Chapter 14: Monetary Policy and the price level

The consumer price index (CPI)

Measures the overall change in the prices of goods and services that people typically buy over time. It does this by collecting approximately 53,000 prices every month and comparing to the month previous

Economic uses of CPI

~measures the rate of inflation
~it allows us to make international comparisons
~ it is an indicator of the countries/ government's performance
~it is and indexation of savings and investments
~it is used in wage negotiations
~ it is used but the government to index tax bands

cost-push inflation

When prices rise due to an increase in the cost of production.

Consequences of change in price level for firms

~increase in unemployment (cost push inflation)
~increase in demand (demand pull inflation)
~borrowing in encouraged

Consequences of change in price levels for the economy

~loss of international competitiveness
~difficulty attracting FDI
~higher tax receipts
~higher public expenditure

monetary policy

The way in which a central bank affects the amount of money in circulation using tools of quantitative easing, changing the ECB base rate of interest and changing the availability of credit

European Central Bank

It's making task is to maintain price stability in the euro area and so preserve the purchasing power of the single currency

Deflation

Hapens when there is a general decrease in the average level of prices

Measures of Inflation

~simple price index
~composite price index
~consumer price index

Precautions to take when using CPI

~it is an index of only the average consumer
~it is not a cost of living index
~it lags behind consumer trends and fashion
~static weights
~quality changes in product
~substitution of products

Inflation

A steady and persistent increase in the general level of prices. It is the rate at which your money loses purchasing power.

Steps to create a composite price index

1. Choose a base year
2. Select the goods and find the prices for all goods in all years
3. Construct a simple price index for each good
4. Multiply the simple price index by the weight
5. Add to get the composite price index for the current year

demand-pull inflation

increases in the price level (inflation) resulting from an excess of demand over output at the existing price level, caused by an increase in aggregate demand

Imported inflation

increasing domestic prices as a result of increasing import prices.

Government induced inflation

A sustained annual increase in prices caused by expansion of the money supply to pay for government-supplied goods and services

Consequences of change in price level for consumers

~lower standard of living
~increased wage demands
~fixed income
~savings are discouraged
~speculation is encouraged