Unit 2:

Macro Measures

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 REVIEW ACTIVITY
Name That Concept
Rules:
1. Cannot use the word(s)
2. Focus on the concept not word
Ex: Price Maker
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 NAME THAT CONCEPT
1.Macroeconomics
2.Inflation
3.Nominal GDP
4.Structural Unemp.
5.C+I+G+Xn
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 NAME THAT CONCEPT
1.REAL GDP
2.FULL EMPLOYM.
3.CYCLICAL UNEMP.
4.NATURAL RATE
5.FRICTIONAL
UNEMPLOYMENT
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 Goal #3
LIMIT INFLATION
Country and Time-
Zimbabwe, 2008
Annual Inflation Rate-
79,600,000,000%
Time for Prices to Double-
24.7 hours

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 What is Inflation?
Inflation is rising general level of prices and
it reduces the “purchasing power” of
money
Examples:
• It takes $2 to buy what $1 bought in 1987
• It takes $6 to buy what $1 bought in 1970
• It takes $24 to buy what $1 bought in 1913
When inflation occurs, each dollar of income
will buy fewer goods than before

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 Is Inflation Good or Bad?

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 Good or Bad?
In general, ramped inflation is bad because
banks don’t lend and people don’t save.
This decreases investment and GDP.
What about deflation?
Deflation- Decrease in general prices or a
negative inflation rate.
Deflation is bad because people will hoard
money (financial assets)
This decreases consumer spending and GDP.
Disinflation- Prices increasing at slower rates
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 But inflation doesn’t effect everyone equally.
Identify which people are helped and which
are hurt by unanticipated inflation
1. A man who lent out $500 to his friend in 1960
and gets paid back in 2015.
2. A tenant who is charged $850 rent each year.
3. An elderly couple living off fixed retirement
payments of $2000 a month
4. A man that borrowed $1,000 in 1995 and paid
it back in 2014.
5. A women who saved $500 in 1950 by putting
it under her mattress
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 Effects of Unanticipated Inflation
Hurt by Inflation Helped by Inflation
• Lenders-People who • Borrowers-People
lend money (at fixed who borrow money
interest rates) • A business where the
• People with fixed price of the product
incomes increases faster than
• Savers the price of
Nominal Wage- Wage measuredresources
by dollars rather
than purchasing power
Real Wage- Wage adjusted for inflation
If there is inflation, you must ask your
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boss for a raise
 Historic Inflation Rates

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 Nominal vs. Real
Interest Rates

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 Interest Rates and Inflation
What are interest rates? Why do lenders charge them?
Who is willing to lend me $100 if I will pay a
total interest rate of 100%?
(I plan to pay you back in 2050)
If the nominal interest rate is 10% and the inflation
rate is 15%, how much is the REAL interest rate?
Real Interest Rates-
The percentage increase in purchasing power that a
borrower pays. (adjusted for inflation)
Real = nominal interest rate - expected inflation
Nominal Interest Rates-
the percentage increase in money that the borrower
pays not adjusting for inflation.
Nominal = Real interest rate + expected inflation
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 Nominal vs. Real Interest Rates
Example #1:
You lend out $100 with 20% interest. Inflation is 15%.
A year later you get paid back $120.
What is the nominal and what is the real interest rate?
Nominal interest rate is 20%. Real interest rate was 5%
In reality, you get paid back an amount with less
purchasing power.
Example #2:
You lend out $100 with 10% interest. Prices are expected
to increased 20%. In a year you get paid back $110.
What is the nominal and what is the real interest rate?
Nominal interest rate is 10%. Real rate was –10%
In reality, you get paid back an amount with
less purchasing power.
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 Achieving the Three Goals
The governments role is to prevent unemployment and
prevent inflation at the same time.
•If the government focuses too much on preventing
inflation and slows down the economy we will have
unemployment.
•If the government focuses too much on limiting
unemployment and overheats the economy we will have
inflation
Unemployment Inflation GDP Growth

Good 6% or less 1%-4% 2.5%-5%

Worry 6.5%-8% 5%-8% 1%-2%

Bad 8.5 % or more 9% or more .5% or less

 Measuring Inflation

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 How is inflation measured?
The government tracks the prices of specific “market
baskets” that included the same goods and services.
There are two ways to look at inflation over time:
The Inflation Rate- The percent change in prices from
year to year
Price Indices- Index numbers assigned to each year that
show how prices have changed relative to a specific
base year.
Examples:
• The U.S. inflation rate in 2014 was 0.8%.
• The Consumer Price Index for 2014 was 235 (base
year 1982). This means that prices have increased
135% since 1982.
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 Consumer Price Index (CPI)
The most commonly used measurement of inflation for
consumers is the Consumer Price Index (CPI)
Here is how it works:
• The base year is given an index of 100
• To compare, each year is given an index # as well

CPI = Price of market basket

Price of market
x 100
basket in base year
1997 Market Basket: Movie is $6 & Pizza is $14
Total = $20 (Index of Base Year = 100)
2009 Market Basket: Movie is $8 & Pizza is $17
Total = $25 (Index
125of )
•This means inflation increased 25% b/w ’97 & ‘09
•Items that cost $100 in ’97 cost $125 in ‘09
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 Problems with the CPI
1. Substitution Bias- As prices increase for the fixed
market basket, consumers buy less of these products
and more substitutes that may not be part of the
market basket. (Result: CPI may be higher than
what consumers are really paying)
2. New Products- The CPI market basket may not
include the newest consumer products. (Result: CPI
measures prices but not the increase in choices)
3. Product Quality- The CPI ignores both
improvements and decline in product quality.
(Result: CPI may suggest that prices stay the same
though the economic well being has improved
significantly)
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 Calculating Nominal GDP,
Real GDP, and Inflation

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 Calculating GDP Deflator
GDP
Real, Deflator Inflation
Units of Price Nominal, GDP Rate
Output Per Unit GDP (Year 1 as
Year Base Year)
1 10 $4
2 10 5
3 15 6
4 20 8
5 25 4
Make year one the base year

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 Calculating GDP Deflator
GDP
Real, Deflator Inflation
Units of Price Nominal, GDP Rate
Output Per Unit GDP (Year 1 as
Year Base Year)
1 10 $4 $40 $40 100 N/A
2 10 5 50 40 125 25%
3 15 6 90 60 150 20%
4 20 8 160 80 200 33.33%
5 25 4 100 100 100 -50%

Inflation Rate
% Change
in Prices = Year 2 - Year 1
Year 1
X 100

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 Practice
Real, GDP Deflator
Units of Price Nominal, GDP (Year 3 as Base Year)
Output Per Unit GDP
Year
1 5 $6 $30 $50 60
2 10 8 80 100 80
3 20 10 200 200 100
4 40 12 480 400 120
5 50 14 700 500 140
Make year three the base year (for prices)

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 CPI vs. GDP Deflator
The GDP deflator measures the prices of all goods
produced, whereas the CPI measures prices of only
the goods and services bought by consumers.
An increase in the price of goods bought by firms or the
government will show up in the GDP deflator but not in the
CPI.
The GDP deflator includes only those goods and services produced
domestically. Imported goods are not a part of GDP and
therefore don’t show up in the GDP deflator.
Nominal GDP
GDP
Deflator = Real GDP
x 100
If the nominal GDP in ’09 was 25 and the real GDP
(compared to a base year) was 20 how much is the
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GDP Deflator?
 Calculating GDP Deflator
Nominal GDP
GDP
Deflator = Real GDP
x 100

(Deflator) x (Real GDP)

Nominal
GDP = 100
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 Calculations
1. In an economy, Real GDP (base year = 1996) is $100
billion and the Nominal GDP is $150 billion.
Calculate the GDP deflator.
2. In an economy, Real GDP (base year = 1996) is $125
billion and the Nominal GDP is $150 billion.
Calculate the GDP deflator.
3. In an economy, Real GDP for year 2002 (base year =
1996) is $200 billion and the GDP deflator 2002 (base
year = 1996) is 120. Calculate the Nominal GDP for
2002.
4. In an economy, Nominal GDP for year 2005 (base
year = 1996) is $60 billion and the GDP deflator 2005
(base year = 1996) is 120. Calculate the Real GDP for
2005.
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2008 Audit Exam
2012 Audit Exam
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 Review
1. Identify the 3 goals of all economies
2. Define Natural Rate of Unemployment
3. Define inflation rate
4. What is a market basket?
5. Explain the difference between nominal and real
interest rates
6. How do you calculate CPI?
7. What does a CPI of 130 mean?
8. Who is helped and hurt by inflation?
9. Why did Bolivia experience hyperinflation?
10.List 10 old-school Nintendo games
 Three Causes of
Inflation
1. If everyone suddenly had a million dollars, what
would happen?
2. What two things cause prices to increase? Use
Supply and Demand

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 3 Causes of Inflation
1. The Government Prints TOO MUCH
Money (The Quantity Theory)
• Governments that keep printing money to
pay debts end up with hyperinflation.
• Result: Banks refuse to lend so investment
falls and people don’t save up to buy things.
Examples:
• Bolivia, Peru, Brazil
• Germany after WWI

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 Quantity Theory of Money
If the real GDP in a year is $400 billion but the
amount of money in the economy is only $100
billion, how are we paying for things?
The velocity of money is the average times a
dollar is spent and re-spent in a year.
How much is the velocity of money in the above
example?
Quantity Theory of Money Equation:
MxV=PxY
M = money supply P = price level
V = velocity Y = quantity of output
Notice that P x Y is Nominal GDP
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 MxV=PxY
Why does printing money lead to inflation?
•Assume the velocity is relatively constant because
people's spending habits are not quick to change.
•Also assume that output (Y) is not affected by the
amount of money because it is based on
production, not the value of the stuff produced.
If the govenment increases the amount of money
(M) what will happen to prices (P)?
Ex: Assume money supply is $5 and it is being used to
buy 10 products with a price of $2 each.
1. How much is the velocity of money?
2. If the velocity and output stay the same, what will
happen if the amount of money is increase to $10?
Notice, doubling the money supply doubles prices 37
2012 Audit Exam
 3 Causes of Inflation
2. Demand- Pull Inflation
DEMAND PULLS UP PRICES!!!
“Too many dollars chasing too few goods”
An overheated economy with excessive
spending but same amount of goods.
3. Cost-Push Inflation
Higher production costs increase prices
A negative supply shock increases the costs of
production and forces producers to increase
prices.
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 The Wage-Price Spiral
A Perpetual Process:
1.Workers demand raises
2.Owners increase prices to
pay for raises
3. High prices cause workers
to demand higher raises
4. Owners increase prices to
pay for higher raises
5. High prices cause workers
to demand higher raises
6. Owners increase prices to
pay for higher raises
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Holding cash becomes more expensive.

The name comes from Germany in the 1920’s.

Workers had to spend extra time walking to the bank,

Which would wear out their shoes.

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