Chapter 8 - The Price Level and Inflation

Inflation

The growth in the overall level of prices in an economy.

deflation

Occurs when overall prices fall; it is negative inflation.

Bureau of Labor Statistics (BLS)

A government agency that (1) determines the prices of all goods and services a typical consumer buys and (2) identifies how much of a typical consumer’s budget is spent on these items.

Consumer Price Index (CPI)

A measure of the price level based on the consumption patterns of a typical consumer in the U.S.

CPI = (basket price for the given year/basket price of the base year) x 100

basket of goods

A collection of goods and services used to track price changes for a typical consumer in the Consumer Price Index (CPI).

Inflation Rate Formula

price in today’s dollars formula

chained CPI

A version of the Consumer Price Index (CPI) that updates the basket of goods and services monthly to provide a more accurate measure of inflation.

Shoe-leather costs

the resources wasted when people change their behavior to avoid holding money due to inflation. Example: extra trips to the bank.

money illusion

when people misinterpret nominal changes in wages or prices as real changes in value

nominal wage

A worker’s wage expressed in current dollars, without adjusting for inflation

real wage

A worker’s wage adjusted for changes in the price level, showing actual purchasing power.

menu costs

The costs that firms incur to change their prices, such as reprinting menus or updating price tags.

price confusion

When businesses struggle to differentiate between an increase in demand for their product and a rise in overall inflation.

future price level uncertainty

The risk that inflation will make long-term agreements (like loans or wages) unpredictable.

wealth redistribution

When surprise inflation benefits borrowers by devaluing their future debt payments while harming lenders.

deflation

A decrease in the overall price level, which can discourage borrowing and reduce consumption.

capital gains tax and inflation

Taxes on the profits from selling assets can be distorted by inflation, as tax laws often do not adjust for rising prices.

cause of inflation

Inflation occurs when the supply of money in the economy grows faster than the supply of goods and services.

equation of exchange

velocity of money

The number of times a unit of money is used to purchase goods and services in a given year.