Prices

Inflation

An increase in the average level of prices

• A “tax on savers”

• decreases purchasing power of a unit of currency

Deflation

A decrease in the average level of prices

• an increase in the purchasing power of a unit of currency

Measuring changes in inflation

1. Changes in the simple average of all prices in an economy

• can be misleading because expensive goods bias inflation upward

2. changes in the weighted average of some prices in an economy

Price index

the cost of a basket of goods in year “T” expressed as a percentage of the cost of the same basket during a base year

Implications of Price index

if the price index is higher than 100, inflation has occured since the base year

Inflation rate

the percentage change in a price index between any two periods (p2-p1/p1)

Interpretation of inflation rate

the cost of the basket of goods increased by X% over the given time period

Consumer price index (CPI)

tracks the cost of goods based on typical consumer expenditure

• more representation depending on how much was spent on said good

• food, shelter, transportation, healthcare, education, recreation, clothes, household furnishings

Core CPI

• CPI without food and energy

• some thing the CPI is too volitile because the basket includes things notoriously sensitive to geo-political developments like war

It’s really difficult to have a productive conversation about inflation

• too many different CPIs

• Time periods matter

• social security payments adjust with inflation according to CPI

Nominal Values

values expressed in current dollars without adjusting for inflation

Real values

values adjusted for inflation

Evolution of median real wages and housholdl income

• wages have kept up with inflation

• households are better off in terms of compensation, but there are imilations as the inflation rate is national and doesn’t capture regional differences

Comparing purchasing power

Year B amount / 1 + inflation rate