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Macroeconomics ECO 403
VU
LESSON 06
THE DATA OF MACROECONOMICS (Continued...)
Other Measures of Income
Net National Product (NNP) =
·
GNP ­ Depreciation
National Income (NI) =
·
NNP ­ Indirect Business Taxes
Personal Income (PI) =
·
NI ­ Corporate Profits
­ Social Insurance Contributions
­ Net Interest
+ Dividends
+ Govt. Transfers to Individuals
+ Personal Interest Income
Disposable Personal Income (DPI) =
·
PI - Tax
CONSUMER PRICE INDEX (CPI)
A measure of the overall level of prices
·
Published by the Federal Bureau of Statistics
·
Used to
·
·  track changes in the
typical household's cost of living
·  adjust many contracts for inflation
(i.e. "COLAs": Cost of Living Adjustments)
·  allow comparisons of dollar figures from different years
How to construct the CPI
1. Survey consumers to determine composition of the typical consumer's "basket" of
goods.
2. Every month, collect data on prices of all items in the basket; compute cost of basket
3. CPI in any month equals
Cost of basket in that month
100 ×
Cost of basket in base period
CPI: an example
The basket contains 20 pizzas and 10 compact discs.
Prices:
Pizza
CDs
2000
$10
$15
2001
$11
$15
2002
$12
$16
2003
$13
$15
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Macroeconomics ECO 403
VU
For each year, compute
·  the cost of the basket
·  the CPI (use 2000 as the base year)
·  the inflation rate from the preceding year
Cost of
inflation
basket
CPI
rate
2000 $350
100.0
N.A.
2001 370
105.7
5.7%
2002 400
114.3
8.1%
2003 410
117.1
2.5%
Understanding the CPI
Example with 3 goods
For good i = 1, 2, 3
Ci = the amount of good i in the CPI's basket
Pit = the price of good i in month t
Et = the cost of the CPI basket in month t
Eb = cost of the basket in the base period
Et
CPI in month t = 100 ×
Eb
P1tC1 + P2tC2 + P3tC3
= 100 ×
Eb
⎡⎛ C1
C3 ⎞  ⎤
C2
= 100 × ⎢⎜  ⎟ P1t + ⎜  ⎟ P2t + ⎜  ⎟ P3t
⎢⎝ Eb
Eb
Eb ⎠  ⎥
The CPI is a weighted average of prices.
The weight on each price reflects that good's relative importance in the CPI's basket.
Note that the weights remain fixed over time.
Reasons why the CPI may overstate inflation
Substitution bias: The CPI uses fixed weights,
·
so it cannot reflect consumers' ability to substitute toward goods whose relative prices
have fallen.
CPI uses fixed weights.
Introduction of new goods: The introduction of new goods makes consumers better
·
off and, in effect, increases the real value of the dollar. But it does not reduce the CPI,
because the CPI uses fixed weights.
Unmeasured changes in quality: Quality improvements increase the value of the
·
dollar, but are often not fully measured.
CPI vs. GDP deflator
prices of capital goods
·  included in GDP deflator (if produced domestically)
·  excluded from CPI
prices of imported consumer goods
·  included in CPI
·  excluded from GDP deflator
the basket of goods
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Macroeconomics ECO 403
VU
CPI: fixed
·
GDP deflator: changes every year
·
CATEGORIES OF THE POPULATION
Employed
·
working at a paid job
Unemployed
·
not employed but looking for a job
Labor force
·
the amount of labor available for producing goods and services; all employed plus
unemployed persons
Not in the labor force
·
not employed, not looking for work.
Two important labor force concepts
unemployment rate
·
percentage of the labor force that is unemployed
Unemployment Rate = Number of Unemployed x 100
Labor Force
labor force participation rate
·
the fraction of the adult population that `participates' in the labor force
Labor-Force Participation Rate =
Labor Force  x 100
Adult Population
Suppose
·
the population increases by 1%
·
the labor force increases by 3%
·
the number of unemployed persons increases by 2%
Okun's Law
·  One would expect a negative relationship between unemployment and real GDP.
·  This relationship is clear in the data...
Percentage Change in Real GDP = 3% - 2 * (change in the Unemployment rate)
Okun's Law states that a
one-percent decrease in
unemployment is
Percentage
associated with two
change in
percentage points of
real GDP
additional growth in real
10
GDP
8
1951
1984
6
2000
4
1999
2
1993
1975
0
-
1982
0
1
2
3
4
-
-
-
Change in
unemployment rate
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