inflation

inflation definition and formula

inflation is an increase in the general price level

= Pnew - Pold / Pold * 100%

ways to measure price level (4)

CPI, PCE, GDP deflator, PPI

GDP deflator

nomianl gdp / real gdp * 100

PCE

a measure of consumer prices. differs from cpi in coverage and weighitng.

includes certain expenditures made on a households behalf

PPI

CPI but for wholesalers

headline vs core CPI

all covered items vs excluding food and energy (which are most volatile)

CPI

weighted purchases of consumers

= cost of basket in year t / cost of baket in base year * 100

CPI in base year is automatically 100.

CPI of 125 represents 25% inflation

why cpi isnt perfect

substitution bias, consumers switch to cheaper alternatives not in the basket

quality change bias, highe rprices could reflect better produts

new products may not be included

hedonic adjustment

method for separating price change attributable to quality from price changes for otherwise comparable products

inflation vs disinflation vs deflation

inflation means price level rises

disinflation means price level rises but not as quick

deflation is price level falls

nominal vs real interest rates

real interest rate = nomina interest rate - inflation rate

hidden costs of inflation

money illusion - people focus on nominal dollars instead of purchasing power

menu costs - businesses incur costs changing prices

uncertainty

wealth redistribution - affects borrowers and lenders

tax distortion - taxes on nominal values that dont account for inflation

wages and prices don’t move together in sync, some lag

two causes of inflation

demand pull - aggregate demand increases relative to productive capacity

supply push - production becomes more costly/scarce, prices increase