Macro exam chap. 12 (Inflation/Quantity Theory of Money)

Outlines

\-Defining and measuring inflation

\-quantity theory of money

\-costs of inflation

define **inflation**

an INCREASE in the __AVERAGE level of price__

\-increases in the money supply

what is the **inflation rate?**

__new - old / old 100__ *→* P2 - P1 / P1 \*100

**example problem to find inflation rate:** If the price index is 200 in year 1 and 210 in year 2, the rate of inflation is

5%

What are the 3 components of **price indexes**?

\-Consumer price index (CPI)

\-GDP deflator

\-Producer price indexes (PPI)

define **CPI**

consumer price index:

\-measures __average basket of goods and services__ bought by a typical consumer

\-80k+products, weight each product differ

define **GDP deflator**

\-nom/real \*100

\-covers __ALL finished goods/services__

define **PPI**

Producer price indexes:

\-__measures prices__ received for products by producers

define **real price**

a __price__ that has been __corrected__ (ADJUSTED) __for inflation__ & USED to compare prices of goods over time → PRICE OVER BASKET

define **shrinkflation**

rather thank hike prices, brands are __reducing serving size (prices stays the same but the products are smaller)__

define **shadowinflation**

consumer inflation- OFFICIAL vs. SHADOWSTATS (__year to year changed)__

define **hyperinflation**

when price increases are so OUT OF CONTROL that the concept of __inflation is meaningless__ (ex: hungary’s 1.3\*10^24)

define **quantity theory of money**

\-sets out a general __relationship btw supply of $, velocity of $ (spending), real output, and prices__

\-EXPLAINS how the supply of __$ impacts inflation rates__

A **real price** is a price that has been corrected for?

inflation

**quantity theory of money formula** **/ variables**

M= money supply

P= price level

V= velocity of money

YR= real GDP

→ M(V)=P(YR)

\-__M(V)__ represents the __total amount spent on finished goods and services__

\-P(YR) is the price level times real GDP

\-both sides of this equation are also __equal to → nominal GDP__

define **velocity of money**

average number of times a dollar is __spent on Goods and Services in year__

**velocity of money formula**

M(V)=P(YR)

→ velocity of money is about 7 in US

→__an increase in M= increase in prices__

\*\*V and YR are fixed (aka don’t move)

define **deflation**

NEGATIVE inflation rate __(decreases in price levels)__

define **disinflation**

a r__eduction in the inflation rate__

what are the **4 problems associated with inflation?**

1)price confusion and money illusion

2)redistribute wealth (btw savers/borrowers and btw gov/citizens)

3)interact with other taxes

4)painful to stop

define **money illusion**

when people mistake changes in nominal prices for changes in real prices

**Inflation has two:**

\-unexpected

\-expected

Inflation: **unexpected**

\-__bad for lenders__

__-good for borrowers__

Inflation: **expected**

\-__lenders demand increase in interest rates__

what is the **real rate of return?**

nominal rate of return minus inflation rate → __nominal interest rate - inflation (expected/actual)__

what is the **nominal rate of return?**

rate of return not accounting for inflation

what is the **fisher effect?**

tendency for nominal interest rates to increase with __expected inflation rates__

**fisher effect formula**

__Nominal interest rate - inflation rate__

define **monetizing the debt**

when a gov. __pays off debts by printing money__ → more inflation good for borrower