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Chapter-2: National Income Accounting: Contents
Chapter-2: National Income Accounting: Contents
Contents:
1
….Ch-2: National Income Accounting…cond.
Measuring the value of economic activities (=Output)
- Gross Domestic Product (GDP)-is the market value of all final goods &
services produced within a country’s domestic territory regardless of the
producer’s nationality in a given period of time.
- GDP figures tells us about the level of income & expenditure at a time
since one person expenditure is the income of another person and vice-
versa,
Financial Market
saving borrowing borrowing
production
government
consumption spending investment
Goods Market
4
… Measuring the Value of Economic Activity: Gross
Domestic Product…cond.
• The sum of the final uses of goods and services (all uses
except intermediate consumption) measured in
purchasers' prices, less the value of imports of goods and
services, or
• the sum of primary incomes distributed by resident
producer units.
5
Rules for Computing GDP
Some questions on what GDP should constitute and should not Constitute
Is it true that even if I own my house, the rent for my house is counted as a
component of GDP?
Suppose a firm produces $10 million worth of final goods, but only
sells $9 million worth. Does this violate the expenditure = output
identity?
6
…Rules for Computing GDP…cond.
7
…Rules for Computing GDP…cond.
• Treatment of Used Goods- GDP measures the value of currently
produced goods and services. Hence,
ü transaction values related to a simple transfer of asset (like
reselling an item bought earlier from the producer) do not
constitute any addition to an economy, and here be excluded from
GDP.
For instance:
o When a farmer sale cotton for a merchant for 200 birr, that 200
birr is added to the nation’s GDP (b/s the farmer produce an
additional birr 200 worth of Cotton for the economy),
ü One way to compute the value of all final goods and services is to sum
the value added at each stage of production,
ü The value added of a firm equals the value of the firm’s output less
the value of the intermediate goods that the firm purchases,
ü In the case of the milk, the value added of the rancher is 2 birr
(assuming that the rancher bought no intermediate goods), and the
value added of butter is birr 1.00.Total value added is 2 birr + 1birr,
which equals 3 birr.
ü Therefore, for the economy as a whole, the sum of all value added must
equal the value of all final goods and services,
ü Hence, GDP is also the total value added of all firms in the economy.
11
…Rules for Computing GDP…cond.
• Treatment of Housing Services and Other Imputations:
ü Some goods and services may not be sold in the market place,
ü Hence, they may not have market prices,
ü To include such goods & services in GDP estimation, we must use an estimate of
their value,
ü Such an estimate is called an imputed value.
Example of such goods include:
Ø Housing Service
üthough some people rent house(expenditure) and pay to landlord(income), many
people still live in their own house. To account for own house service, we impute its
value by using the rental price of similar house in the economy,
Ø valuing government services
ü to value gov’t services like police officers, firefighters, and others, we can impute the
price of such services using the wages of these public servants as a measure of the
value of their output.
12
…Rules for Computing GDP…cond.
Note:
ü In practice, applying imputation is not possible for all goods services(like
meals cooked at home, jewelry etc).
üB/s imputations(if applied are simply approximation), and the value of many
goods and services are total left out in calculating GDP, GDP is a an
imperfect measure of nations economic performance, w/c makes
comparison of countries economy very challenging,
• As shown in the circular flow model, the returns (income) to factors of production such as
labor, Land and capital sum up together to arrive at the amount of output produced in a
given economy per unit of time,
• In this approach, depending up on the owner of factor input, the components of GDP may
include:
ü Employment compensations payment made for labor in the form of wages and
salaries,
ü Rents payments for use of land, building and other capital input,
ü Interest income received by households on their saving deposit,
ü Profit payments made to the owner of firms in return to the output produced after
deduction of cost of production. 14
2.2. Approaches of Measuring National Income(GDP/GNP)…cond.
…Income Approach…cond.
• Aggregating together the above returns to factor input will gives national income
of an economy.
• So, to arrive at GDP, indirect business tax and depreciations are added to
national income,
Ø Indirect business tax such as sales taxes are payments that represent the
difference between what buyers pay for final product and what users
receives from excise and sales taxes,
o It is the income generated through production process but not earned by
factor owners,
Ø Hence, indirect business tax and depreciation enter the income side in the
15
process of GDP computation.
2.2. Approaches of Measuring National Income(GDP/GNP…cond.
…Income Approach…cond.
• The following table represents an example of GDP
computation for hypothetical economy using income
approach,
Table 2.1. GDP of hypothetical economy in billions of dollars
16
2.2. Approaches of Measuring National Income(GDP/GNP)
• Economists and policymakers care not only about the economy’s total
output of goods and services but also about the allocation of this
output among alternative uses,
• The national income accounts divide GDP into four broad categories of
spending as shown in the diagram on the next slide.
17
2.2. Approaches of Measuring National Income(GDP/GNP)…cond.
…Expenditure Approach…cond.
GDP
= Total output/production
= Total Income
= Total Expenditure Net exports
Consumption Government
spending by purchases
households
…Expenditure Approach…cond.
Components of Consumption(C)- consumption consists of
the values of all goods and services bought by
households,
o It is divided into three subcategories: nondurable goods,
durable goods, and services.
i) Durable goods - are goods that last a long time, such as cars, TV, various
home appliances etc,
ii) Nondurable goods- are goods that last only a short time, such as food and
` clothing and the like,
iii) Services- include the work done for consumers by individuals & firms, such
19
as haircuts, doctor visits, air travel and so on.
2.2. Approaches of Measuring National Income(GDP/GNP)
…Expenditure Approach…cond.
Example: U.S. consumption, 2008
percentage
billions of US$
of GDP
Personal consumption 10,129.90
70.1%
expenditures
Goods 3,403.20 23.6%
Durable goods 1,095.20 7.6%
Nondurable goods 2,308.00 16.0%
Services 6,726.80 46.6%
20
2.2. Approaches of Measuring National Income(GDP/GNP)…cond.
…Expenditure Approach…cond.
…Expenditure Approach…cond.
Investment (I)
Investment: Consists of spending on [the factors of
production], and/or spending on goods for
future use.
o Investment is also divided into three subcategories as:
i) business fixed investment- Spending on/purchase of/
plant and equipment that firms will use to produce
other goods & services.
ii) residential fixed investment- Spending on/purchase of/
housing units by consumers and landlords,
iii) Inventory investment- The change(increase) in the value
of all firms’ inventories of goods. If
inventories are falling, inventory
investment negative/disinvestment).22
2.2. Approaches of Measuring National Income(GDP/GNP)…cond.
…Expenditure Approach…cond.
…Expenditure Approach…cond.
U.S. investment, 2008
percentage
billion of $
of GDP
Gross private domestic 2,136.10
investment 14.8%
24
2.2. Approaches of Measuring National Income(GDP/GNP)…cond.
…Expenditure Approach…cond.
Note: Difference b/n Investment vs. Capital
percentage
billion of $
of GDP
Government consumptio 2,883.20 20.0%
n expenditures and gross
investment
28
2.2. Approaches of Measuring National Income(GDP/GNP)…cond.
…Expenditure Approach…cond.
• In summary, a GDP computation based expenditure approach could be done by
adding expenditures made on output produced in a given economy during a given
period. An illustration of this is given below using the product side of 1987 USA GDP
with its components
GDP and it components, in $ billions in 1987 for USA
29
2.2. Approaches of Measuring National Income(GDP/GNP)…cond.
• A firm’s value added is the value of its output minus the value of the
intermediate goods the firm used to produce that output.
30
2.2. Approaches of Measuring National Income(GDP/GNP)…cond.
Note:
o The value of the final product(bread) is equal to $0.75, and this is exactly equal to the sum of
all value additions at each stage of production (i.e. $0.75 = $0.12+ $0.16 + $0.32 + $0.15).
o Hence, the final value of the bread is $0.75, not $1.75(w/c exaggerated due to inclusion of
intermediate goods in to the value of final good(bread)-a double counting problem).
o Hence, in value added approach, we need carefully different b/n final and intermediate goods
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in calculating GDP.
2.3. Other National Accounts (GNP, NNP, NI, PI, DI)
Alternative to GDP, other measures are used to represent the total output produced in an
economy includes:
o Net domestic product (NDP) –It represent the value of total output of an economy
after net out depreciation, i.e. NDP=GDP – depreciation.
o Net national product (NNP)-measures the value of total output produced by a citizen
of a given country within a specified time period after subtracting the consumption of
fixed capital (depreciation) i.e. NNP=GNP – Depreciation.
o National Income (NI) – It is the total income earned by resource owner from current
production, w/c can be computed in two ways:
i. First, by summing up the factor incomes earned in producing total output,
i.e. NI=wages and salaries + proprietors income + Rental income
+corporate profit +Interest income.
i. Second, by making adjustment to NNI through subtracting indirect business
tax,
ii. i.e. NI= NNP-Indirect business tax (e.g. sales tax) ; or
• Personal income- is the amount of income that households & non corporate
businesses receive,
• It can be obtain from national income(NI) after series of adjustments:
ü First, reduces from the national income by the amount of corporate
earnings, but add payments to its share holders (retained earnings & taxes
i.e. income earned but not received),
ü Secondly, increase the national income by the amount government &
businesses pay transfers to individuals (income received, but not earned),
ü Thirdly, national income(NI) is adjusted for interest rate that households
earn rather than interest rate paid by firms,
ü Real GDP-measure these values using the prices of a base year (i.e.
Real GDP = Actual Output of current period/year X Base year price).
o Real GDP is a better measure of country’s economic wellbeing as it changes
only due to change in real out put of goods and services.
o It is not influenced by price changes since constant/base year price is used in
this case.
• For this purpose, economists usually use real GDP, to analyze country’s economic
wellbeing,
• This distinction between real & nominal can also be applied to other monetary
37
values, like wages, interest rate, money supply and demand etc).
…Nominal vs Real GDP…Cond.
Illustration:
To see how real GDP is computed, imagine we wanted to compare output in 2002 and
output in 2003 in an economy that produces two goods(apple & orange) and one
service(haircut) during these years. We could begin by choosing a set of prices, called
base-year prices, such as the prices that prevailed in 2002. Goods and services are then
added up using these base-year prices to value the different goods in both years.
39
…Nominal vs Real GDP…Cond.
40
…Nominal vs Real GDP…Cond.
Chain-Weighted Measures of GDP
o One problem with traditional “real GDP” calculations is that, since it values all
goods at base year prices, it looks like prices never change,
o As time goes on, goods whose prices go down (and quantities usually go up)
are still weighted by the old prices, and consequently get too much weight in
later years’ GDP calculations,
o The goods don’t require a large expenditure share, but if they are valued at
base year prices, it would look like a spuriously high share of GDP.
o Hence, since relative prices change over time, so the base year should be
updated periodically,
Required:
i) Calculate nominal GDP in each of the three years.
Nominal GDP is simply equal to the sum of the current year price * current year quantity
of all the goods.
Year-2006: (7*400) + (8*225) + (10*175) = 2,800 + 1,800 + 1,750 = $6,350.
Year-2007: (8*550) + (7*250) + (12*275) = 4,400 + 1,750 + 3,300 = $9,450.
Year-2008: (9*900) + (6*275) + (15*275) = 8,100 + 1,650 + 4,125 = $13,875.
42
…Nominal vs Real GDP…Cond.
…Chain-Weighted Measures of GDP…cond.
ii) Calculate Real GDP in each of the three years, using 2006 as the base year(traditional
method).
Real GDP is equal to the sum of the base year price * current year quantity of all the goods.
Year-2006: (7*400) + (8*225) + (10*175) = 2,800 + 1,800 + 1,750 = $6,350.
Year-2007: (7*550) + (8*250) + (10*275) = 3,850 + 2,000 + 2,750 = $8,600.
Year-2008: (7*900) + (8*275) + (10*275) = 6,300 + 2,200 + 2,750 = $11,250.
iii) Calculate Real GDP for 2007 and 2008 using the chain-weighted method.
o Using 2006 as the base year, we know that Real GDP is equal to nominal GDP. Thus
Real GDP in 2006 is $6,350. This gives us the starting point for the chain-weighted
method of calculating real GDP.
o To calculate chain-weighted Real GDP for 2007 we need the following four pieces of
information:
ü Year- 2006 quantities at 2006 prices: See part-i above, $6,350.
ü Year-2007 quantities at 2006 prices: See part-ii above, $8,600.
ü Year-2006 quantities at 2007 prices: (8*400) + (7*225) + (12*175) = $6,875.
ü Year-2007 quantities at 2007 prices: See part-i above, $9,450.
o Now, we calculate the growth rate of GDP using 2006 prices: (8,600 – 6,350)/6,350)*100 = 35.4%,
o Then, the growth rate of GDP using 2007 prices: (9,450 – 6,875)/6,875)*100 = 37.5%.
43
…Nominal vs Real GDP…Cond.
• The next step is to average the two growth rates as: (35.4 + 37.5)/2 = 36.45%.
This gives us the chain weighted growth rate of real GDP for 2007.
• So, to calculate 2007 Real GDP we multiply 2006 real GDP by this growth rate
as: (6,350 + (6,350*36.45%)) = $8,664.6.
44
2.5. The GDP Deflator, Consumer Price Index(CPI) and Inflation
To measuring the price level, we usually use:
– GDP Deflator
– Consumer price index (CPI)
– One measure of the price level is the GDP deflator, also called the implicit
price deflator for GDP,
– The GDP deflator reflects what’s happening to the overall level of prices in
the economy, and is defined as the ratio of nominal GDP to real GDP,
N om inal G D P
G D P deflator = 100
R eal G D P 45
…The GDP Deflator, Consumer Price Index(CPI) and Inflation…cond.
Illustration:
Ex-1: Consider our previous example of three different goods(fish, pork, and beef)
presented in the below table.
iii) Calculate the GDP Deflator for each of the three years using the information given in the
above information.
o The GDP deflator is equal to (Nominal GDP / Real GDP)*100.
o Year-2006: 100, because 2006 is the base year we know the deflator has to equal 100 even without doing any
calculations, since nominal GDP and Real GDP of the base year are exactly the same(equal).
o Year -2007: Nominal GDP 2007 / Real GDP2007* 100 = (9,450 / 8,600)*100 = 109.9.
o Year-2008: Nominal GDP 2008 / Real GDP2008* 100 = (13,875 / 11,250)*100 = 123.3 .
iv) Calculate inflation for 2007 and 2008.
o Inflation is equal to the growth rate of the GDP deflator.
o The growth rate formula is: ((Year2 –Year1)/Year1)*100.
o Year-2007: (109.9 – 100)/100)*100 = 9.9% - increase in general price level b/n 2006 & 2007.
46
o Year 2008: (123.3 – 109.9)/109.9)*100 = 12.2% - increase in general price level b/n 2007 &2008.
…The GDP Deflator, Consumer Price Index(CPI) and Inflation…cond.
Ex-2: Compute GDP Deflator and Inflation for the years 2006 to 2008 .
GDP Inflation
Nominal GDP Real GDP
deflator rate
2006 $46,200 $46,200 n.a.
2007 51,400 50,000
2008 58,300 52,000
Answer:
GDP Inflation
Nominal GDP Real GDP
deflator rate
2006 $46,200 $46,200 100.0 n.a.
2007 51,400 50,000 102.8 2.8%
2008 58,300 52,000 112.1 9.1% 47
…The GDP Deflator, Consumer Price Index(CPI) and Inflation…cond.
Ex: If your hourly wage rises 5% and you work 7% more hours, then
your wage income rises approximately 12%.
2. Percentage change in (X/Y ) percentage change in X percentage
change in Y
48
…The GDP Deflator, Consumer Price Index and Inflation…cond.
Consumer Price Index (CPI)
• CPI- measure the current cost/price/ of a fixed basket of goods & services
purchased by a typical consumer relative to the same basket of goods and
services in some base year,
• It is the most commonly used price index to measure the general price level of
an economy,
• The Consumer Price Index (CPI) turns the prices of many goods and services
into a single index measuring the overall level of prices,
• The formula for calculating the price index is:
cost of basket in current year
CPI = 100
cost of basket in base year
• Inflation rate-is the percentage change in the price index from the
preceding period.
C P I Year 2 - C P I Year 1
in fla tio n ra te = 100% 49
C P I Year 1
…The GDP Deflator, Consumer Price Index(CPI) and Inflation…cond.
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
Example: Assume that consumer's basket contain two goods Pizza and Compact Disks.
Assume that the quantity consumed by a household during each period is 20 pizzas &
10 compact discs) as shown in the table below:
prices:
Year pizza CDs
2002 $10 $15
2003 $11 $15
2004 $12 $16 50
2005 $13 $15
…The GDP Deflator, Consumer Price Index(CPI) and Inflation…cond.
Note: Do the same thing for other years. The answer is given in the below table.
Cost of Inflation
basket CPI rate
2002 $350 100.0 n.a.
2003 370 105.7 5.7%
2004 400 114.3 8.1%
2005 410 117.1 2.5% 51
Trend of CPI and Inflation rate in Ethiopia-2016/17
52
…The GDP Deflator, Consumer Price Index(CPI) and Inflation…cond.
– Substitution bias: The CPI uses fixed weights, so it cannot reflect consumers’ ability to
substitute toward goods whose relative prices have fallen.
– Introduction of new goods: The introduction of new goods makes consumers better off and,
in effect, increases the real value of the dollar/birr; 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/birr,
but are often not fully measured.
54
The Two Measures of Inflation Using GDP Deflator and CPI- (U.S. 1950-2005).
from 12 months earlier
Percentage change
55
2.6. Inflation and Unemployment
In previous sections, we have seen how to measure the value of output produced in
an economy with different parameters such as GDP and others income measures,
In this section, we will consider other measures of performance of the economy such
as:
ü inflation
ü unemployment.
Inflation:
Ø Inflation- is defined as a sustained rise in the general level of prices,
• First, the increase in price must be a sustained one, and it is not simply a
once for all increase in prices.
57
…Inflation and Unemployment…cond.
Cause of inflation
(i) Demand pulls inflation –according to demand pull theory of inflation
inflation results from a rapid increase in demand for goods & services than supply of
goods and services (fixed level of goods and services supplied).
But, why aggregate demand may increase rapidly than aggregate supply? There are
two different views on this:
i) Classical View of Demand Pulls Inflation
ii) Keynesian View of Demand Pulls Inflation
ü Increase in money supply → increase demand for new investment → rises aggregate
demand for goods & services → upward shift in aggregate demand curve(say from AD0
to AD1).
(see fig on the next slide)
58
…Inflation and Unemployment…cond.
üThe Aggregate Demand(AD) or what firms & gov’t would like to purchase Y1 amount
of goods & services,
üThis create excess demand of Y1-Ῡ in the economy, and
üThis excess demand causes the overall price to rises from P 0 to P 1 , and cause
inflation in the economy.
59
…Inflation and Unemployment…cond.
o The central bank may expand money supply for various reasons such as:
61
…Inflation and Unemployment…cond.
…Keynesian View of Demand Pull Inflation…cond.
Fig. Keynesian view of Demand-Pull Inflation
When the value of aggregate demand exceeds the
value of aggregate supply at the full employment level,
the inflationary gap arises,
62
…Inflation and Unemployment…cond.
…Keynesian View of Demand Pull Inflation…cond.
ü But, this time, much less is produced than in the previous shift( as diminishing returns might
also set in some industries), and the price level has risen from P2 to P3, a much higher
increase in price than in the previous shift,
The graph in the previous slide illustrate the Keynesian view of demand pull inflation, and
shows that:
ü increased employment results in increased aggregate demand (AD), which leads to
further hiring by firms to increase output,
ü Due to capacity constraints, this increase in output will eventually become so small
that the price of the good will rise,
ü At first, unemployment will go down, shifting AD1 to AD2, which increases demand
(noted as "Y") by (Y2 - Y1),
ü This increase in demand means more workers are needed, and then AD will be shifted
from AD2 to AD3,
ü This increase in price is called inflation.
63
…Inflation and Unemployment…cond.
üAt times, price may not decline, even though aggregate demand decline (ex. 1958
recession in western economies),
üThese conditions which are not demand side factors are explained by supply side
factors.
64
…Inflation and Unemployment…cond.
o As a result, many developing economies are characterized by high rate of inflation with large
scale of unemployment(stagflation),
oTherefore, anti inflationary policies based on the standard theories have very little impact to
reduce inflation in developing economies.
o Hence, it is important to identify the factors which result in inflationary condition in developing
economics before we design and implement anti inflationary policies,
o That is why a search for appropriate explanation to inflation in less developed countries led to
the emergence of a new school of economists called the structuralists theories of
inflation. 67
…Inflation and Unemployment…cond.
…Cost Push (supply side) factors…cond.
According to the structuralist view, inflation in developing economies is caused mainly by the
structural imbalances in these economies.
o Resources imbalance – like surplus labor and extremely scarce capital, budget deficit
w/c cause gab b/n supply & demand for goods & services, etc
o Foreign exchange bottle necks- export are limited (due to limited exportable items,
high cost of production, low quality of export items, and low competitiveness; while
import is high. This cause huge trade deficit( Import > Export),
68
…Inflation and Unemployment…cond.
q In the 1970s, Keynesian economists had to reconsider their beliefs as the U.S.
and other industrialized countries entered a period of Stagflation- defined as a
simultaneous incidence of:
ü Slow economic growth
ü high unemployment,
ü High inflation rate.
q The US economy in 1970s was largely characterized
ü High oil price
ü Inflation
ü Unemployment 71
ü Recession.
Hyperinflation
q def: 50% per month
q All the costs of moderate inflation described German Hyperinflation
above become huge under hyperinflation.
q Money ceases to function as a store of value,
and may not serve its other functions (unit of
account, medium of exchange).
q People may conduct transactions with barter
or a stable foreign currency.
What causes hyperinflation?
¡ Hyperinflation is caused by excessive
money supply growth:
¡ When the central bank prints money, the
price level rises.
¡ If it prints money rapidly enough, the
result is hyperinflation.
72
Hyperinflation…cond.
Money and Prices in Brazil, 1985-
1995 Consumer Prices in Zimbabwe, 1999-2008
73
Deflation vs Disinflation
q Deflation- is a decrease in the general
price level of goods and services,
q Deflation occurs when the inflation
rate falls below 0% (a negative inflation Japan’s Lost Decade: Deflation
rate say -1%, -2% etc),
76
…Inflation and Unemployment…cond.
Unemployment
As discussed in the preceding chapter, ensuring full level employment
is one of the major macroeconomic goals,
Unemployment- is a situation in which able bodied persons willing to work at
prevailing wage rate do not able to find job,
People in economically active age group are divided in to three major
categories: These are:
i. Employed- working at a paid job or self employment,
ii. Unemployed- not employed, available for work, looking for work,
iii. Not in labor force- not employed, not looking for work.
Labor Force- the amount of labor available for producing goods and
services; all employed plus unemployed persons.
77
…Inflation and Unemployment…cond.
…Unemployment…cond.
Two important labor force concepts:
ü unemployment rate- percentage of the labor force that is unemployed,
ü labor force participation rate- the fraction of the adult population that
“participates” in the labor force
78
…Inflation and Unemployment…cond.
…Unemployment…cond.
Use the above data to calculate
i. the labor force
ii. the number of people not in the labor force
iii. the labor force participation rate
iv. the unemployment rate
Answer:
Data: E = 138.9, U = 15.1, Adult Pop = 236.3
i) labor force
L = E +U = 138.9 +15.1 = 154.0
ii) not in labor force
NILF = POP – L = 236.3 – 154.0 = 82.3
iii) unemployment rate
U/L x 100% = (15.1/154.0) x 100% = 9.8%
iv) labor force participation rate
L/POP x 100% = (154.0/236.3) x 100% = 65.2%
79
…Inflation and Unemployment…cond.
Required:
i) Compute the percentage changes in the labor force participation rate.
= Percentage change in (X/Y ) percentage change in X percentage change in Y
= 3% -1% = 2%
80
…Inflation and Unemployment…cond.
Types of unemployment
• Frictional unemployment - temporary and quickly wiped out through an automatic
process of market mechanism and adjustment (time taken to
match workers with job due to information or geographic
barriers),
• Structural unemployment – arises due to:
ü structural change in dynamic economy- say from agriculture to industry, from
labor intensive to technology intensive etc,
ü wage rigidity- due to minimum wage law, unions & collective
bargaining, efficiency wage( w/c is meant to promote
better nutrition & health, reduce employee turnover,
reduce adverse selection and moral hazards ), etc.
• Cyclic unemployment- is associated with short run fluctuation of the economy,
where workers become unemployed for some period when
their job evaporates due to recession and returns to job
when there is expansion in economic activities.
Note: High unemployment rate means underutilizations of resources, and hence
production of less goods and services(decreases the real GDP of an
economy, w/c in turn affect the wellbeing of citizens).
81
…Inflation and Unemployment…cond.
u t u t 1 0.4 ( g yt 3%)
Okun’s Law: The below figure shows the Relationship Between
Unemployment and GDP Growth/output
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OKUN’S LAW- THE RELATION BETWEEN OUTPUT, UNEMPLOYMENT, AND INFLATION..COND
Okun’s Law
ut ut 1 0.4( g yt 3%)
If g yt 3% , then ut ut 1 0.4( ) 0
If g yt 3% , then ut ut 1 0.4( ) 0
If g yt 3% , then ut ut 1 0.4(0) 0
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OKUN’S LAW- THE RELATION BETWEEN OUTPUT, UNEMPLOYMENT, AND INFLATION..COND
Okun’s Law
ut ut 1 0.4( g yt 3%)
According to the equation above, output growth 1% above normal
leads only to a 0.4% reduction in unemployment, for two reasons:
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OKUN’S LAW- THE RELATION BETWEEN OUTPUT, UNEMPLOYMENT, AND INFLATION..COND
Okun’s Law
12/1/2015
ut ut 1 0.4( g yt 3%)
ut ut 1 ( g yt g y )
g yt g y ut ut 1
g yt g y ut ut 1
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OKUN’S LAW:
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12/1/2015
…Inflation and Unemployment…cond.
o the curve suggests that less unemployment can always be attained by incurring more inflation ,
o inflation rate can always be reduced by incurring the costs of more unemployment.
o in other words the curve suggests there is a trade-off between inflation and unemployment.
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1. Gross Domestic Product (GDP) measures both total income and
total expenditure on the economy’s output of goods & services.
2. Nominal GDP values output at current prices;
real GDP values output at constant prices. Changes in output
affect both measures,
but changes in prices only affect nominal GDP.
3. GDP is the sum of consumption, investment, government
purchases, and net exports.
4. The overall level of prices can be measured by either
– the Consumer Price Index (CPI),
the price of a fixed basket of goods
purchased by the typical consumer, or
– the GDP deflator,
the ratio of nominal to real GDP
5. The unemployment rate is the fraction of the labor force that is not
employed. 89