Economics: Inflation, Unemployment, and Growth Key Concepts

What is inflation?

The general increase in prices over time, meaning your money buys less than it used to.

What is the CPI? Who measures it?

Consumer Price Index, used for cost of living adjustment. Measures the cost of goods and services bought by the typical consumer.

How is CPI calculated?

CPI = (Cost of basket in current year / Cost of basket in base year) × 100

How is inflation calculated?

Inflation Rate = (New Price Index - Old Price Index) / Old Price Index × 100

How is the producer price index different than the CPI?

Producer Price Index measures the cost of goods and services bought by firms.

What are the problems with the CPI?

Substitution bias, introduction of new goods, unmeasured changes in quality.

Does CPI tend to overstate or understate inflation? By how much?

Overstates by 0.5-1% per year.

What are the main differences between CPI and GDP Deflator?

Imported consumer goods not included in GDP; Capital goods & government purchases not included in CPI; GDP deflator uses production-based weights.

Why can we not directly compare dollar figures across time?

Because you need to adjust for the cost of living.

What is indexation?

Automatically adjusting wages, benefits, taxes, or contracts to keep up with inflation.

What is the formula for converting dollar figures across time?

Value in new year = Value in old year × (CPI in new year / CPI in old year)

What is the difference between nominal and real interest rate?

Nominal interest rate: percent change in dollar amount; Real interest rate: nominal rate corrected for inflation.

What is the formula for real interest rate?

Real interest rate = Nominal interest rate - Inflation rate

Who measures the labor market in the U.S.?

Bureau of Labor Statistics (BLS)

Who is included in the 'Adult Population'?

People 16+, not in institutions, not active military.

What are the three categories of labor market status?

Employed, Unemployed, Not in labor force.

Who is considered unemployed?

No job, able to work, actively looking in past 4 weeks.

What is the labor force comprised of?

Employed + Unemployed.

What is the formula for unemployment rate?

Unemployment rate = (Number of unemployed / Labor force) × 100

What is the formula for labor force participation rate?

Labor force participation rate = (Labor force / Adult population) × 100

How does average duration of unemployment change across the business cycle?

Lengthens in recessions, shortens in expansions.

Why is the unemployment rate never 0%?

Due to job transitions, skill mismatches, and seasonal work.

What is frictional unemployment?

Unemployment due to the time it takes for workers to find a job that fits their preferences.

What factors explain frictional unemployment?

Job search process, matching workers to jobs, geographic mobility.

How does the government try to reduce frictional unemployment?

Improves job matching and supports workers during transitions.

How do unemployment insurance benefits affect frictional unemployment?

Provide security, slightly increase frictional unemployment, improve job-worker matching.

What is structural unemployment?

Unemployment due to mismatch between labor demand and supply.

What factors explain structural unemployment?

Technological changes, industry shifts, skill gaps.

What are efficiency wages?

Paying above market wages to boost productivity and loyalty, may contribute to structural unemployment.

What percentage of U.S. workers are paid at or below federal minimum wage?

1.9%

What are the costs and benefits of labor unions?

Counterbalance large firms; make firms more responsive to worker conditions.

What is the best metric to compare living standards across the world?

GDP per capita

What is productivity?

Output per unit of labor.

What determines productivity?

Physical capital and human capital.

What is the paradox of plenty?

Abundant resources do not guarantee prosperity and may hinder development.

What is the difference between technological knowledge and human capital?

Technological knowledge = collective know-how in society; Human capital = individual skills and education.

What is the production function?

Formula connecting resources and technology to total output: Y = F(K, L, A)

What does higher investment lead to? Trade-off?

More future growth, but less current consumption.

What is diminishing returns to productivity?

Each extra unit of input produces less additional output than the previous one.

What is the catch-up effect?

Poor countries can grow faster than rich ones, narrowing the income gap.

How does foreign investment influence growth?

Provides more capital, better technology, higher productivity → accelerates long-run growth.

What is the difference between FDI and FPI?

FDI = control + long-term investment; FPI = financial investment without control.

Why might domestic investment be better than foreign investment?

Keeps money, jobs, and growth within the country, creating stronger long-term benefits.

What is the opportunity cost of education?

Foregone earnings from working instead of studying.

What are the political structures for property rights and growth?

Secure property rights, enforce contracts, limit corruption → support investment and entrepreneurship.

Does free trade lead to more or less growth?

More growth → higher productivity, innovation, and output.

How does R&D influence growth?

Drives new technology and innovation → raises productivity and long-run growth.

How does population growth influence productivity?

Can boost output, but may reduce per-worker productivity if capital and resources are insufficient.

Why has U.S. long-run growth slowed?

Slower labor, capital, and productivity growth limit potential output.