2.4-2.5 Inflation and CPI - PART 1

Inflation

• A rise in the overall price level and fall in the purchasing value of money. In practical terms, the price of everything goes UP.

• Anticipated Inflation - usually 2% when economy is functioning properly

• Unanticipated Inflation - NOT GOOD!

Consumer Price Index (CPI)

• A measure that examines the average prices of a basket of consumer goods and services

  • such as transportation, food, and medical care

• It’s a very simple way of tracking inflation year-to-year

Why CPI was created and by whom?

• It is more accurate when looking at prices of consumer goods and help the government with social programs that depend on COLAs (Cost-of-living adjustments)

• Bureau of Labor Statistics (BLS) has been collecting the data since the early 1900s

CPI formula

CPI = 100 * (current year market basket price)/

(base year market basket price)

Rate of Inflation (with CPI) formula

Rate of Inflation = 100 * (CPI y2 - CPI y1) /

(CPI y1)

Nominal

• term refers to variables that have NOT been adjusted for inflation:

  • Nominal income - amt of money earned in wages/salary (before taxes)

  • Nominal GDP - value of an economy’s output in current dollars

  • Nominal interest rate - stated interest rate (the amount the bank offers you)

Real

• term refers to variables that HAVE been adjusted for inflation:

  • Real income - the purchasing power of a given wage or salary

  • Real GDP - the value of an economy’s output in inflation-adjusted dollars

  • Real interest rate - inflation-adjusted cost of borrowed money

Real Value formula (not required)

Real Value = 100 * (Nominal Value) /

([Consumer] Price Index)