Lesson 5.5: Inflation and Deflation

Flashcards made from a presentation segment created as a lesson on inflation and deflation.

Inflation

The rate at which the value of a currency is falling and, consequently, the general level of prices for goods and services is rising

• Leads to a decline of the purchasing power of a given currency over time

Deflation

The general decline of the price level of goods and services

• Associated with a contraction in the supply of money and credit, but prices can also fall due to increased productivity and technological improvements

Aggregate price level

A measure of the overall level of prices in an economy

Consumption bundle

A typical group of goods and services purchased by customers

Market basket

A hypothetical consumption bundle used to measure changes in the overall price level

• Revised approximately every decade to reflect shifts in consumer purchasing behavior

Price index

A way of measuring how the average price of a standard group of goods changes over time

• Helps consumers and businesses make economic decisions

• Aids governments in making policy decisions, such as in setting interest rates to ease inflation

Base year

A year arbitrarily chosen for comparison when calculating a price index, which compares the price of the market basket of goods in a given year to its price in this

Inflation rate

Calculated as the annual percentage change in an official price index

• Can lead to workers or pensioners losing money if income does not keep up with this

Consumer price index (CPI)

Measures the cost of a market basket of a typical urban American family

• Calculated by the Bureau of Labor Statistics by surveying 23,000 retail outlets in 87 cities, tabulating over 80,000 prices per month for an overall weighted average

• Used to evaluate changes in the cost of living as well as the rate of inflation or deflation; is thus used to index the price of certain goods or payments like Social Security

• However, it can ignore technological improvements or households moving away from a good due to price increases

Producer price index (PPI)

Measures the cost of a typical basket of goods and services purchased by producers

• Usually moves in tandem with other measures of inflation

Money supply

One of the factors of inflation describing a rise in the supply of a currency without a matching rise in the production of goods and services

• Prices thus rise due to heightened demand for a limited supply of products, reducing purchasing power

Quantity theory of money

Believes that the value of money and resulting inflation are caused by the supply and demand of the currency

Wage-price spiral

Phenomenon that states that employers providing higher wages lead to higher costs, leading to higher overall prices and thus a need for even higher wages