price level

3 macro variables

Price level

national output

Unemployment (inversely related to national output)

Price level

Average price of all goods and services

Inflation

Percentage increase in the average price

Deflation

Percentage decrease in the average price

Signals possible recession and economic contraction.

Disinflation

Slowdown in the inflation rate

Demand-pull inflation

caused by an increase in demand that outpaces supply, leading to higher prices.

We observe good employment.

Cost-push inflation

caused by rising costs of production, such as wages and raw materials, leading to increased prices for consumers.

Absorb inflation plus falling output (recession)

Effects of inflation

Purchasing power falls

transaction costs rise

Market Interests rates rise

Price index

a measure that examines the weighted average price of a basket of consumer goods and services, reflecting the cost of living.

Base year = year of comparison

Weights = levels of importance (quantity purchased)

CPI = Spending on goods in year or given time period/spending on the same goods in base year

Inflation rate

(p2-p1/p1)*100

CPI of year - 100 ( for the exams)

Real income

Nominal income/CPI*100

Aggregate demand

Shifts as a result of spending

Problems with interpretation of CPI

If the quality of goods increases, price increases then the CPI overstates the true price level (makes it look worse)

If consumers substitute towards buying less expensive brands and no longer buy more expensive brands, then CPI understates the true price (makes it look not as bad)