GDP, National Income, National Output, Inflation and Unemployment PDF

## Chapter 1: National Output ### Essentials of National Output * Gross domestic product (GDP) measures national output; it tells you how much the economy produces in a particular period of time. * GDP is expressed either in current dollars or in constant dollars; figures expressed in current doll...

## Chapter 1: National Output ### Essentials of National Output * Gross domestic product (GDP) measures national output; it tells you how much the economy produces in a particular period of time. * GDP is expressed either in current dollars or in constant dollars; figures expressed in current dollars are actual dollar amounts, whereas those expressed in constant dollars are corrected for changes in the price level. * GDP is not an ideal measure of economic well-being. It is not very meaningful unless you know the size of the population of the country in question, and it does not take adequate account of leisure, quality changes, or environmental damage. * There are two approaches to measure GDP: the expenditures approach and the income approach. ### 1. Gross Domestic Product Gross domestic product (GDP) is a measure of national output, or of how much the economy produces in a particular period of time. But the U.S. economy produces millions of types of goods and services. How can we add up the output of everything from lemon meringue pies to helicopters, from books to houses? The only feasible answer is to use money as a common denominator and to make the price of a good or service-the amount the buyer is willing to pay-the measure of value. In other words, we add up the value in money terms of the total output of goods and services in the economy during a certain period, normally a year, and the result is the gross domestic product during that period. Although the measurement of gross domestic product may seem straightforward ("just add up the value in money terms of the total output of the economy"), this is by no means the case. Some of the more important pitfalls that must be avoided and problems that must be confronted are the following: **Double Counting** Gross domestic product does not include the value of all goods and services. It includes only the value of final goods and services produced. Final goods and services are those destined for the ultimate user. For example, flour purchased for family consumption is a final good, but flour to be used in manufacturing bread is an intermediate good, not a final good. We would be double counting if we counted both the bread and the flour used to make the bread as output. Thus the output of intermediate goods-goods that are not destined for the ultimate user, but are used as inputs in producing final goods and services-must not be included in gross domestic product. **Nonmarketed Goods** Some final goods and services that must be included in gross domestic product are not bought and sold in the marketplace, so they are valued at what they cost. Consider the services performed by government-police protection, fire protection, the use of the courts, defense, and so forth. Such services are not bought and sold in any market (despite the old saying about the New Jersey judge who was "the best that money could buy"). Yet they are an important part of our economy's final output. Economists and statisticians have decided to value them at what they cost the taxpayers. This is by no means ideal, but it is the best practical solution advanced to date. **Omitted Final Output** It is necessary for practical reasons to omit certain types of final output from gross domestic product. In particular, some non-marketed goods and services, such as the services performed by homemakers, are excluded from the gross domestic product. This is not because economists fail to appreciate these services, but because it would be extremely difficult to get reasonably reliable estimates of the money value of a homemaker's services. At first glance, this may seem to be a very important weakness in our measure of total output, but so long as the value of these services does not change much (in relation to total output), the variation in gross domestic product will provide a reasonably accurate picture of the variation in total output-and, for many purposes, this is all that is required. **Nonproductive Transactions** Purely financial transactions are excluded from gross domestic product because they do not reflect current production. Such financial transactions include government transfer payments, private transfer payments, and the sale and purchase of securities. Government transfer payments are payments made by the government to individuals who do not contribute to production in exchange for them. Payments to welfare recipients are a good example of government transfer payments. Since these payments are not for production, it would be incorrect to include them in GDP. Private transfer payments are gifts or other transfers of wealth from one person or private organization to another. Again, these are not payments for production, so there is no reason to include them in GDP. The sale and purchase of securities are not payments for production, so they too are excluded from GDP. **Secondhand Goods** Sales of secondhand goods are also excluded from gross domestic product. The reason for this is clear. When a good is produced, its value is included in GDP. If its value is also included when it is sold on the secondhand market, it would be counted twice, and thus lead to an overstatement of the true GDP. Suppose that you buy a new bicycle and resell it a year later. The value of the new bicycle is included in GDP when the bicycle is produced. But the resale value of the bicycle is not included in GDP; to do so would be double counting. ### Test your understanding True or False? 1. Private transfer payments are included in GDP. 2. When you sell 100 shares of stock, the amount you receive is included in GDP. 3. If you buy a used car, this is included in GDP. 4. If you buy a new car and do not use it for business purposes, it is a final good. 5. One of the major limitations of GDP is that services like health care are not included. ### Exercises 1. If Bill Clinton wins $100,000 from Al Gore in a poker game, will this increase, decrease, or have no effect on GDP? Explain. 2. Which of the following are included in calculating GDP this year? * Interest on a government bond * Payment by the government to a naval officer * Wages paid by the University of Michigan to a professor * Payment for a secondhand car by a Florida student * The amount a person would be willing to pay for his or her spouse's homemaking services * The amount John Jones pays for 30 shares of IBM stock * The allowance a parent gives a 12-year-old child ### 2. Adjusting GDP for Price Changes Since gross domestic product values all goods and services at their current prices, it is bound to be affected by changes in the price level as well as by changes in total output. If all prices doubled tomorrow, this would produce a doubling of gross domestic product. Clearly, if gross domestic product is to be a reliable measure of changes in total output, we must correct it somehow to eliminate the effects of such changes in the price level. To correct for price changes, economists choose some base year and express the value of all goods and services in terms of their prices during the base year. For example, suppose we want to compare beef output in 1989 with that in subsequent years. If 1989 is taken as the base year and if the price of beef was $3 per pound in 1989, beef is valued at $3 per pound in all other years. Thus, if 100 million pounds of beef were produced in 1997, this total output is valued at $300 million even though the price of beef in 1997 was actually higher than $3 per pound. In this way, distortions caused by changes in the price level are eliminated. Gross domestic product is expressed in either current dollars or in constant dollars. Figures expressed in current dollars are actual dollar amounts, whereas those expressed in constant dollars are corrected for changes in the price level. Expressed in current dollars, gross domestic product is affected by changes in the price level. Expressed in constant dollars, gross domestic product is not affected by the price level because the prices of all goods are maintained at their base-year level. GDP, after being corrected for changes in the price level, is called real gross domestic product. Figure 1.1 shows the behavior of both real GDP and GDP expressed in current dollars. GDP expressed in current dollars has increased more rapidly (due to inflation) than GDP in constant dollars **Price Indexes** It is often useful to have some measure of how much prices have changed over a certain period of time. One way to obtain such a measure is to divide the value of a set of goods and services expressed in current dollars by the value of the same set of goods and services expressed in constant (or base-year) dollars Suppose that a set of goods and services costs $100 when valued at 1997 prices, but $70 when valued at 1994 prices. Apparently, prices have risen an average of 43 percent for this set of goods between 1994 and 1997. How do we get 43 percent? The ratio of the cost in 1997 prices to the cost in 1994 prices is 100 + 70 = 1.43: thus prices must have risen on the average by 43 percent for this set of goods. The ratio of the value of a set of goods and services in current dollars to the value of the same set of goods and services in constant (base-year) dollars is a price index. Thus 1.43 is a price index in the example above. An important function of a price index is to convert values expressed in current dollars into values expressed in constant dollars This conversion, known as deflating, can be achieved simply by dividing values expressed in current dollars by the price index. In the illustration above, values expressed in 1997 dollars can be converted into constant (that is, 1994) dollars by dividing by 1.43. This procedure is an important one, with applications in many fields other than the measurement of gross domestic product. For example, firms use it to compare their output in various years To correct for price changes, they deflate their sales by a price index for their products. In many cases, price indexes are multiplied by 100; that is, they are expressed as percentage changes. Thus, in the case described in the previous paragraph, the price index might be expressed as 1.43 x 100, or 143, which would indicate that 1997 prices on the average were 143 percent of their 1994 level. In the next chapter, we shall say more about price indexes that are expressed in this way. For now, we assume that the price index is not multiplied by 100. ### Test your understanding True or False? * GDP in constant dollars has been adjusted for changes in the price level. * If a price index (which has been multiplied by 100) equals 130, this means that the price level is 30 percent higher than in the base period. ### Exercise: The following table shows the value of GDP in the nation of Puritania. The figures shown are in millions of 1970 dollars and current dollars. Fill in the blanks. | Year | GDP (in millions of 1970 dollars) | GDP (in millions of current dollars) | Price index | Price index 1970 | |---|---|---|---|---| | 1974 | 1000 | | | 1.00 | | 1976 | | 1440 | 1.20 | 1.20 | | 1978 | 1300 | | 1.40 | 1.40 | | 1980 | 1500 | | 1.60 | 1.60 | | 1997 | | 2720 | 1.70 | | ### 3. Using Value-Added to Calculate GDP You have seen that gross domestic product includes the value of only the final goods and services produced. Obviously, however, the output of final goods and services is not due solely to the efforts of the producers of the final goods and services. The total value of an automobile when it leaves the plant, for example, represents the work of many industries besides the automobile manufacturers. The steel, tires, glass, and many other components of the automobile were not produced by the automobile manufacturers. In reality, the automobile manufacturers only added a certain amount of value to the value of the intermediate goods-steel, tires, glass, and so forth-they purchased. This point is basic to an understanding of how the gross domestic product is calculated. To measure the contribution of a firm or industry to final output, you use the concept of value-added. Value-added means just what it says: the amount of value added by a firm or industry to the total worth of the product. It is a measure in money terms of the extent of production taking place in a particular firm or industry. Suppose that $160 million of bread was produced in the United States in 1997. To produce it, farmers harvested $50 million of wheat, which was used as an intermediate product by flour mills, which turned out $80 million of flour. This flour was used as an intermediate product by the bakers who produced the $160 million of bread. What is the value-added at each stage of the process? For simplicity, assume that the farmers did not have to purchase any materials from other firms in order to produce the wheat. Then the value-added by the farmers is $50 million; the value-added by the flour mills is $30 million ($80 million - $50 million); and the value-added by the bakers is $80 million ($160 million - $80 million). The total of the value-added at all stages of the process ($50 million + $30 million + $80 million) must equal the value of the output of final product ($160 million), because each stage's value-added is its contribution to this value. Since the total of the value-added by all industries must equal the value of all final goods and services, which, of course, is gross domestic product, it follows that you can calculate GDP by adding up the value-added by all industrial groups in the economy. ### Test your understanding True or False? * If the Miller Company's sales in 1997 are $160 million and if it purchases $60 million worth of intermediate goods from other firms in 1997, its value-added in 1997 equals $100 million. * All flour produced in the United States is an intermediate good. ### Exercise A small country contains only ten firms. William Moran, the country's top statistician, calculates the county's GDP by totaling the sales of these ten firms. Do you agree with this procedure? Why, or why not? ### 4. Limitations of GDP You should understand the limitations of gross domestic product, as it is by no means an ideal measure of economic well-being. Five limitations of GDP should always be borne in mind. **Population**GDP is not very meaningful unless you know the size of the population of the country in question. For example, the fact that a particular country's GDP equals $50 billion means one thing if the country has 10 million inhabitants, and quite another thing if it has 500 million inhabitants. To correct for the size of the population, GDP per capita-GDP divided by the population is often used as a rough measure of output per person in a particular country. **Leisure** GDP does not take into account one of humankind's most prized activities, leisure. During the past century, the average work week in the United States has decreased substantially. It has gone from almost 70 hours in 1850 to about 40 hours today. As people have become more affluent, they have chosen to substitute leisure for increased production. Yet this increase in leisure time, which surely contributes to our well-being, does not show up in GDP. Neither does the personal satisfaction (or displeasure and alienation) people get from their jobs. **Quality Changes** GDP does not take adequate account of changes in the quality of goods. An improvement in a product is not reflected accurately in GDP unless its price reflects the improvement. For example, if a new type of drug is put on the market at the same price as an old drug, and if the output and cost of the new drug are the same as the old drug, GDP will not increase, even though the new drug is twice as effective as the old one. Because GDP does not reflect such increases in product quality, it is sometimes argued that the commonly used price indexes overestimate the amount of inflation, since although prices may have gone up, quality may have gone up too. **Value and Distribution** GDP says nothing about the social desirability of the composition and distribution of the country's output. Each good and service produced is valued at its price. If the price of a Bible is $10 and the price of a pornographic novel is $10, both are valued at $10, whatever you or I may think about their respective worth. Moreover, GDP measures only the total quantity of goods and services produced. It tells you nothing about how this output is distributed among the people. If a country's GDP is $500 billion, this is its GDP whether 90 percent of the output is consumed by a relatively few rich families or the output is distributed relatively equally among the citizens. **Social Costs** GDP does not reflect some of the social costs arising from the production of goods and services. In particular, it does not reflect the environmental damage resulting from the operation of a country's factories, offices, and farms. It is common knowledge that the atmosphere and water supplies are being polluted in various ways by firms, consumers, and governments. Yet these costs are not deducted from GDP, even though the failure to do so results in an overestimate of the country's true economic welfare. ### Test your understanding True or False? * The gross domestic product of Switzerland is much smaller than that of the United States; thus, U.S. citizens are much better off than Swiss. * GDP could be increased tomorrow if we all agreed to work 80 hours a week. ### Exercise If a paper mill produces $1 million worth of paper this year, but adds considerably to the pollutants in a nearby river, are the social costs arising from this pollution reflected in the gross domestic product? If so, how? Should these costs be reflected in the GDP? If so, why? ### 5. The Expenditures Approach to GDP To use the expenditures approach to determine GDP, one must add up all the spending on final goods and services. Economists distinguish among four broad categories of spending, each of which is taken up below. **Personal Consumption Expenditures** Personal consumption expenditures include the spending by households on durable goods, nondurable goods, and services. This category of spending includes your expenditures on items like food and drink, which are nondurable goods. It also includes your family's expenditures on a car or on an electric washer or dryer, which are durable goods. Further, it includes your payments to a dentist, who is providing a service (painful though it sometimes may be). Table 1.1 shows that in 1995 personal consumption accounted for about two-thirds of the total amount spent on final goods and services in the United States. Expenditures on consumer durable goods are clearly much less than on consumer nondurable goods, whereas expenditures on services are now larger than expenditures on either durable or nondurable goods. **Gross Private Domestic Investment**Gross private domestic investment consists of all investment spending by U.S. firms. As shown in Table 1.1, three broad types of expenditures are included in this category. First, all final purchases of tools, equipment, and machinery are included. Second, all construction expenditures, including expenditures on residential housing, are included. (One reason houses are treated as investment goods is that they can be rented out.) Third, the change in total inventories is included. An increase in inventories is a positive investment; a decrease in inventories is a negative investment. The change in inventories must be included, because GDP measures the value of all final goods and services produced, even if they are not sold this year. Thus GDP must include the value of any increases in inventories that occur during the year. On the other hand if a decrease occurs during the year in the value of inventories, the value of this decrease in inventories must be subtracted in calculating GDP because these goods and services were produced prior to the beginning of this year. In other words, a decline in inventories means that society has purchased more than it has produced during the year. Gross private domestic investment is "gross" in the sense that it includes all additions to the country's stock of investment goods, whether or not they are replacements for equipment or plant that are used up in producing the current year's output. Net private domestic investment includes only the addition to the country's stock of investment goods after allowing for the replacement of used-up plant and equipment. Net private domestic investment indicates the change in the country's stock of capital goods. If it is positive, the nation's productive capacity, as gauged by its capital stock, is growing. If it is negative, the country's productive capacity, as gauged by its capital stock, is declining. **Government Purchases of Goods and Services** This category of spending includes the expenditures of the federal, state, and local governments for the multitude of functions they perform: defense, education, police protection, and so forth. It does not include transfer payments, since they are not payments for current production. Table 1.1 shows that government spending in 1995 accounted for about one-fifth of the total amount spent on final goods and services in the United States. State and local expenditures are bigger than federal expenditures. Many of the expenditures of the federal government are on items like national defense, health, and education, while at the state and local levels the biggest expenditure is for items like education and highways. **Net Exports** Net exports equal the amount spent by other countries on our goods and services less the amount we spent on other countries' goods and services. This factor must be included since some of our national output is destined for foreign markets and since we import some of the goods and services we consume. There is no reason why this component of spending cannot be negative; indeed in 1995 it was negative, since imports exceeded exports. The quantity of net exports tends to be quite small. Table 1.1 shows that net exports in 1995 were equal (in absolute terms) to about 1 percent of the total amount spent on final goods and services in the United States. **Putting Together the Spending Components** Finally, because the four categories of expenditures described above include all possible types of spending on final goods and services, their sum equals the gross domestic product. In other words, GDP = personal consumption expenditures + gross private domestic investment + government purchases of goods and services + net exports. As shown in Table 1.1, the gross domestic product in 1995 equaled $4,925 + $1,066 + $1,358 - $95, or $7,254 billion. ### Test your understanding True or False? * Expenditures by General Motors on paper, typewriters, and fuel oil are all included in consumption expenditure. * Net exports can be positive or negative. * Consumption includes your expenditures on meals and clothing, and your parents' expenditures on the family car or on an electric washer and dryer. * If the Malone family buys a 15-year-old house from Mr. D. Blair, a (hypothetical) real estate speculator, this purchase would be included in gross private domestic investment. ### Exercises Given the following data (in millions of dollars) concerning the Puritanian economy in 1996, compute its gross domestic product. * Gross private domestic investment: 400 * Personal consumption expenditure: 1,000 * Exports: 300 * Imports: 100 * Government purchases: 300 * Increase in inventories: 50 * Depreciation: 100 ### 6. The Income Approach to GDP Another, equally valid way to measure GDP is to use the income approach. To do so, you must add up all the income stemming from the production of this year's output. This income is of various types: compensation of employees, rents, interest, proprietors' income, and corporate profits. In addition, you must include a capital consumption allowance and indirect business taxes. Each of these items is defined and discussed below. **Compensation of Employees** This is the largest of the income categories (see Table 1.2). It includes the wages and salaries that are paid by firms and government agencies to suppliers of labor. In addition, it contains a variety of supplementary payments by employers for the benefit of their employees, such as payments into public and private pension and welfare funds. These supplementary payments are part of the employers' costs and are included in the total compensation of employees. **Rent** In the present context, rent is defined as a payment to households for the supply of property resources. For example, it includes house rents received by landlords. Quite different definitions of rent are used by economists in other contexts. **Interest** Interest includes payments of money by private businesses to suppliers of money capital. If you buy a bond issued by General Motors, the interest payments you receive are included. Interest payments made by the government on Treasury bills, savings bonds, and other securities are excluded on the grounds that they are not payments for current goods and services. They are regarded as transfer payments. **Proprietors' Income** Profits are split into two parts in the national income accounts: proprietors' income and corporate profits. Proprietors' income consists of the net income of unincorporated businesses-businesses that are not corporations. **Corporate Profits** Corporate profits consist of the net income of corporations. (A corporation is a fictitious legal person separate and distinct from the stockholders who own it.) This item is equal to corporate profits before the payment of corporate income taxes. **Depreciation** All the items discussed above-compensation of employees, rents, interest, proprietors' income, and corporate profits-are forms of income. In addition, there are two nonincome items, depreciation and indirect business taxes, that must be added to the sum of the income items to obtain GDP. Depreciation is the value of the country's plant, equipment, and structures that are worn out this year. In the national income accounts, depreciation is often called a capital consumption allowance, because it measures the value of the capital consumed during the year. **Indirect Business Taxes** The government imposes certain taxes, such as general sales taxes, excise taxes, and customs duties, which firms treat as costs of production. These taxes are called indirect business taxes because they are not imposed directly on the business itself, but on its products or services instead. A good example of an indirect business tax is the tax on cigarettes; another is the general sales tax. Before a firm can pay out incomes to its workers, suppliers, or owners, it must pay these indirect business taxes to the government. These indirect business taxes, like depreciation, must be added to the total of the income items to get GDP. **Putting Together the Income Components** The sum of the five types of income described above (plus depreciation and indirect business taxes) equals gross domestic product. In other words, GDP = compensation of employees + rent + interest + proprietors' income + corporate profits + depreciation + indirect business taxes. ### Test your understanding True of False? * The Guiliani Restaurant is not a corporation; thus, its profits are included in proprietors' income. * If your employer contributes to a pension fund for you, this contribution is included in compensation of employees. * Interest payments by the U.S. government are included in interest in calculating GDP. ### Exercise Based on the data to the right (in millions of dollars), use the income approach to determine GDP. | Category | Value (in millions of dollars) | |---|---| | Compensation of employees | 50 | | Interest | 10 | | Rent | 5 | | Corporate profits | 8 | | Indirect business taxes | 10 | | Depreciation | 22 | | Proprietor's Income | 6 | | Transfer payments | 4 | ### 7. The Two Approaches Yield the Same Result Suppose that you want to measure the market value of an automobile. One way to do this is to look at how much the consumer pays for the automobile. Although this is the most straightforward way to measure the automobile's market value, it is not the only way it can be done. Another, equally valid way is to add all the wage, interest, rental, and profit incomes generated in the production of the automobile. The amount that the automobile producer receives for this car is equal to its profit (or loss) on the car plus the amount it pays the workers and other resource owners who contributed their resources to its production. Thus, if you add all the wage, interest, rental, and profit incomes resulting from the production of the automobile, the result is the same as if you determine how much the consumer pays for the automobile. By the same token, there are two ways to measure the market value of the output of the economy as a whole. Or, put differently, there are two ways of looking at GDP. One is the expenditures approach, which regards GDP as the sum of all the expenditures on the final goods and services produced this year. The other is the income approach, which regards GDP as the sum of incomes derived from the production of this year's total output. Since both these approaches are valid, it follows that GDP can be viewed as either the total expenditure on this year's total output or as the total income stemming from the production of this year's total output. In other words, total expenditure on this year's total output = GDP = total income stemming from the production of this year's total output. This is an identity; the left-hand side of this equation must equal the right-hand side. Or to be more precise, this is true if the right-hand side also includes depreciation and indirect business taxes, as you saw in Section 6. ### Test your understanding True or False? * For the income approach to yield the same result as the expenditures approach, depreciation and indirect business taxes must be added to the sum of incomes. * Depreciation is the value of the country's plant, equipment, and structures that are worn out during the period. ### Exercise Using Tables 1.1 and 1.2, demonstrate that the income and expenditures approaches yield the same result ### Chapter Review **Key Terms:** * Gross domestic product * Final goods and services * Intermediate good * Government transfer payments * Private transfer payments * Base year * Current dollars * Constant dollars * Real gross domestic product * Price index * Deflating * Expenditures approach * Personal consumption expenditures * Nondurable goods * Durable goods * Service * Gross private domestic investment * Net exports * Income approach * Interest * Proprietors' income * Corporate profits * Depreciation * Indirect business taxes ### Completion Questions 1. If a recession occurs, with the result that automobile sales decline and John Martin (an automobile salesperson) is laid off, this is a case of ___ unemployment. If a skilled worker in the printing industry is laid off because of the adoption of a new technology, and if his skills do not enable him to find employment elsewhere, this is a case of ___ unemployment. 2. If 1 million people who formerly were not in the labor force decide to look for jobs, and if it takes time for them to find jobs, the initial result is likely to be (a decrease, an increase, no change) in the unemployment rate. 3. Potential GDP is the level of GDP that could be achieved if there were ___. In the past, full employment was defined as ___ percent unemployed; recently, many economists have believed that it should be defined as about ___ percent unemployed (but in 1996, some economists felt that the figure should be lower). 4. If the Murphy family's money income is increasing by 10 percent per year, and its real income is increasing by 8 percent per year, the price level must be rising by ___ percent per year. If the price level continues to rise at this rate and if you invest in a bond yielding 6 percent interest per year, you will receive ___ percent interest in real terms. 5. If lenders foresee an inflation rate of 10 percent per year, they are unlikely to lend money at 10 percent or less because it would mean they would receive an interest rate of ___ percent or less in real terms. If lenders anticipate increased inflation, they will tend to (increase, decrease) interest rates. 6. If the U.S. Treasury offsets the effects of inflation on both the principal and interest on a particular type of U.S. Treasury bond, and if you bought such a bond in 1996 for $1,000, you would receive ___ in principal when it falls due in 2000 if the price level were 30 percent higher in 2000 than in 1996. If the bond yields interest of $60 (in 1996 dollars) per year, you would receive interest (in current dollars) of ___ in 2000 if the price level were 16 percent higher in 2000 than in 1996. 7. The classical economists maintained that the amount of ___ businesses can sell depends on ___ charged, as well as on total spending. Recognizing this, they further argued that firms would cut prices to sell their ___. Competition among firms would prod them to reduce their prices in this way, with the result that the ___ level of output would be taken off the market. 8. ___ and his followers attacked the classical economists' assumption that ___ and ___ are flexible. Contrary to the classical economists' argument, they said that the modern economy contains many departures from ___ that are barriers to ___ of prices and wages. ### Numerical Problems 1. The data below pertain to country A in 1996 and 1997. Fill in the blanks. | Year | Percent of civilian labor force unemployed | Percent of civilian labor force employed | Civilian labor force | Total employment | Total unemployment | |---|---|---|---|---|---| | 1996 | 7.0 | | | | | | 1997 | 6.0 | | 97.4 million | 100.4 million | | 2. In Israel the annual inflation rate was about 50 percent in 1978, and nearly 100 percent during the summer of 1979, according to William C. Freund of the New York Stock Exchange. In the New York Times on June 24, 1979, Freund concluded that: "The solution lies in marshalling the necessary political courage and consensus.... It is political fortitude, above all else, which is needed now-to cut back on excess claims against resources, to promote production and productivity, and to relieve intense demand pressures." Indicate how this advice is related to the discussion presented in this chapter. What specific measures would you suggest to accomplish these results? 3. Commenting on the inflation during the 1970s in Israel, the Jerusalem Post observed that "75 percent of Israeli families live in flats they own. Most of these were bought with government assistance and low interest mortgages. The payments on these mortgages are peanuts in light of our current inflation spiral. Someone who received a loan of 200,000 Israeli pounds at the beginning of the year-even at 32 percent interest-will have earned about 65,000 Israeli pounds by the end of it, clear and nontaxable. This sum is possibly more than his annual wages, so why complain?" Does this prove that inflation is of no consequence? Why or why not? Explain in detail. 4. Mr. Rich has $1 million in cash, bank accounts, and savings and loan accounts. They are his only assets. a. If the inflation rate is 8 percent, how much must Mr. Rich save per year to maintain the real value of his assets? b. Mr. Rich must pay 70 percent of his income in taxes. If all Mr. Rich's income is taxable, what is the minimum amount that Mr. Rich must make per year if he wants to maintain the real value of his assets? ### Answers to Completion Questions 1. Cyclical; Structural 2. An increase 3. Full employment; 4; 5 or 6 4. 2; 4 5. Zero; increase 6. $1,300; $69.60 7. Goods and services; prices; prices; high-employment 8. Keynes; prices; wages; perfect competition; downward ### Answers to Test your Understanding **Section 1:** True