: improve the productivity of existing inputs.
Purchasing power parity (PPP) the theory that purchasing power in different countries should be the same when stated in a common
currency. Example :Compounding => Balance = $100 => Interest rate = 10%
Transaction costs: One reason that PPP doesn't hold is transaction costs, such as transportation: It costs money to move goods from Year 1 = $100(1 + 0.10 ) = $110 => Year 2 = $110(1 + 0.10 ) = $121 =>Year 3 = $121(1 + 0.10 ) = $132
place to place. Non-tradables: Some goods and services just can't be taken from place to place very easily, or at all. Example GDP growth rate 5% ? How much go take for double? $ 10000-----?-----$20000 => 70/5 =14
Trade restrictions: Finally, international trade isn't free. GDP year A => GDP year a = GDP year b *(1 + growth rate) ^ (year a – year b)
Purchasing power indexes (PPIs) help describe differences in prices across locations. Example => GDP growth rate = 3% => Current GDP =$5000 => After 5 years GDP = ?
Big Mac in different countries to estimate the fair exchange rate based on purchasing power parity (PPP). GDP future year = GDP current (1 + growth rate) ^ # of year =$5000(1 + 0.03)^5 =$5,796.37
U.S. Big Mac price (Dec 2022): $5.36. Mexico Big Mac price: 79 pesos Example of the final exam : GDP 2012 = $400 => GDP2015 =$ 430 => Growth rate?
PPP exchange rate (calculated): 79 pesos ÷ $5.36 = 14.74 pesos per USD GDP future = GDP current (1 + growth rate) ^ # of year = $430 =$ 400 (1 + growth rate)^3= 2.44% or 0.0244
The actual exchange rate on December 30, 2022, was 18.84 pesos per USD, meaning the peso was undervalued compared to
the PPP estimate. Big Mac Index calculation: 14.74−18..84×100 = −21.8%
This result suggests that the Mexican peso was 21.8% undervalued against the U.S. dollar based on the Big Mac Index.
To compare GDP across countries:
PPP – adjusted GDP=Nominal dollars country A ׿])
The price level adjustment is the percentage difference in purchasing power between the two countries.
PPP-adjusted variables account for cost-of-living differences across countries. A price index compares the cost of a market basket in
each country. Lower cost of living → PPP-adjusted GDP higher than nominal GDP. Higher cost of living → PPP-adjusted
GDP lower than nominal GDP.
PROBLEM Price index In US a cup of coffee $3.00(base), In Italy a cup of coffee $1.00 euro
PPP- implied exchange rate = 1.00 euro / $ 3.00 = 0.33 euro/$. Official exchange rate = 0.92 euro/$
Coffee index = (PPP – implied exchange rate – official end rate /official exchange rate) * 100%
= (0.33 – 0..92) * 100 % = - 64.13% Undervalue
PROBLEM PPP adjustment Cost of living in Mexico is 20% lower compared to US (worth more)
GDP per capita in Mexico = $ 30,000
PPP – adjusted GDP per capita = $30, + price level adjustment = $30,+ (-0.20)<= ((-) lower price) = $37,500
Chapter 9: 1. Measuring Unemployment
Unemployment is a situation where someone wants to work but cannot find a job in the current market. (People who do not have
jobs and are not interested in obtaining one are not counted as unemployed.)
The working-age population includes all civilians, non-institutionalized, aged 16+, excluding:Military personnel (e.g.,
soldiers),Institutionalized individuals (e.g., prisoners, mental facility inmates)
Labor force consists of people in the working-age population who are either currently working ("employed") or who would like to
work and are actively trying to find a job.
Labor force = Number of Employed workers + Unemployed workers
Unemployment rate The percentage of the labor force unemployed at any time.
Number of unemployed unemployed
Unemployment rate = × 100. Unemployed rate = × 100
Labor force employed + unemployed
Labor force participation rate =
Labor force
Working-age population
× 100
Example: Labor force = 75 million , LFPR= 60% unemployment rate = 8%
( )
Working age population= (Labor force / LFPR )*100% = (75/ 0.6 or 60%) = 125 million
Working age population – labor force = Working age population not part of labor force = 125 - 75 = 50 million
Unemployment rate=(number of unemployed / labor force)*100%=8% = (unemployed /75 ) *100% = 0.08 = unemployed /75
Number unemployed workers= (75)(0.08) = 6 million
Labor force = number of unemployed workers + number of employed workers 75 = employed + 6. = Employed = 69 million
Labor Force Participation Rate measures the fraction of the population that wants to work, regardless of employment status. It
typically declines during recessions. Limitations of the unemployment rate:
Discouraged workers: People who have looked for work in the past year but have given up because of labor market conditions.
Underemployed workers: People who are either working less than they would like or in jobs below their skill level.
Labor market => Good = “labor” => Price = wage (W) =>Quantity =numbers of workers
Ld = quantity of labor demanded (by producers) => Ls = quantity of labor supplied (by consumers)
Law of demand => W increased Ld decrease => W decrease Ld increase
Law of supply => W increase Ls increase => W decrease Ls decrease
Unemployment occurs when the wage rate is higher than the equilibrium wage.
Example: Ld = 40 - 1.5 w , Ls= 0.5 w , W= $ 25 => Are we at equilibrium surplus or shortage? Surplus = unemployment
Ld =(w=$25) = 40 – 1.5(25) = 2.5 workers - Ls = (w=$25)= 0.5(25) = 12.5 workers
Ld = Ls => 40 – 1.5 w = 0.5 w => 40 = 2w => W* =$20 => Ls = 0.5(20) => L* = 10 workers
Natural rate of unemployment is the normal level of unemployment that persists in an economy in the long run.
Frictional unemployment is caused by workers who are changing location, job, or career. It is a natural and healthy part of life in a
dynamic economy.
Structural unemployment is caused by a mismatch between the skills workers can offer and the skills in demand.
Real-wage or classical unemployment results from wages being higher than the market-clearing level.
Cyclical unemployment has to do with business cycle (economic ups and down)
Peak = low unemployment rate => Contractions => Trough = high unemployment rate => Expansion
Unemployment reflects economic health but is complex to address due to wage rigidities. Several factors can keep wages above
equilibrium, unintentionally causing unemployment: Government policies: Minimum-wage laws prevent wage declines. Labor
unions: Bargain for higher wages and better conditions. Efficiency wages: Firms set wages above market rates to boost
productivity. Types of unemployment: Frictional & Structural Unemployment: Functioning economy, influenced government
policies. Unemployment Insurance: money paid by the government to people who are unemployed. Other Influences: Taxes on
wages: Lower taxes would reduce unemployment, all else equal Firing restrictions: can also affect unemployment.
Chapter 10: 1. Calculating Economic Growth
Real GDP per capita growth rate = Nominal GDP growth rate - Inflation rate - Population growth rate
Economic growth builds on itself over time.
Total change in GDP over time is much bigger than the small annual growth rate suggests.
Using an average growth rate and any year’s GDP, GDP in the future can be estimated.
GDP per capita in any year: GDPYear A = GDPYear B × (1 + Growth rate)(year A - year B)
A simple shortcut to understand how many years it takes for GDP to double is the rule of 70:
70
Years until income doubles =
real GDP growth rate or annual growth rate
Productivity average output/real output per/unit of input. Productivity of labor = dividing real output by hours of work.
Rule of 70 to estimate how many years it will take for the income in each country to double.
Productivity measures output per worker and determines living standards. The only way to consume more and improve quality
of life is by increasing individual productivity. Higher productivity per person leads to higher per capita income and economic
growth.
Physical capital (K) is the stock of equipment and structures that allows for production of goods and services.
Real values of goods and services are determined by the economy. Nominal price changes, on the other hand, occur when the value Natural resources are production inputs that come from the earth.
of money changes. Market Basket a list of specific goods and services in fixed quantities(change over time/location) Technological improvements (A) are innovations that cause the same inputs to produce more outputs.
Price index is a measure showing how much the cost of a market basket has changed relative to the cost in a base time period or Accounting for growth the growth of a nation decomposes: gY = gA + α gK + (1 - α)gL
location. (base year index always be= 100) Consumer Price Index (CPI) is a measure that tracks changes in the cost of a basket of g = represents growth rates of a variable, measured in percentage change.
goods and services purchased by a typical U.S. household.
α = represents the share of GDP distributed to owners of capital. (0 < α < 1)
Consumer Price Index (CPI) Formula:
1 – α = represents the share of GDP distributed to laborers.
Cost of basket ∈target year gY =growth rate of output gA = growth rate of technology
CPI= ×100 gK = growth rate of capital gL = growth rate of labor
Cost of basket∈base year Convergence Theory (Catch-Up Eff.): Poor countries grow faster and eventually converge to the same growth rate as rich ones.
Savings & Population Growth: Differences in rates of savings and population growth do not prevent countries from converging.
Price indices transform nominal values into real values. Growth Rate vs. Income: Countries may converge in growth rates but not in income levels.
Inflation Rate Formula The inflation rate is the size of the change in the overall price level. Growth Pattern: Poor countries grow rapidly at first but slow as they converge with richer nations.
Inflation Rate = [(CPI Year 2 - CPI Year 1) / CPI Year 1] × 100 Investment in physical capital should increase productivity of workers.
Report inflation: 1)Headline inflation measures price changes for the entire market basket. CPI Less money for consumption: Investment means less spending on current consumption.
2)Core inflation measures price changes with food and energy costs removed. CORE CPI Investment trade-off: Reducing current consumption to fund capital investment for future production.
Producer price index (PPI) measures the prices of goods and services purchased by firms. Sources of Capital Investment: Savings come from domestic or foreign sources.
GDP deflator measures the prices of goods and services produced in the country. Domestic Savings: Funds for capital investment generated within a country.
Deflating nominal variables CPI (or another price index) can be used to deflate nominal values into real values. Compares Three Sources of Domestic Savings Households
purchasing power over time. Any nominal value in year X can be put into year Y value using: (spend less than they earn), corporations (retain profits), and governments (run surpluses).
CPI year Y Domestic savings = domestic income - consumption spending
New CPI
Developing nations tend to save more. - Developed nations tend to save less.
Real value year Y =Nominal value year X × Inflatacion adjustment =Older price × Foreign direct investment (FDI) is when a firm runs part of its operation abroad or invests in another company abroad.
CPI year X Old CPI
Government policy can shape economic growth in many ways.
Government spending: directly contribute to the economy.
Education and Health: high-quality public education to children and good health increases human capital and productivity.
Example: Suppose a worker made $4.25/hour in 1993. How much is this worth today if the CPI in 1993 was 142 and today it
Infrastructure and industrial policy: invest in infrastructure that companies rely on for operations. Governments can focus resources
is 251? Answer: $4.25 in 2016 prices = $4.25 × (251/142) = $7.51
on industries that contribute most to growth.
Indexing the practice of automatically increasing payments in proportion to the cost of living Technological development: improve the productivity of existing inputs.
Purchasing power parity (PPP) the theory that purchasing power in different countries should be the same when stated in a common
currency. Example :Compounding => Balance = $100 => Interest rate = 10%
Transaction costs: One reason that PPP doesn't hold is transaction costs, such as transportation: It costs money to move goods from Year 1 = $100(1 + 0.10 ) = $110 => Year 2 = $110(1 + 0.10 ) = $121 =>Year 3 = $121(1 + 0.10 ) = $132
place to place. Non-tradables: Some goods and services just can't be taken from place to place very easily, or at all. Example GDP growth rate 5% ? How much go take for double? $ 10000-----?-----$20000 => 70/5 =14
Trade restrictions: Finally, international trade isn't free. GDP year A => GDP year a = GDP year b *(1 + growth rate) ^ (year a – year b)
Purchasing power indexes (PPIs) help describe differences in prices across locations. Example => GDP growth rate = 3% => Current GDP =$5000 => After 5 years GDP = ?
Big Mac in different countries to estimate the fair exchange rate based on purchasing power parity (PPP). GDP future year = GDP current (1 + growth rate) ^ # of year =$5000(1 + 0.03)^5 =$5,796.37
U.S. Big Mac price (Dec 2022): $5.36. Mexico Big Mac price: 79 pesos Example of the final exam : GDP 2012 = $400 => GDP2015 =$ 430 => Growth rate?
PPP exchange rate (calculated): 79 pesos ÷ $5.36 = 14.74 pesos per USD GDP future = GDP current (1 + growth rate) ^ # of year = $430 =$ 400 (1 + growth rate)^3= 2.44% or 0.0244
The actual exchange rate on December 30, 2022, was 18.84 pesos per USD, meaning the peso was undervalued compared to
the PPP estimate. Big Mac Index calculation: 14.74−18..84×100 = −21.8%
This result suggests that the Mexican peso was 21.8% undervalued against the U.S. dollar based on the Big Mac Index.
To compare GDP across countries:
PPP – adjusted GDP=Nominal dollars country A ׿])
The price level adjustment is the percentage difference in purchasing power between the two countries.
PPP-adjusted variables account for cost-of-living differences across countries. A price index compares the cost of a market basket in
each country. Lower cost of living → PPP-adjusted GDP higher than nominal GDP. Higher cost of living → PPP-adjusted
GDP lower than nominal GDP.
PROBLEM Price index In US a cup of coffee $3.00(base), In Italy a cup of coffee $1.00 euro
PPP- implied exchange rate = 1.00 euro / $ 3.00 = 0.33 euro/$. Official exchange rate = 0.92 euro/$
Coffee index = (PPP – implied exchange rate – official end rate /official exchange rate) * 100%
= (0.33 – 0..92) * 100 % = - 64.13% Undervalue
PROBLEM PPP adjustment Cost of living in Mexico is 20% lower compared to US (worth more)
GDP per capita in Mexico = $ 30,000
PPP – adjusted GDP per capita = $30, + price level adjustment = $30,+ (-0.20)<= ((-) lower price) = $37,500
Chapter 9: 1. Measuring Unemployment
Unemployment is a situation where someone wants to work but cannot find a job in the current market. (People who do not have
jobs and are not interested in obtaining one are not counted as unemployed.)
The working-age population includes all civilians, non-institutionalized, aged 16+, excluding:Military personnel (e.g.,
soldiers),Institutionalized individuals (e.g., prisoners, mental facility inmates)
Labor force consists of people in the working-age population who are either currently working ("employed") or who would like to
work and are actively trying to find a job.
Labor force = Number of Employed workers + Unemployed workers
Unemployment rate The percentage of the labor force unemployed at any time.
Number of unemployed unemployed
Unemployment rate = × 100. Unemployed rate = × 100
Labor force employed + unemployed
Labor force participation rate =
Labor force
Working-age population
× 100
Example: Labor force = 75 million , LFPR= 60% unemployment rate = 8%
( )
Working age population= (Labor force / LFPR )*100% = (75/ 0.6 or 60%) = 125 million
Working age population – labor force = Working age population not part of labor force = 125 - 75 = 50 million
Unemployment rate=(number of unemployed / labor force)*100%=8% = (unemployed /75 ) *100% = 0.08 = unemployed /75
Number unemployed workers= (75)(0.08) = 6 million
Labor force = number of unemployed workers + number of employed workers 75 = employed + 6. = Employed = 69 million
Labor Force Participation Rate measures the fraction of the population that wants to work, regardless of employment status. It
typically declines during recessions. Limitations of the unemployment rate:
Discouraged workers: People who have looked for work in the past year but have given up because of labor market conditions.
Underemployed workers: People who are either working less than they would like or in jobs below their skill level.
Labor market => Good = “labor” => Price = wage (W) =>Quantity =numbers of workers
Ld = quantity of labor demanded (by producers) => Ls = quantity of labor supplied (by consumers)
Law of demand => W increased Ld decrease => W decrease Ld increase
Law of supply => W increase Ls increase => W decrease Ls decrease
Unemployment occurs when the wage rate is higher than the equilibrium wage.
Example: Ld = 40 - 1.5 w , Ls= 0.5 w , W= $ 25 => Are we at equilibrium surplus or shortage? Surplus = unemployment
Ld =(w=$25) = 40 – 1.5(25) = 2.5 workers - Ls = (w=$25)= 0.5(25) = 12.5 workers
Ld = Ls => 40 – 1.5 w = 0.5 w => 40 = 2w => W* =$20 => Ls = 0.5(20) => L* = 10 workers
Natural rate of unemployment is the normal level of unemployment that persists in an economy in the long run.
Frictional unemployment is caused by workers who are changing location, job, or career. It is a natural and healthy part of life in a
dynamic economy.
Structural unemployment is caused by a mismatch between the skills workers can offer and the skills in demand.
Real-wage or classical unemployment results from wages being higher than the market-clearing level.
Cyclical unemployment has to do with business cycle (economic ups and down)
Peak = low unemployment rate => Contractions => Trough = high unemployment rate => Expansion
Unemployment reflects economic health but is complex to address due to wage rigidities. Several factors can keep wages above
equilibrium, unintentionally causing unemployment: Government policies: Minimum-wage laws prevent wage declines. Labor
unions: Bargain for higher wages and better conditions. Efficiency wages: Firms set wages above market rates to boost
productivity. Types of unemployment: Frictional & Structural Unemployment: Functioning economy, influenced government
policies. Unemployment Insurance: money paid by the government to people who are unemployed. Other Influences: Taxes on
wages: Lower taxes would reduce unemployment, all else equal Firing restrictions: can also affect unemployment.
Chapter 10: 1. Calculating Economic Growth
Real GDP per capita growth rate = Nominal GDP growth rate - Inflation rate - Population growth rate
Economic growth builds on itself over time.
Total change in GDP over time is much bigger than the small annual growth rate suggests.
Using an average growth rate and any year’s GDP, GDP in the future can be estimated.
GDP per capita in any year: GDPYear A = GDPYear B × (1 + Growth rate)(year A - year B)
A simple shortcut to understand how many years it takes for GDP to double is the rule of 70:
70
Years until income doubles =
real GDP growth rate or annual growth rate
Productivity average output/real output per/unit of input. Productivity of labor = dividing real output by hours of work.
Rule of 70 to estimate how many years it will take for the income in each country to double.
Productivity measures output per worker and determines living standards. The only way to consume more and improve quality
of life is by increasing individual productivity. Higher productivity per person leads to higher per capita income and economic
growth.
Physical capital (K) is the stock of equipment and structures that allows for production of goods and services.
