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THE DATA OF MACROECONOMICS (Continued…):How to construct the CPI

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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
16
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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
17
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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
18
Table of Contents:
  1. INTRODUCTION:COURSE DESCRIPTION, TEN PRINCIPLES OF ECONOMICS
  2. PRINCIPLE OF MACROECONOMICS:People Face Tradeoffs
  3. IMPORTANCE OF MACROECONOMICS:Interest rates and rental payments
  4. THE DATA OF MACROECONOMICS:Rules for computing GDP
  5. THE DATA OF MACROECONOMICS (Continued…):Components of Expenditures
  6. THE DATA OF MACROECONOMICS (Continued…):How to construct the CPI
  7. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES
  8. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
  9. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
  10. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
  11. MONEY AND INFLATION:The Quantity Equation, Inflation and interest rates
  12. MONEY AND INFLATION (Continued…):Money demand and the nominal interest rate
  13. MONEY AND INFLATION (Continued…):Costs of expected inflation:
  14. MONEY AND INFLATION (Continued…):The Classical Dichotomy
  15. OPEN ECONOMY:Three experiments, The nominal exchange rate
  16. OPEN ECONOMY (Continued…):The Determinants of the Nominal Exchange Rate
  17. OPEN ECONOMY (Continued…):A first model of the natural rate
  18. ISSUES IN UNEMPLOYMENT:Public Policy and Job Search
  19. ECONOMIC GROWTH:THE SOLOW MODEL, Saving and investment
  20. ECONOMIC GROWTH (Continued…):The Steady State
  21. ECONOMIC GROWTH (Continued…):The Golden Rule Capital Stock
  22. ECONOMIC GROWTH (Continued…):The Golden Rule, Policies to promote growth
  23. ECONOMIC GROWTH (Continued…):Possible problems with industrial policy
  24. AGGREGATE DEMAND AND AGGREGATE SUPPLY:When prices are sticky
  25. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…):
  26. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…):
  27. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…)
  28. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…)
  29. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…)
  30. AGGREGATE DEMAND IN THE OPEN ECONOMY:Lessons about fiscal policy
  31. AGGREGATE DEMAND IN THE OPEN ECONOMY(Continued…):Fixed exchange rates
  32. AGGREGATE DEMAND IN THE OPEN ECONOMY (Continued…):Why income might not rise
  33. AGGREGATE SUPPLY:The sticky-price model
  34. AGGREGATE SUPPLY (Continued…):Deriving the Phillips Curve from SRAS
  35. GOVERNMENT DEBT:Permanent Debt, Floating Debt, Unfunded Debts
  36. GOVERNMENT DEBT (Continued…):Starting with too little capital,
  37. CONSUMPTION:Secular Stagnation and Simon Kuznets
  38. CONSUMPTION (Continued…):Consumer Preferences, Constraints on Borrowings
  39. CONSUMPTION (Continued…):The Life-cycle Consumption Function
  40. INVESTMENT:The Rental Price of Capital, The Cost of Capital
  41. INVESTMENT (Continued…):The Determinants of Investment
  42. INVESTMENT (Continued…):Financing Constraints, Residential Investment
  43. INVESTMENT (Continued…):Inventories and the Real Interest Rate
  44. MONEY:Money Supply, Fractional Reserve Banking,
  45. MONEY (Continued…):Three Instruments of Money Supply, Money Demand