Chapter 6

 The consumer price index (CPI) is a measure of the cost of living during a particular period
• The CPI measures
– The cost of a standard basket of goods and services in a given year
– Base year changes periodically
• A price index measures the average price of a given quality of goods and
services relative to the price of the same goods and services in a base year
• Other indices
• Core inflation is CPI without energy and food
• Producer price index
• Import / export price index
 The rate of inflation is the annual percentage change in the price level
 A nominal quantity is measured in terms of its current dollar value
 A real quantity is measured in physical terms
• Deflating a nominal quantity converts it to a real quantity
• Divide a nominal quantity by its price index to express the quantity in real terms
 The real wage is the wage paid to the worker measured in terms of purchasing power
• Indexing increases a nominal quantity each period by the percentage increase in a
specified price index
• Indexing automatically adjusts certain values, such as Social Security payments, by
theamount of inflation
 The price level is a measure of the overall level of prices at a particular point in time
• Measured by a price index such as the CPI
 The relative price of a specific good is a comparison of its price to the prices of other
goods and services
• Calculated as a ratio
• Relative prices can change markedly without corresponding changes in inflation
• Labor market is an input market
– Firms buy labor to produce goods and services
• Macroeconomics looks at aggregate levels of employment and real wages
– Microeconomics looks at wage determination for a category of workers
 • The demand for labor depends upon:
– The productivity of workers
• Greater productivity increases employment
– The price of the worker’s output
• A higher real price increases employment
 Diminishing returns to labor
– Assumes non-labor inputs are held constant
– Adding one worker increases output but by less than the previous worker added
 Value of Marginal Product (VMP) is extra revenue that an added Demand shifts when the
value of the marginal product of a worker changes
• Two factors determine the demand (VMP) for labor
• The price of the company’s output
• An increase in market demand
• The productivity of the workers
• Greater quantity of non-labor inputs
• Organizational change
• Training and education

 Reservation wage is the lowest wage a worker would accept for a given job
• A shift in labor supply is caused by any change in the number of workers willing to
work at each wage
• Increase in the working-age population
• Increase in the share of working-age population willing to work
• Globalization results in an expansion of many markets to worldwide supply
• Increasing ease of goods and services crossing national borders
• Benefit of globalization is increased specialization and efficiency
• Principle of Comparative Advantage
• Globalization also means that some goods produced domestically are no longer
competitive
• Some domestic sectors shrink
 • Worker mobility is the movement of workers between jobs, firms, and industries
• Skill-biased technological change affects the marginal products of higher skilled
workers differently from those of lower-skilled workers
• Recent changes favor higher skilled workers
• Automobile production lines increasingly use robots
 Types of Unemployment
• Frictional unemployment occurs when workers are between jobs
• Short duration, low economic cost
• May increase economic efficiency
• Cyclical unemployment is the increase in unemployment during economic slow-
downs
• Usually short duration
• Structural unemployment is long-term, chronic unemployment in a well-
functioning economy
• Lack of skills, language barriers, or discrimination
• Unemployment insurance is a government transfer to unemployed workers
• Helps to reduce the costs of unemployment

Q1
a) Define nominal quantity and real quantity.
b) Assume that the cost of basket of goods and services in the year 2010 as a base year was $800. In 2018, it
increased to $1200. Calculate the consumer price index in 2018.Interpret your answer.

Cost of CPI 2010= 800 Cost of CPI2018=

1200CPI= 1200/800
answer
a) A nominal quantity is measured in terms of its current dollar valueA real quantity is
measured in physical terms
b) CPI in year 2018 = 1200/800 = 1.50. This means that the cost of living in the year 2018 is 50 percent
higher than it was in 2010, the base year.
 Q2
A consumer expenditure survey reports the following information on consumerspending:

2020 2021
Price Quantity Price Quantity
Product (1) $10 7 $10 7
Product (2) $6 10 $8 12
Product (3) $12 5 $14 10

a) Using 2020 as the base year, by how much does a "cost of products"index increase between 2020
and 2021?

Percentage change = 1.158 – 1 = 15.8%

Calculate the inflation rate between 2020 and 2021, using the CPI you calculated in (a)

The inflation rate is the same percentage change in consumers price index calculated before. So,
it equals 15.8%

1. The CPI equals 1.00 in year one and 1.40 in year two. If the nominal wage is
$3000 in year one and a contract calls for the wage to be indexed to the CPI, what will be the
nominal wage in year two?
Nominal wage in the year two that is equivalent to real wage (3000) equals:Nominal Wage =
Real wage * CPI = 3000 * 1.40 = $4200

2. Waleed is lending Emad $1,000 for one year. The CPI is 1.40 at the time the loan is made. They
expect it to be 1.54 in one year. If Waleed and Emad agreethat Waleed should earn a 6% real
return for the year, what is the nominal interest rate?

Q3
Production data for ABC Factory are as follows:

Number of workers Output per week

1 18
2 33
3 45
4 54

Assume the product is sold at price of $140 each, find the marginal product and the value of the marginal product for
each worker. (30 marks)
Answer
Number of Marginal Value of the marginal product
workers product for each worker
1 18 2520
2 15 2100
3 12 1680
4 9 1260

1c if the real wage in the market is $300 per week, what number of workers you suggest employing?
Explain your answer.
1c if the wage in the market is $300, then the data shows that the firm can employ four workers. This is because the value of
marginal product for each worker exceeds the real wage in the market.

Q4
1. For people to be considered out of the labor force, they can be:
A. A full-time student
B. A full-time retiree
C. Homemakers
D. All of the above
Answer: D
2. In order to measure the unemployment rate, the right formula is:
A. Total number of unemployed/total labour force X 100
B. Total labour force / Total number of unemployed x 100
C. Total number of unemployed/total labour force x 1000
D. Total labour force / Total number of unemployed x 1000Answer: A

3. What would be the causes of Structural unemployment?

Structural unemployment is long-term, chronic unemployment in a well-functioning economy dueto lack of skills,
language barriers, or discrimination, which cause high economic, psychological, and social costs

4. Define discouraged worker?

A discouraged worker is a person who would like to have a job but they have not looked for work (during the
survey period). Counted as out of the labour force and is not counted as unemployed.

Question Three (30 points; 5 each)

How would each of the following likely affect the real wage and employment ofunskilled workers
on an automobile plant assembly line?
1) Demand for the type of car made by the plant increases.
a. Real wage and employment decrease
b. Real wage and employment increase
c. Real wage increase and employment decrease
d. Real wage decrease and employment increase
2) A sharp increase in the price of gasoline causes many commuters to switch to public
transportation.
a. Real wage and employment decrease
b. Real wage and employment increase
c. Real wage increase and employment decrease
d. Real wage decrease and employment increase
3) Because of alternative opportunities, people become less willing to do factorywork
a. Real wage and employment decrease
b. Real wage and employment increase
c. Real wage increase and employment decrease
d. Real wage decrease and employment increase
4) The plant management introduces new assembly-line methods that increasethe number of
cars unskilled workers can produce per hour while reducing defects.
a. Real wage and employment decrease
b. Real wage and employment increase
c. Real wage increase and employment decrease
d. Real wage decrease and employment increase
5) Robots are introduced to do most basic assembly-line tasks.
a. Real wage and employment decrease
b. Real wage and employment increase
c. Real wage increase and employment decrease
d. Real wage decrease and employment increase
6) The workers unionize.
a. Real wage and employment decrease
b. Real wage and employment increase
c. Real wage increase and employment decrease
d. Real wage decrease and employment increase

Question One
Use the data below related to price of some goods and services to answer thefollowing
requirements:

 10 units of food, the price of each unit is $24

 Rent of apartment, $1500 per month
 Gasoline, car insurance, and maintenance, $300
 Phone service (basic service plus 10 long-distance calls), $100
In the year following the base year, the survey takers determine that pizzas have risen to $30
each, apartment rent is $1620, gasoline, car insurance, andmaintenance have risen to $340, and
phone service has dropped in price to $80.

a. Find the CPI in the subsequent year and the rate of inflation between thebase year
and the subsequent year.

Items Base year price Current year price

Units of food 10x24 = 120$ 10x30 = 300$
Rent of apartment 1500$ 1620$
Gasoline, car insurance, 300$ 340$
and maintenance

Phone service 100$ 80$

CPI FOR THE BASE YEAR = 100

CPI of the subsequent year = Cost of basket of goods in the subsequentyear /
 Cost of basket of goods in the base year x 100 CPI of the subsequent year = 300 +
1620 + 340 + 80 / 120 + 1500 +

300 + 100 x 100

CPI of the current year = 109.345%

The inflation rate = CPI of the current year – CPI of the base year /CPI of the
base year x 100

The inflation rate = 109.345 – 100 / 100 x 100 = 9.3%

b. The family’s nominal income rose by 10 percent between the base year and the
subsequent year. Are they worse off or better off in terms of what their income is able to
buy? (10 points)

The change in real income = change in nominal income – the inflation rateThe
change in real income = 10% - 9.3% = 0.7%

The family is better off, because the change in their real income ispositive.

Question Two
Suppose these are the actual per-liter prices for unleaded regular gasoline for June of each year between 1978 and 1986,
together with the values of the CPIs for those years. The base year is assumed to represent the average over the 1982–
1984 period. For each year from 1979 to 1986 find the CPI inflation rate and the change in the relative price of gasoline,
both from the previous year.

a. Find the CPI inflation rate and the change in the relative price of gasoline, both from
the previous year.
 The change in the relative price = price 2 – price 1 / price 1 x 100 CPI inflation rate = CPI 2 –
CPI 1 / CPI 1 x 100

b. Would it be fair to say that most of the changes in gas prices during this period were due to general
inflation, or were factors specific to the oil market playing a role as well?

The most change in the price of gas is not caused by the inflation, becausethe inflation
rate is above than the change in the price of gas in the most years so the factors of oil
market playing a role as well.

Question Three (20 points; 4 each)

How would each of the following likely affect the real wage and employment ofunskilled workers
on an automobile plant assembly line?

a. Demand for the type of car made by the plant increases.

 If the demand for the type of car made by the plant increases, the number of labors
needed will increase then the demand for labor will increase lead to anincrease in the
real wage and employment.
b. A sharp increase in the price of gasoline causes many commuters to switch to public
transportation.

 If a sharp increase in the price of gasoline causes many commuters to switch topublic
transportation, the demand of cars will decrease then the cars productiondecreases
therefore, the demand of workers in the plant decreases causing a decrease in real wage
and employment.

c. Because of alternative opportunities, people become less willing to do factory

work.

 If people become less willing to do factory work, the factory labor supplydecreases
then the employment decreases and the real wage increases.
 d. The plant management introduces new assembly-line methods
 If the plant management introduces new methods, the productivity will increasethen the
demand of labor increase causing an increase in real wage and employment.

e. Robots are introduced to do most basic assembly-line tasks.

 If robots are introduced to do most basic tasks, the demand of labor will decreasecausing a
decrease in real wage and employment.
Question Four (30 points)
a. Maria is downloading labor market data for the most recent month, but her
connection is slow and so far this is all she has been able to get:

Find the labor force, the working-age population, the number of employed workers,
and the number of unemployed workers. (20 points)

> Labor force = employed workers + unemployed workers Labor Force Population
Rate = Labor force/ Population x 100 62.5% = Labor force /(Labor Force + 60)

0.625 Labor Force + 37.5 = Labor Force

Labor Force = 37.5/0.375 = 100 million

Working-age population = labor force + not in the labor force

= 100 + 60 = 160 million

Unemployment rate = unemployed workers / labor force

Unemployed workers = labor force x 5%
= 100 x 5% = 5 million

Employed workers = labor force – unemployed workers

= 100 – 5 = 95 million
B- According to the principle of diminishing returns to labor, if the amount of capital and other inputs
are held constant, what is the impact of employing additional workers on the level of output?

 The principle of diminishing returns to labor states that when any factor of production such as labor
increases, while other factors as capital and other inputs are held constant, the output perunit will
diminish
 A. Assume the product is sold at price of $3000 each, find the marginal product and the value of themarginal
product for each worker.
B. If the real wage in the market is $300 per week, what number of workers you suggest employing?
Explain your answer.

Answer
a

B. if the wage in the market is $35000, then the data shows that the firm canemploy 7
workers. This is because the value of marginal product for each worker Less Than the
real wage in the market.