Econ Notes session 1

Consumer Price Index (CPI) Limitations

• Substitution Effect

  • CPI measures inflation through a fixed basket of goods, primarily Coca Cola, which may not account for consumer substitution to alternatives like energy drinks and other sugar-laden beverages.

  • This limitation indicates that inflation may appear to rise while actual consumer behavior shifts to cheaper substitutes, skewing inflation metrics.

• Product Update Delays

  • CPI updates its basket of goods slowly, often taking years to include new products (e.g., iPhones, cell phone services) since they were not available in previous decades.

  • Emphasizes that while CPI is a useful indicator, it may not reflect current buying trends.

GDP Deflator vs. CPI

• GDP Deflator

  • A more comprehensive measure of inflation, accounting for all goods and services, represented by the formula: C + I + G.

  • It includes a wider scope than CPI which focuses on a limited basket of consumer goods.

• Exclusions from GDP

  • GDP does not incorporate:

    • Intermediate goods

    • Used goods

    • Black market activities

    • Transfer payments (e.g., Social Security)

  • Understanding these exclusions is crucial for analysis of economic health.

Elasticity of Demand

• Price Elastic

  • Goods whose demand reacts significantly to price changes (e.g., luxury items).

  • Price increases lead to decreased demand, and price decreases lead to increased demand.

• Price Inelastic

  • Goods not sensitive to price changes, where demand remains stable regardless of price fluctuations (e.g., medicine, toilet paper).

  • Consumers will purchase necessities despite price increases, indicating a lack of substitutes that affect demand.

Types of Market Competition

• Pure Competition

  • Defined by many buyers and sellers; products are homogeneous.

  • Example: Farmer’s markets.

• Monopoly

  • A single entity dominates the market.

  • Example: Diamond industry where one company controls most of the market.

• Natural Monopoly

  • The government permits one company to serve the market while regulating it to prevent overcharging.

  • Example: Duke Power Energy, which is regulated by the state.

• Oligopoly

  • A few firms control a significant market share (85-90%), influencing prices.

  • Example: Airlines, which are difficult to enter due to high barriers.

• Monopolistic Competition

  • Few businesses share market dominance but differ in branding, creating brand loyalty.

  • Example: Cereal companies, where slight differences can build consumer preference.

Federal Reserve and Monetary Policy

• Federal Reserve Banks

  • There are 12 Federal Reserve Banks tasked with implementing monetary policy.

• Expansionary vs. Contractionary Policy

  • Expansionary Monetary Policy:

    • Used during recessions; includes lowering interest rates on reserves and the federal discount rate to encourage borrowing.

  • Contractionary Monetary Policy:

    • Implemented to combat inflation; increases interest rates, making borrowing more expensive to curtail economic activity.

Understanding the Business Cycle

• Phases of the Business Cycle

  • Four phases include:

    • Peak: Highest point, indicating maximum economic growth.

    • Contraction: Begins at peak, signifies a recession.

    • Trough: Lowest point, leading to recovery.

    • Expansion: Recovery phase, where the economy grows until the next peak.

• Full Employment

  • Characterized by a natural rate of unemployment (NRU) between 4%-6% in the U.S., representing the balance where supply meets demand labor-wise.

Types of Unemployment**

• Frictional Unemployment: Transition between jobs, taking time to match jobs and skills.

• Structural Unemployment: Results from shifts in the economy, often due to technological changes or market changes.