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slide 0 CHAPTER 2 The Data of Macroeconomics
Chapter 2
The Data of Macroeconomics (Continued)
slide 1 CHAPTER 2 The Data of Macroeconomics
CPI and PPI
An index similar to CPI is the PPI (producer
price index) which measures the prices of a
typical basket of goods bought by firms rather
than consumers.
Both CPI and PPI are closely watched by
politicians to understand the state of the
economy. (www.tuik.gov)
slide 2 CHAPTER 2 The Data of Macroeconomics
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.
Example: Let’s continue with our typical consumer
who only consumes apples and oranges
Suppose that due to a major frost, orange production is
destroyed in a given year.
Quantity of oranges produced declines and the
price of oranges increases.
slide 3 CHAPTER 2 The Data of Macroeconomics
Recall that
The increase in the price of oranges will cause a
significant rise in the CPI in 2006 (and therefore the
inflation rate
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2006200220062002
2006
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slide 4 CHAPTER 2 The Data of Macroeconomics
Wouldn’t we have the same problem if we calculated the
inflation rate based on the GDP deflator?
Because the QO2006 is very small, the increase in orange
prices will not inflate the GDP deflator as much.
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DeflatorGDP200220062002200620022006
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2006
slide 5 CHAPTER 2 The Data of Macroeconomics
Reasons why
the CPI may overstate inflation
Introduction of new goods:
The introduction of new goods makes consumers
better off because you have more to choose from
This increases the real value of the dollar (it is as if
you are buying more with the same dollar).
But it does not reduce the CPI, because the CPI uses
fixed weights.
Whereas the GDP deflator includes any new goods
that is produced every year
slide 6 CHAPTER 2 The Data of Macroeconomics
Unmeasured changes in quality Suppose TUIK has been tracking the price of some specific brand of
cell phones for inclusion in the CPI.
At some date, the chosen variety of cell phone disappears from
store shelves, and in its place retailers start offering a new, higher
priced model with additional features.
How much of the difference in the prices of the new and old models
should be treated as a price increase, and how much reflects quality
improvement in the cell phone?
slide 7 CHAPTER 2 The Data of Macroeconomics
In constructing a measure of the change in the cost of
living, it is appropriate to exclude that part of the price
increase that results from improvements in the quality of
the good.
CPI overlooks this problem. Because it uses fixed
weights, it would treat the new model as a pricier version
of the old model and overstate the inflation.
The GDP deflator treats each new model as a
different product
slide 8 CHAPTER 2 The Data of Macroeconomics
CPI vs. GDP Deflator: Differences
The GDP deflator measures the prices of all
goods and services produced whereas the CPI
measures the prices of goods and services
bought by consumers only.
Examples:
Prices of capital goods are included in the GDP
(if they are produced domestically) such as
factories, machinery, tools, equipment
slide 9 CHAPTER 2 The Data of Macroeconomics
CPI vs. GDP Deflator
The GDP deflator includes only those goods
produced domestically whereas the CPI includes
imported consumer goods.
Example:
Increase in the price Korean noodles could
show up in Turkish CPI but not in the GDP
deflator.
slide 10 CHAPTER 2 The Data of Macroeconomics
CPI vs. GDP Deflator
The CPI assigns fixed weights to the prices of
different goods
Based on the quantities that a typical consumer
is believed to purchase (quantities produced in
a base year)
The GDP deflator assigns changing weights
Based on the quantities produced in each year
slide 11 CHAPTER 2 The Data of Macroeconomics
CPI vs. GDP Deflator
Laspeyres index is the general name for a price
index with a fixed basket of goods
such as the CPI
This type of an index with fixed weights tends to
overstate the cost of living
because it does not consider the fact that
people may substitute other goods for the
expensive good (i.e. the weights of each good
in the typical basket may change).
slide 12 CHAPTER 2 The Data of Macroeconomics
CPI vs. GDP Deflator
Paashe index is the general name for a price index with
a changing basket of goods
such as the GDP Deflator
This type of an index with changing weights tends to
understate the increase in cost of living
because even though people switch their preferences
(i.e. weights change) this may lead to a reduction in
welfare
Example: If you have to substitute apples for oranges
and you don’t necessarily enjoy consuming that many
apples...
slide 13 CHAPTER 2 The Data of Macroeconomics
Two measures of inflation in the U.S.
-3%
0%
3%
6%
9%
12%
15%
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
GDP deflator CPI
Pe
rce
nta
ge
ch
an
ge
from
12 m
onth
s e
arlie
r
slide 14 CHAPTER 2 The Data of Macroeconomics
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 (e.g. a fulltime student, retired) If a person wants a job but no longer looks for a job,
he/she is a discouraged worker and not counted in the labor force.
slide 15 CHAPTER 2 The Data of Macroeconomics
Two important labor force
concepts
unemployment rate
percentage of the labor force that is unemployed
labor force participation rate
the fraction of the adult population that “participates” in
the labor force
100ForceLabor
unemployedofnumberRatentUnemployme
100PopulationAdult
ForceLaborLFPR
slide 16 CHAPTER 2 The Data of Macroeconomics
Exercise:
Compute labor force statistics
U.S. adult population by group, June 2006
Number employed = 144.4 million
Number unemployed = 7.0 million
Adult population = 228.8 million
Use the above data to calculate
the labor force
the number of people not in the labor force
the labor force participation rate
the unemployment rate
slide 17 CHAPTER 2 The Data of Macroeconomics
Answers:
data: E = 144.4, U = 7.0, POP = 228.8
labor force L = 151.4
not in labor force NILF = POP – L = 77.4
unemployment rate U/L = 4.6%
labor force participation rate L/POP = 66.2%
slide 18 CHAPTER 2 The Data of Macroeconomics
Okun’s Law
What type of a relationship should we expect to
find between the unemployment rate and the
real GDP?
Increases in the unemployment rate are
associated with decreases in the real GDP. This
relationship is called Okun’s law.
slide 19 CHAPTER 2 The Data of Macroeconomics
Case study: Turkish GDP
: GDP and its components
www.tuik.gov.tr
National accounts/Gross Domestic Product by
expenditure approach/
Statistical tables
CPI numbers
http://www.tcmb.gov.tr/
slide 20
End of Chapter Problem 6
Consider an economy that produces and
consumes bread and automobiles. In the
following table are data for two years
2000 2010
Q P Q P
Auto 100 $50,000 120 $60,000
Bread 500,000 $10 400,000 $20
CHAPTER 2 The Data of Macroeconomics
slide 21
a) Using 2000 as the base year, compute NGDP, RGDP,
the implicit price deflator for GDP, and CPI
b) How much have prices changed between 2000 and
2010? Compare the answers given by the Laspeyres
and Paasche price indexes. Explain the difference
c) Suppose you are a senetor writing a bill to index social
security and federal pensions. That is, your bill will
adjust these benefits to offset the changes in the costs
of living. Will you use the GDP deflator or the CPI?
Why?
CHAPTER 2 The Data of Macroeconomics
slide 22
a) NGDP(2000)=$10,000,000
NDGP (2010)=$15,200,000
RDGP (2010)=$10,000,000
GDP deflator=NGDP/RGDP=1.52
CHAPTER 2 The Data of Macroeconomics
slide 23
Cost of basket in 2000=NGDP (2000)
Cost of basket in 2010=$16,000,000
CPI=1.6
CHAPTER 2 The Data of Macroeconomics
slide 24
Problem 7
Abby consumes only apples. In year 1, red apples
cost $1 each, green apples cost $2 each, and
Abby buys 10 red apples. In year 2, red apples
cost $2, green apples cost $1, and Abby buys 10
green apples.
a) Compute a CPI for apples for each year.
Assume that year 1 is the base year in which the
consumer basket is fixed. How does your index
change from year 1 to year 2?
CHAPTER 2 The Data of Macroeconomics
slide 25
b) Compute Abby’s nominal spending on apples in each
year. How does it change from year 1 to year 2?
c) Using year 1 as the base year, compute Abby’s real
spending on apples in each year. How does it change from
year 1 to year 2?
d) Defining the implicit price deflator as the nominal
spending divided by real spending, compute the deflator for
each year. How does the deflator change from year 1 to
year 2?
CHAPTER 2 The Data of Macroeconomics
slide 26
e) Suppose that Abby is equally happy eating red
or green apples. How much has the true cost of
living increased for Abby? Compare this answer to
your answers to parts (a) and (d). What does this
example tell you about Laspeyres and Paasche
indexes?
CHAPTER 2 The Data of Macroeconomics
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