Issues in Economics Today 8th Edition Guell Solutions Manual Download

Chapter 6
Every Macroeconomic Word You Ever Heard: Gross

Domestic Product, Inflation, Unemployment, Recession
and Depression
Solution Manual for Issues in Economics Today
8th Edition Guell 1259746399 9781259746390
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Learning Objectives
After reading this chapter you should be able to:
LO1 Define the basic vocabulary of macroeconomics.
LO2 Describe how the economy is measured.
LO3 Describe how gross domestic product, our national measure of output, is
calculated.
LO4 Calculate inflation using a price index.
LO5 Describe real gross domestic product as the inflation-adjusted value of

economic activity and judge its use as the measure of the economy’s health.
LO6 Describe how unemployment is measured and enumerate the types of

unemployment that economists recognize.
LO7 Define and apply the vocabulary of the business cycle.
Chapter Outline
Page 1
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 Measuring the Economy
 Real Gross Domestic Product and Why It Is Not Synonymous with Social
Welfare
 Measuring and Describing Unemployment Productivity 
 Seasonal Adjustment 
 Business Cycles
 Kick It Up a Notch: National Income and Product Accounting
Page 2
Microeconomics vs. Macroeconomics
 Microeconomics: that part of the discipline of economics that deals with
individual markets and firms
 Macroeconomics: that part of the discipline of economics that deals with the
economy as a whole
Teaching Tips
1) Emphasize the prefixes “micro” and “macro” and their everyday uses.
2) Go through some issues in the news and let students discuss whether they are primarily
“micro” or “macro”.
MEASURING THE ECONOMY

Gross Domestic Product
 Gross Domestic Product: the dollar value of all of the goods and services
produced for final sale in the United States in a year
o “Final Sale” avoids double counting of intermediate production.
o “Sale” implies exclusively market activities.
o “Produced...in the United States” implies that Hondas produced in the US
count but Fords produced in Mexico do not.
How Does It Count in GDP? A Good Produced in One Year and Sold the
Next
 GDP counts the value of the product made but not yet sold as an increase to
business INVESTMENT (I), of which inventories are a part.
o When it is made, investment goes up.
o When it is sold, investment drops but either CONSUMPTION (C) or
EXPORTS (X) go up.
Teaching Tip
1) Explain the following equation: GDP=C+I+G+(X-M)
a. When something is made but not sold it goes into inventories.
b. When it is sold, it comes out of I and into either C or X.
Page 3
How Does It Count in GDP? A Used Car
 The only part of a used car sale that counts is the markup from its purchase price
from the previous owner to the sale to the next owner.
 That is the value the used car dealer created in cleaning and preparing the car for
sale.
Teaching Tips
1) Explain that the only things “produced” in the sale of a used car are the services of the used
car dealer.
2) Let students discuss what used car operations produce (in that context). Make sure you
include cleaning/preparing/repairing and retailing services.
How Does It Count in GDP? Stock Sales

 The sale of an already existing share of stock doesn’t count.
 It is only when a business uses the sale of (initial public offering) stock to raise
money to buy equipment and inventory that there is any crossover.
Teaching Tip
Make sure students understand the economist’s notion of investment is NOT the same as the financial
adviser’s notion of investment.
How Does It Count in GDP? Illegal Drug Sales

 The simple answer is they aren’t.
 It isn’t because they shouldn’t be counted.
 Only recorded sales that are part of the system of business reporting to state and
federal governments count.
Teaching Tips
1) Let students discuss their cash earnings (babysitting, lawn mowing).
2) Note that selling illegal drugs and selling babysitting services are similar in that they are
rarely reported, and as a result they are uncounted.
Measuring Prices
 Market Basket: what average people buy and in what quantities they buy it
 Base Year: year in which the market basket is established and year to which all
other prices are compared
 Price of the Market Basket in the Base Year: national average of the total cost
of the market basket for the first month in the first year.
Page 4
Price Index
 Price Index: a device that centers the price of the market basket around 100
 Consumer Price Index: the price index based on what average consumer’s buy
𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑀𝑎𝑟𝑘𝑒𝑡 𝐵𝑎𝑠𝑘𝑒𝑡 𝑖𝑛 2015

𝐶𝑃𝐼 𝑖𝑛 2015 = × 100
𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑀𝑎𝑟𝑘𝑒𝑡 𝐵𝑎𝑠𝑘𝑒𝑡 𝑖𝑛 𝑡ℎ𝑒 𝐵𝑎𝑠𝑒 𝑌𝑒𝑎𝑟 𝑜𝑓 1998
Teaching Tips
1) Have students imagine “the world’s largest Walmart Supercenter” where they could buy
everything they buy in a year.
2) Mathematically challenged students will need you to spell out the sub- and superscripts so
they know what they mean.
Measuring Inflation
Inflation Rate: the percentage increase in the consumer price index
𝐶𝑃𝐼 𝑜𝑛 𝐽𝑎𝑛𝑢𝑎𝑟𝑦 1, 2016−𝐶𝑃𝐼 𝑜𝑛 𝐽𝑎𝑛𝑢𝑎𝑟𝑦 1, 2015

𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 𝑑𝑢𝑟𝑖𝑛𝑔 2015 = × 100%
𝐶𝑃𝐼 𝑜𝑛 𝐽𝑎𝑛𝑢𝑎𝑟𝑦 1, 2015
Teaching Tip
Do not be surprised if students have forgotten how to do percentage increases.
Problems Measuring Inflation

 Changes in the market basket occur every two years which is too infrequent for
some goods (like consumer electronics).
 The treatment of improvements in the quality of goods is inadequate.
 People frequently change the places they buy goods and services.
 There is no accounting for substitutions.
Page 5
Bureau of Labor Statistics Adjustments
 The BLS is dealing with
o consumer electronics issues by pricing an index of quality rather than a
specific item.
o the “infrequent updates problem” by moving to a two-year chain-based index,
a price index that is based on a biannually adjusted market basket.
 The CPI still overstates the cost-of-living by 0.8%.
Teaching Tips
1) Note that computer quality is indexed but food quality (especially meats, vegetables, and
fruits) has increased substantially over the last 40 years without any adjustments.
2) Ask students where they would buy a TV (they will likely answer Sam's, Walmart, Best Buy,
etc.). If you are over 50, note where your family bought its first color TV (likely a relatively
expensive electronics store).
3) Note that there are many substitutes for goods and that an increase in the price of one good
can have little impact on a family’s cost of living, if a perfectly acceptable substitute does not
increase in price.
4) Let students discuss the impact of reducing COLAs by .8 percentage points.
Alternative Measures of Inflation

 Core CPI: the consumer price index that has had the impact of food and energy
costs removed
 Personal Consumption Expenditures Deflator: a chain-based price index that
adjusts for the substitution problem
 Core PCE: the Personal Consumption Expenditures Deflator that has had the
impact of food and energy costs removed
 Producer Price Index: a price index based on what firms buy
Teaching Tip
Note that the Federal Reserve uses the Core PCE to measure inflation because it is the most stable and
most indicative of systemic inflationary pressures.
Page 6
Figure 6.1
CPI, core CPI, and core PCE.
Page 7
Table 6.1
CPI and inflation in selected years, 1920-2015; base Years 1982-1984.
Year CPI Inflation Rate
1930 16.1
1950 25.0
1970 39.8
1990 134.2 6.3
1995 153.9 2.5
2000 174.6 3.4
2005 198.1 3.3
2010 220.5 1.4
2015 237.8 0.7
*Abridged; complete table found on page 83.
Cost of Living Adjustments

 Cost of Living Adjustment or COLA: a device that compensates people for the
fact that inflation makes the spending power of their income less
Teaching Tip
Students may be familiar with COLAs if they live in union households and have a parent with a COLA-
tied contract. Refer to the Social Security COLAs.
Inflation’s Winners and Losers

 Losers
o People on fixed incomes
o Lenders
 Winners
o Borrowers
Interest and Expected Inflation

 If inflation exceeds expectations, then borrowers win and lenders lose.
 If inflation is less expectations, then borrowers lose and lenders win.
Page 8
REAL GROSS DOMESTIC PRODUCT AND WHY IT IS NOT
SYNONYMOUS WITH SOCIAL WELFARE
Real Gross Domestic Product
 Real Gross Domestic Product: an inflation adjusted measure of GDP
 GDP Deflator: the price index used to adjust GDP for inflation, including all
goods rather than a market basket
𝐺𝐷𝑃
𝑅𝐺𝐷𝑃 = × 100
𝐺𝐷𝑃 𝐷𝑒𝑓𝑙𝑎𝑡𝑜𝑟
Teaching Tips
1) RGDP is calculated by taking the sum of
a. current production of goods and services times their previous year prices across different
goods and services, and
b. current production of new goods and services times the current year prices for all new
goods and services.
2) This process is different from that which creates the CPI in that the market basket changes from year
to year, so the choice of a base year is somewhat arbitrary.
3) This measure still allows for a comparison of total production from one year to the next while
eliminating the effects of inflation.
4) Economists feel more comfortable computing inflation using the GDP deflator approach (which is
the annual percentage increase in the GDP deflator) than the CPI approach (which is the annual
percentage increase in the CPI).
Page 9
Figure 6.2
Post-World War II real gross domestic product
by quarter, billions of 2009 dollars.
Teaching Tip
Note that the dips are recessions and that the trend is steadily higher.
Page 10
Problems with RGDP
 GDP only counts market sales so it ignores home production.
 GDP ignores the value of leisure.
 GDP ignores the composition of output.
 GDP should be a per capita measure.
 GDP ignores environmental measures.
 GDP ignores the “underground economy”.
Teaching Tips
1) Note that paying someone to clean you house counts in GDP, but cleaning it yourself doesn’t.
2) Note that people who are forced to work involuntary overtime are, by definition, worse off
with more money.
3) Note that money spent on socially unhealthy items counts the same as socially healthy items.
(A dollar spent by an alcoholic at a bar counts the same as a dollar spent by a nun at a
religious bookstore.)
4) Note that the population of the U.S. has increased by almost 90% in the last half-century and
that an increase of that amount in RGDP would be necessary to keep the per-capita figure
constant.
5) Note that producing a good at a substantial environmental cost could make us worse off but
RGDP would rise. Let students discuss the tradeoff.
6) Note that upwards of 10% of the economy is not measured because it is not reported. Note that
the accounting is done via sale tax receipts and other government reports, so a payment by an
addict to a dealer doesn’t count and neither does the lawn-mowing money they earned as a
kid.
MEASURING AND DESCRIBING UNEMPLOYMENT

Measuring Unemployment
 Labor Force: all those non-military personnel who are over 16 and are employed
or are unemployed and actively seeking employment
 Unemployment Rate: the percentage of people in the work force who do not
have jobs and are actively seeking them
Teaching Tip
Stress that the unemployment rate is a civilian one.
Labor Force Participation Rate

 The percentage of the civilian, noninstitutionalized population that is either
employed or searching for a job
Teaching Tip
Stress that the labor force participation rate reflects not only the health of the economy, but
demographic and social trends. It will usually rise when the economy is healthy (because people will be
attracted to looking for work when there are opportunities). It will also rise when there are large
numbers of people moving into their prime working years or when social trends cause people to work
outside the home.
Page 11
Figure 6.3
Labor force participation rate.
Increases and Decreases in the Labor Force Participation Rate

 Increases 1948 to 2000
o Almost entirely because it rose for women (Age 25-54; from 34% to 77%)
 Decreases 2000 to today
o Fallen for two reasons
• An aging population - more retirees
• It is falling for prime age (25-54)
 men (91%  88%)
 women (77%  74%)
Teaching Tips
1) Stress that the small changes in the labor force participation rate during this period reflected
the health of the economy.
2) Note that the big trends in the data (the rise from 1963 to 2000 and the subsequent fall from
2000 to the present) are explained by social trends (women entering the labor force) and
demographic social trends (baby boomers retiring).
Page 12
Problems Measuring Unemployment
 Underemployed: the state of working significantly below skill level or working
fewer hours than desired
 Discouraged Worker Effect: when bad news induces people to stop looking for
work causing the unemployment rate to fall
 Encouraged Worker Effect: when good news induces people to start looking for
work causing the unemployment rate to rise (until they succeed in finding work)
Figure 6.4
Post-World War II unemployment rates;
the civilian unemployment rate (UR) and the rate as they would be
if we include discouraged workers (DW) and the underemployed.
Teaching Tips
1) Let students discuss the types of underemployment they have seen.
2) Use a numerical example to illustrate the discouraged and encouraged worker effects.
Page 13
Types of Unemployment
 Cyclically Unemployed: people lose their jobs because of a temporary downturn
in the economy
 Seasonally Unemployed: (a subset of the cyclically unemployed) people who
lose their jobs predictably every year at the same time
 Structurally Unemployed: people who lose their jobs because of a change in the
economy that makes their particular skill obsolete
 Frictionally Unemployed: people who are unemployed for a short time in the
transition to an equal or better job
Teaching Tip
Let students discuss each type of unemployment by having them provide examples.
PRODUCTIVITY
Measuring and Describing Productivity
 Labor Force Productivity: the total amount of output per worker hour
 Total Factor Productivity (or multifactor productivity): the increase in output
that cannot be explained by an increase in labor, capital, or materials
Page 14
Figure 6.5
Annual Changes (AC) and Five-year Moving Averages (5 yr MA)
of Labor Productivity and Multifactor Productivity.
Teaching Tips
1) It is, by far, easier to explain the concept of labor productivity.
2) The data is volatile in year-to-year changes so use the 5-year moving average.
3) Note that this measure LP-5yr MA was high in the 50s and 60s, decreased in the 70s,
increased through the 90s and fell over the last 20 years.
SEASONAL ADJUSTMENT
 Seasonal adjustment takes into account predictable, calendar-based changes.
o Christmas shopping season and retail employment
o Weather-related employment and fresh food prices
o Gasoline prices and yearly short-term changes due to refinery maintenance
Teaching Tip
Let students discuss seasonal adjustment by listing industries in which the adjustment is likely most
important.
Page 15
BUSINESS CYCLES
 Business Cycle: regular pattern of ups and downs in the economy
 Trough: the lowest point in the business cycle
 Recovery: the part of the growth period of the business cycle from the trough to
the previous peak
 Expansion: the part of the growth period of the business cycle from the previous
peak to the new peak
 Peak: the highest point in the business cycle
 Recession: the declining period of at least two consecutive quarters in the
business cycle
Drawing Tip
Draw a sine wave with an upward trend.
Teaching Tip
Label the parts of the cycle as you draw.
Page 16
Figure 6.7
An example of three business cycles; 1981 to 2008.
If Inflation is Bad, How Can Deflation be Worse?

 With deflation
o people delay buying big ticket items when they are certain it will be cheaper if
they are patient.
o If they delay buying
• then demand for those goods will fall.
• firms will cut costs by cutting wages and benefits, or by laying people
off.
• when profits decline, the value of stocks decline. With less wealth,
stockholders spend less on consumer goods.
• housing prices may decline. Purchases that are made using home
equity decline.
Teaching Tip
Describe this process in terms of a vicious cycle. The tendency in most economics is to explain things in
terms of modulations around an equilibrium. Not all economic phenomena are self-modulating.
Depression
 Depression
o There is no generally accepted standard but most are characterized by a
severe recession that results in a financial panic and bank closures,
unemployment rates exceeding 20%, prolonged retrenchment in RGDP on
the magnitude of ten percent or more, and significant deflation.
Page 17
KICK IT UP A NOTCH: NATIONAL INCOME AND PRODUCT
ACCOUNTING
Teaching Tip
Explain the difference between the following:
a. Expenditures Approach: GDP is measured by adding up purchases (consumption, investment,
government spending, net exports)
b. Income Approach: GDP is measure by adding up ways money is made
(wages, salaries, tips, interest, dividends, rents, etc.)
Alternative Calculations for Gross Domestic Product in Billions, 2014.

Expenditures Approach Amount Income Approach Amount
Personal Consumption $12,061.4 Employee $9,434.7
Compensation
Gross Private Investment $2,937.2 All Profits $4,489.4
Government Consumption and $3,162.5 Indirect Business Taxes $1,169.5

Investment Expenditures
Net Exports -$545.2 Depreciation $2,784.2
Statistical Discrepancy -$261.8
Gross Domestic Product $17,615.9 Gross Domestic *$17,616
Product
*Rounding error
Page 18
End of Chapter Questions
Quiz Yourself
1. In measuring gross domestic product, goods produced by foreign firms in the United
States are
a) counted, and so are goods produced by American firms in foreign countries.
b) counted, but goods produced by American firms in foreign countries are not
counted.
c) not counted, but goods produced by American firms in foreign countries are
counted.
d) not counted, and goods produced by American firms in foreign countries are also
not counted.
Explanation: This means that Ford automobiles produced in Mexico are not counted in
the U.S. GDP, but Honda automobiles produced in Ohio are counted in the U.S. GDP.
2. Gross domestic product is counted using two methods: one which counts all the ways
people _____ money and another which counts all the ways people _____ money.
a) earn, spend
b) spend, save
c) earn, save
d) loan, borrow
Explanation: The computation of the GDP is done in two distinct ways. One way is to
count all those things for which people pay money. This is called the expenditures
approach. The expenditures approach adds up all of the following: consumption,
investment, government spending on goods and services, and net exports (net exports =
exports – imports). The other approach, which counts all those ways in which people earn
money, is called the income approach.
3. Inflation is measured using _________ in a price index.

a) the absolute increase
b) a multiyear weighted average increase
c) the percentage year-to-year increase
d) logarithm-adjusted absolute increase
Explanation: The inflation rate is the percentage increase in the consumer price index.
Page 19
4. In early 2005, inflation increased unexpectedly due to an increase oil prices. This
helped
a) borrowers.
b) lenders.
c) people on fixed incomes.
d) workers.
Explanation: If inflation is greater than was expected when the interest rate on a loan was
established, then borrowers are winners because they are paying the loan back using less
valuable dollars than they anticipated.
5. The consumer price index (CPI) is a heavily criticized measure of inflation because
a) the government does nothing to fix its known deficiencies.
b) it consistently understates the increase in the cost of living.
c) it consistently overstates the increase in the cost of living.
d) the government constantly makes adjustments in it without warrant.
Explanation: Economists have argued for many years that the CPI overstates the cost of
living. The degree of that overstatement has been the subject for significant economic
research. Part of the problem in resolving the agreed-upon problems is that any correction
has the effect of reducing Social Security checks and increasing taxes.
6. One problem with using real gross domestic product as a measure of social welfare is
that
a) it fails to count home production.
b) it fails to count services, a growing part of the economy.
c) it double, triple, and sometimes quadruple counts goods that are produced in
stages.
d) it fails to account for imports, a growing part of the economy.
Explanation: One reason that real gross domestic product is not synonymous with social
welfare is because it does not count do-it-yourself production. Second, real GDP does not
see that leisure is valuable. Third, what people buy is not considered important in the
computation of GDP. Fourth, growth in the population can change the per capita real
GDP, and fifth, although we can sacrifice environmental quality of life for economic
gain, we would not necessarily be better off.
7. In 2005, General Motors announced a 20 percent reduction in its staffing levels and the
closure of many assembly plants. Those laid off as a result would likely be classified as
a) seasonally unemployed.
b) cyclically unemployed.
c) frictionally unemployed.
d) structurally unemployed.
Explanation: If people lose their jobs because of a change in the economy that makes
their particular skill obsolete (either because the industry ceases to exist or because it
moves to another country), they are referred to as structurally unemployed.
Page 20
8. On a graph of real gross domestic product over time, recessions appear as
a) relatively short and shallow drops on an otherwise increasing path.
b) long, sharp declines on an otherwise increasing path.
c) the dips on a path that increases and decreases equally.
d) the periods where the rate of growth, while still positive, slows.
Explanation: Traditionally, a recession has been defined as a period of at least two
consecutive quarters when the real GDP falls, which results in a negative growth rate.
9. Of these, economists consider this the worst:

a) inflation of 5 percent.
b) recession.
c) deflation of 5 percent.
d) depression.
Explanation: A depression is a severe recession typically resulting in a financial panic
and bank closures, unemployment rates exceeding 20 percent, prolonged retrenchment in
real GDP on the magnitude of 10 percent or more, and significant deflation.
Short Answer Questions
1. Explain why an economist would focus on real GDP rather than nominal GDP.
2. Suppose you walked into an unemployment office and found the following people: a
laid-off mall Santa Claus, an unemployed auto-industry worker (who is subject to
callback by their company), a woman who lost her job at a manufacturer because the
company relocated to Mexico, and a nurse who just moved to town because his wife
recently started a new job. Assign the following labels to the people above: cyclically
unemployed, frictionally unemployed, structurally unemployed, and seasonally
unemployed. Then, explain your assignment of the terms to each person.
Think about This

Economists have argued for many years that the CPI overstates the cost of living. The
degree of that overstatement has been the subject for significant economic research. Part
of the problem in the resolving the agreed upon problems is that any correction has the
effect of reducing Social Security checks and increasing taxes. Should economic
measures be subject to political debate?
Talk about This

Economist Joseph Schumpeter once argued that people are too often lulled into an
unproductively comfortable state when they have continuous employment. His
conclusion was that recessions (more accurately, depressions, in his era) were good
because they forced people to be creative and entrepreneurial. He labeled this “creative
destruction.” Do you agree with the premise of his argument? Do you agree with his
conclusion?
Page 21

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Issues in Economics Today 8th Edition Guell Solutions Manual Download

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Chapter 6

Every Macroeconomic Word You Ever Heard: Gross

After reading this chapter you should be able to:

LO1 Define the basic vocabulary of macroeconomics.

LO2 Describe how the economy is measured.

LO4 Calculate inflation using a price index.

LO5 Describe real gross domestic product as the inflation-adjusted value of

LO6 Describe how unemployment is measured and enumerate the types of

LO7 Define and apply the vocabulary of the business cycle.

MEASURING THE ECONOMY

How Does It Count in GDP? Stock Sales

How Does It Count in GDP? Illegal Drug Sales

𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑀𝑎𝑟𝑘𝑒𝑡 𝐵𝑎𝑠𝑘𝑒𝑡 𝑖𝑛 2015

𝐶𝑃𝐼 𝑜𝑛 𝐽𝑎𝑛𝑢𝑎𝑟𝑦 1, 2016−𝐶𝑃𝐼 𝑜𝑛 𝐽𝑎𝑛𝑢𝑎𝑟𝑦 1, 2015

Problems Measuring Inflation

Alternative Measures of Inflation

Cost of Living Adjustments

Inflation’s Winners and Losers

Interest and Expected Inflation

MEASURING AND DESCRIBING UNEMPLOYMENT

Labor Force Participation Rate

Increases and Decreases in the Labor Force Participation Rate

If Inflation is Bad, How Can Deflation be Worse?

Alternative Calculations for Gross Domestic Product in Billions, 2014.

Government Consumption and $3,162.5 Indirect Business Taxes $1,169.5

3. Inflation is measured using _________ in a price index.

9. Of these, economists consider this the worst:

Short Answer Questions

Think about This

Talk about This

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