Sunday, January 03, 2010

AP Economics: 4 January 2010 (Chapter 16)

Prayer (alphabetical):

Current Events:

The Farmers Market in a Down Economy, Missoula, MT; in a down economy many people buy local; they buy American. A number of Farmers Markets do acceptably well in a recession.

A Preliminary Quiz Analysis page and grades have been posted for the Ch. 15 True/False Quiz. The Answer Key will be posted after everyone takes the Quiz for additional study.

We will pick up where we left off: Ch. 16, PowerPoint presentation and Handout Ch. 16 question.

Chapter 16

Measuring Inflation and Unemployment

Chapter Overview

In this chapter students will learn how to define and measure both inflation and
unemployment. Some cautions about evaluating the statistics are also presented, in
particular the issue of discouraged workers.

Chapter Outline


Inflation, p. 428

Ron Paul questions Ben Bernanke on definition of inflation 07/21/2009

Defining Inflation Terms (price level, disinflation, deflation, hyperinflation)

Inflation and Price level (p. 429)

Walker Todd, Research Fellow at the American Institute for Economic Research and former Federal Reserve official, speaks with Richard Morais of Forbes about the risks of severe inflation in the near future and gold as an investment hedge against inflation.

"To my knowledge, this is the first time since World War II, that any industrial economy, except for maybe Hungary, has tried to expand its money that much in a single calendar quarter; but traditional monetary theory teaches that, with a lag, it can be anywhere between six months to eighteen months typically, that money creation will catch up to you, observed by the public, in the form of a rising price level", says Todd.

Disinflation, p. 429

The failed bank list on the Federal Deposit Insurance Corp.'s web site is long, very long. If 2008 was the year of the financial crash what is 2009 with 123 bank failures, and still counting? Cf. The Deflation Times.

Deflation (p. 429)

Inflation or Deflation?

Professor Sidney Winter, Deloitte and Touche Professor of Management , Emeritus at the Wharton School of the University of Pennsylvania, and currently the Michael Crouch Visiting Professor in Innovation and Entrepreneurship at the Australian School of Business on the dangers of inflation/deflation.

Hyperinflation, Dr. Marc Faber, 02/05/09 on CNBC, 2:43 (p. 429)

If something goes wrong - print.

If it doesn't get fixed - print more.

If it then goes even worse - print more.

Hyperinflation, 9:03 (p. 429)

Measuring Inflation

The Consumer Price Index (CPI, p. 430).

11/24/08: A two-minute crash course on the consumer price index with NEWSWEEK's Daniel Gross (Video: Lee Wang, Sarah Frank), 2:19.

The Consumer Price Index (CPI), 5:38, a lesson on the Consumer Price Index (CPI) for active traders and investors in the stock, futures and forex markets.

The following is from a project for an Economics class in the Philippines, 6:25. It is a mini-documentary that describes the different spending patterns of people and its relation to the concept of the CPI or the Consumer Price Index.

Written, Licensed, Edited, Narrated and Directed by Carlo Chong

The CPI is often referred to as a "cost-of-living" index, but the current CPI differs from a true cost-of-living measure. For example, in the Fall an economist from the Open University (London) was interviewed. OU economist Alan Shipman finds that for students in higher education inflation is nearer 7% than the government's consumer price index of 3.8%. There are differences then between the CPI and a true cost-of-living index.

Problems in Measuring Consumer Prices (p. 431)

The CPI is a conditional cost-of-goods index in that it measures only private goods and services; public goods and services are excluded, i.e., it does not take into account such issues as homeland security, product substitution, products disappear off the market, new products (cell phones or the introduction of technology), or today, perhaps most importantly, health care costs (pp. 431-432).

The Federal Reserve Bank of Cleveland publishes an indicator called the "Median CPI," which differs from the Bureau of Labor Statistics' Consumer Price Index in significant ways. What makes the Median CPI a better indicator of inflation trends than the CPI?

Personal Consumption Expenditures Index (PCE, p. 432)

The CPI does a good job of measuring inflation for urban consumers and is the most widley reported inflation measure. Policymakers, however, especially the Federal Reserve, have been focusing its attention on the personal consumption expenditures index (PCE, p. 432).

By January 31 2008, when the following video aired, it was apparent that the American economy faced extreme difficulties. The personal consumption expenditure price index, excluding food and energy, rose 2.2 per cent during this period, providing evidence that inflation could remain a concern for US policymakers. The housing meltdown and a financial crisis resulted: Robert Schiller, Yale University Economics Professor, 7:40. At the time, BusinessWeek predicted that Why home prices could drop 25% more on average before the market finally hits bottom.

The Producer Price Index (PPI), (p. 432).

The Producer Price Index, during the December 2009 holiday season, was fairly positive, according to a video report by Reuters, 1:43.

On August 18, 2009, the US Producer Price Index came out worse than expected. The 0.9% monthly declines translates into a year-on-year decline of 6.8%. This together with the decline in the core PPI shows that the US is still deflating, 1:42.

What is PPI as opposed to CPI? Dr. Thomas Scheiding, Professor of Economics in the Business Department of Elizabethtown College in PA, explains what is the Producer Price Index (PPI) and Consumer Price Index (CPI), 7:28.

The GDP Deflator (p. 433)

The GDP deflator shown in Figure 2 on p. 434 is our broadest measure of inflation. On p. 434, inflation from 1930 to Today--GDP Deflator is explained under Figure 2.

Adjusting for Inflation: Escalation and Deflation (p. 434)

Escalator Clauses (p. 434)

Many contracts, including commercial rental agreements, labor union contracts, and Social Security payments are subject to escalator clauses (p. 434).

Labor union contracts rose steadily over the years and wages were priced too highly in comparison with foreign competition with lower wages. For example, in 1967, the auto worker's union agreed to a cap on its COLA (cost-of-living adjustment or escalator clause), apparently not anticipating the inflation that would occur. By 1970, auto unions struck for higher wages which rose considerably higher than comparable wages for foreign auto workers.

Deflating Series: Nominal versus Real Values (p. 435)
The Consequences of Inflation (p. 435)

Senior Editor Paddy Hirsch, of, explains inflation, hyperinflation, and the CPI, 8:12.

Chris Martenson's excellent inflation summary, 6:54.

The National Inflation Association has video published the consequences of inflation on Detroit. The 2nd Part visually is a powerful example of how inflation has harmed one of America's formerly productive cities: Detroit.

Part 1, Intro:

Part 2/4, is a good summary of the entire series, 6:18.

Duck Tales Inflation Lesson, 4:27

Hyperinflation (p. 436)

Peter Schiff Discusses Hyperinflation On Fast Money 12/22/09, 4:36.

Hyperinflation in Germany 1923 (during the Weimar Republic is one of the classic examples of hyperinflation, 3:25.

Checkpoint: Inflation
The Historical Record
The Household Survey
Defining and Measuring Unemployment
Labor Force
Problems with Unemployment Statistics
Underemployment and Discouraged Workers
Checkpoint: Unemployment
Unemployment and the Economy
Types of Unemployment
Frictional Unemployment
Structural Unemployment
Cyclical Unemployment
Defining Full Employment
The Natural Rate of Unemployment
Checkpoint: Unemployment and the Economy
Job Gains and Losses: Establishment (or Payroll) Survey versus Household

Ideas for Classroom Discussion:
■ Illustrate the changing purchasing power of a dollar by using the CPI calculator
on the Web site of the Federal Reserve Bank of Minneapolis at http://www.
The site enables you to enter an amount of money in a particular year and see
what it would be worth in another time period. You may want to prepare for this
by having students gather “data” in the form of prices their parents or grandparents remember; the “when I was a youngster I could go to the movies for 5 cents!” data. See what that would be worth today.
■ Illustrate a hyperinflation. Screen the PBS video “Commanding Heights” or look
at the page on the PBS Web site at

Particular points of interest: there was a 1,000-billion German mark note in circulationand few people bothered to take the change when they spent it! Also note the mention of people buying real assets—including pianos—because of the
depreciating value of the currency.

Chapter Checkpoints

Question: If you lived in a country where you saw the signs of a government beginning to spend excessively relative to its tax base and was funding this immense spending by printing new money, what would you do to protect yourself and your monetary assets?

The point is to check that students can: point out the link between hyperinflation
and excessive money creation.

Question: Does it seem reasonable to require that to be counted as unemployed, a
person must be actively seeking work? Why not simply count those who do not
have a job but indicate they would like to work?

The point is to check that students can: understand statistics are based on assumptions and methodologies. Also, this question serves to reinforce the definition of unemployment as currently used.

Unemployment and the Economy
Question: After the Berlin Wall fell and the Soviet Union split into several countries, the defense industry in the United States underwent a serious decline as part of the “peace dividend.” Many high-skilled engineers and other workers became unemployed as the industry retrenched. For many, their skills were so specialized that they were unable to find new jobs at their old salaries. Were these people frictionally, structurally, or cyclically unemployed? What policies might the government implement to reduce the impact of this type of unemployment?

The point is to check that students can: apply the definitions of the different types of unemployment to this specific scenario.

Extended Examples in the Chapter
Job Gains and Losses: Establishment (or Payroll) Survey versus Household

The term “jobless recovery” came into common use around 2004, and referred to
continuing job loss even after the economy moved from a recession into a recovery
(you’d expect job gains in such circumstances). There is a measurement problem in
assessing this situation. The Labor Department tries to assess the labor market by
surveying businesses (the demand for labor, in theory) and by surveying households
(the supply of labor). In recent years the two measures have not been tracking in
the same way. It is suggested that the Establishment Survey overstates job loss, particularly since people who lose a job but start their own businesses may not be
counted. However, self-employment may be a low-paying alternative to a person’s
previous occupation, leading some to suggest that the Household Survey overstates
how well the economy is doing.

The sources cited for this section are “Two Measures of Employment: How
Different Are They?” by Tao Wu (Federal Reserve Bank of San Francisco Economic
Letter, August 27, 2004) and Edmund L. Andrews, “Two Tales of American Jobs”
(The New York Times, February 22, 2004, page BU-6). The first source is available
on the Web at

Examples Used in the End-of-Chapter Questions

Question 10 references how the Bureau of Labor Statistics measures unemployment.
For more detail, see the Web site at

For Further Analysis

Calculating a Very Simple Inflation Measure

This example (in the student handout at the end of this chapter) can be used as a
small group exercise or as an individual exercise. It is designed to complement the text’s material on how to measure inflation by giving students a hands-on opportunity to see how an index is constructed. This exercise uses no weighting but it can easily be expanded to allow you to explore the meaning of a weighted average. By asking students to research prices of goods they will also get a feel for the data collection performed by the Bureau of Labor Statistics.

Web-Based Exercise

This example below requires students to find current data on the inflation rate and the unemployment rate. You may wish to combine this exercise with a current
events article to add more of a research and analytical component. Points for possible discussion to extend the material in the text would include: different measures of the CPI (for urban consumers, etc.); seasonal adjustment; core inflation measures; state and regional unemployment numbers. You may also wish to discuss whether the two measures move together or inversely to each other.

How Is the Economy Doing?

Two of the most important measures of how well the economy is doing are the inflation rate and the unemployment rate. Go to the Bureau of Labor Statistics Web site at to answer the following:

1) What is the current inflation rate? Put it in the context of previous period’s

2) What is the current unemployment rate? Compare that to the last period’s

Answer: Student responses will vary depending on when this assignment is
1) As of the middle of June 2007, the Consumer Price Index showed an
increase of 0.6% in May, which made it 2.7% higher than it was in May
2006. For data see the Web site at

2) As of the middle of June 2007 the unemployment rate was 4.5%,
unchanged since May. For data see the Web site at


Current events are often the best way to motivate students with regard to the material in this chapter. Consider reading an article about current inflation and/or unemployment (even take a short “quiz” on it) and then repeat the activity
after covering the course material. Students may enjoy feeling that they can read
a business story and understand the statistics being discussed.

Handout 16.1

Calculating a Very Simple Inflation Measure


Dr. Marc Faber on CNBC on 30 December 2009, 10:38.

The American Revolution and Hyperinflation by a young American, 6:17.

Project for AP Economics 2009 (the class or school that made this video is not identified; I do not know where it is from):


The productivity, is the GDP
Take the sum up of the C I G
There's no X in a closed economy
Open it up and free trade is what you'll see
The CPI is your price index
Shows you what you pay for a bottle of windex
Compared to the price level of last year
We should keep it at 100, now y'hear?

**Macroeconomics, study as a whole,
The wealth of a nation, or so I'm told
A one letter change and we're looking at a firm
But macro's what we're here for, sit back and learn.

A phillips curve, shows you the tradeoffs
'tween inflation/unemployment, yeah those layoffs.
Take the two rates, do not perplex,
The sum is known as the misery index
Did you know that money has speed?
Actually, it's called, velocity
P Q over M, that's what V
is equal to in, this economy


Something that's important yeah to me
is known to you as the MPC
It is the Marginal Propensity
to consume and shop and spend money
If aggregate demand, and aggregate supply
shift to the right, then GDP's up high
Don't know bout chu, but more output is fly
That's the way it is so don't ask me why


Say's law says supply creates demand
It's something that you should probably understand
Gave classical theory the the upper hand
'Til Keynes came along, what a man
Short run was the game of his theory
Didn't think that the world's economy
Functioned at its full capacity
Pessimistic Negativity?

Break it down...

Inflation the nation
cuz theres a justification
Of its short term relation
Between unemployment otherwise
Oh, dont get a bruther-wise
When rational expectation-wise
The sacrifice ratio-nality
Due to contractionary policy
Is smaller than expected in the theory
Of rational expectation, oh
Just ask my man Volcker,
Who went up to that suckah
Stagflation and smackd hah [her],
Like Alan Greenspan,
Who went up to tha man,
Inflation, and he demanded
Some respect, or lest
He get charged of vehicular manslaughter
Of inflations mother and daughter.
To OPEC he said, who's your father, boy?

Email HW to

1. We will have the Ch. 15 Objective Questions Quiz, Short Answer Quiz, and Multiple Question Test soon now that we have returned after the break per the announcement. We will also begin the Free Response Test questions.

All these assessments will be announced as they arise. The break was an opportune time to catch up on HW (for those who fell behind and have work to make up) and to plan ahead for the rest of the class who are on track.

2. Define the Key Concepts, p. 448.

3. Answer the Checkpoint Questions, pp. 436, 442, and 444; check your initial responses with the answers in the textbook.