# Ch8.1 - CHAPTER 8 1 The Natural Rate of Unemployment and...

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C HAPTER 8 h N t l R t f The Natural Rate of Unemployment and the Phillips urve 1 Curve

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I NFLATION RATE 2
1.1 I NFLATION | What is inflation rate? ± The inflation rate is the rate at which the price level increases. ± π t =(P t -P t-1 )/P t-1 where (P t –P t-1 ) represents the change in the price level from date t-1 to date t. | In this chapter, inflation is simply referred to as inflation rate and unemployment is referred to as unemployment rate. 3

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1.2 P RICE I NDEXES | A price index is a measure of the average level of prices for some specified set of goods and services. | The GDP deflator is a price index that measures the overall level of prices of goods and services included in GDP. | It is defined as the ratio of nominal GDP to real GDP in year t: t t \$Y GDP Nominal P = = 4 t t t Y GDP Real
P RICE I NDEXES | The rate of change in the GDP deflator equals the rate of inflation. | The GDP deflator measures the average price of goods and services produced in the domestic economy, while the consumer price index, or CPI , measures the average price of goods and services consumed by the average household. | reference_cpi.pdf 5

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P RICE I NDEXES | An increase in the price of goods bought only y firms or the government will show up in the by s o t e go e e t s o up t e GDP deflator but not the CPI. DP deflator includes only those goods | GDP deflator includes only those goods produced domestically. Imported goods are ot part of GDP and do not show up in the not part of GDP and do not show up in the GDP deflator. For example, an increase in the rice of a Toyota made in Japan and sold in price of a Toyota made in Japan and sold in the US affects the CPI, but not the GDP eflator deflator. 6
P RICE I NDEXES | Figure 2-4 yields two conclusions. he CPI and the GDP deflator move together ± The CPI and the GDP deflator move together most of the time. In most years, the two flation rates differ by less than 1% inflation rates differ by less than 1%. ± However, in both 1974 and in the late 1970s, e increase in the CPI was significantly larger the increase in the CPI was significantly larger than the increase in the GDP deflator, because e price of imported goods increases faster the price of imported goods increases faster than the GDP deflator. 7

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P RICE I NDEXES 8 Figure 2-4 Inflation Rate, Using the CPI and the GDP Deflator since 1960
1.3 W HY D O E CONOMISTS C ARE A BOUT I NFLATION ? | Economists care about inflation for two r asons: easo s ± During periods of inflation, not all prices nd wages rise proportionately In this and wages rise proportionately. In this sense, inflation affects income distribution. igh inflation tends to be volatilie and this ± High inflation tends to be volatilie and this creates uncertainty and undermines the ay in which price conveys information way in which price conveys information.

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## This note was uploaded on 02/19/2011 for the course ECON 1021 taught by Professor Kokwanwai during the Fall '08 term at CUHK.

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Ch8.1 - CHAPTER 8 1 The Natural Rate of Unemployment and...

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