Econ Unit 6 - Inflation

Inflation (pie sign)

overall increase in prices. This does NOT mean EVERY price must go up during inflation. Some individual prices may fall

How is inflation measured?

Its measured using the price level which is the average level of prices in the economy

How Do We Measure Inflation(the price leve)?

CPI, GDP Deflator, and The PCE Deflator

The Consumer Price Index (CPI)

A price index made each month to represent the “market basket”. It is a measure of the price level in the economy relative to the prices in a base year.

The Market Basket

Everything purchased monthly by a consumer (transporation, housing, medical care, food, other goods and services)

CPI Formula

CPI = 100 times Cost of the basket in the current period divided by cost of the basket in the base period

Potential Problems with CPI (on the final???)

Substitution Bias, Introduction of New Goods, Unmeasured changes in Quality

GDP Deflator

GDP Deflator equals 100 times Nominal GDP divided by Real GDP

CPI vs GDP Deflator Prices of Capital Goods

Included in GDP Deflator (if produced domestically)

Excluded from CPI

CPI vs GDP Deflator - Prices of Imported Consumer goods

Included in CPI

Excluded from GDP deflator

CPI Vs GDP Deflator - The Basked of Goods

CPI: fixed

GDP deflator: changes every year

The PCE Deflator

Personal Consumption Expenditure Deflaor. The ratio of nominal to real consumer spending (C). It only includes consumer spending, imported goods, and the market basket changes over time.

Core Inflation

It excludes the prices of food and energy because they can create volatility in the measure of inflation.

Interest Rate, Bank vs purchasing power

Interest rate bank pays = nominal interest rate (i)

Your Increase in purchasing power = real interest rate (r )

r=i-pie(inflation)

Expected inflation Costs

shoeleather costs, menu costs, tax distortions, measurement problems, and relative price variability.

Unexpected Costs

redistributes wealth between borrowers and lenders and hurts people on fixed incomes.

One benefit of inflation

The false notion of raises. All inflation is raly doing is changing the units of measurement. It’s like moving from feet to inches, the distance doesn’t change, just the numbers.

Deflation

When the overall prices of goods and services decrease over time. Unexpected deflation harms firms because they end up receiving less than they expected from their output.