Macro Chap 7 - Inflation

Inflation

increase in the average level of prices of goods and services

Deflation

a decrease in the average level of prices of goods and services

Relative Price

price of one good in comparison with the price of other goods

Impact of inflation

depends on how the prices of the goods and services each person buys or sells change.

Nominal income

amount of money income received in a given time period, measured in current dollars

Real income

income in constant dollars.

What do higher prices mean

nominal income doesn't change but your real income does.

Price effects

People who buy products that are increasing in price the fastest end up worse off.

Income effects

People whose nominal incomes rise more slowly than the rate of inflation end up worse off.

Wealth effects

People who own assets that are declining in real value end up worse off.

What do redistributive effects of inflation

increase social and economic tensions

What types of redistributive effects of inflation

Tensions between labor and management

Tensions between government and the people

Tensions among consumers

What is the significant real cost of inflation

Morale

Social coherence

People's attitudes toward each other

Money illusions

use of nominal dollars rather than real dollars to guage changes in one's income or wealth

Uncertainty

not knowing the prices of goods in the future makes purchasing

and production decision making much more difficult

Speculation

decisions will shift from standard economic activity to betting

on the future prices of goods which can fuel hyperinflation (inflation rates in excess of 200% lasting at least one year)

Bracket creep

in a progressive tax system, when nominal incomes rise, the taxpayer gets pushed into a higher tax bracket.

Deflation dangers

this has redistribution effects that are the opposite of

those for inflation. Declining price levels deflate incomes and assets and decrease consumer confidence.

Consumer Price Index (CPI)

a measure (index) of changes in the average price of consumer goods and services.

Inflation rate

annual rate of increase in the average price level.

Inflation rate

(price level in year 2-price level in year 1)/(price level in year 1) x 100

Bureau of Labor Statistics

Surveys a large sample of families every year

Identifies a market basket of goods and services the typical consumer buys

CPI

usually expressed in terms of what the market basket cost in a specific base year

Item weight

percentage of total expenditure spent on a specific product.

Percentage Change in CPI formula

Item wright x Percentage change in price of item

Core inflation

measures changes in the CPI, excluding food and energy prices received by producers

What does the three Producer Price Indexes (PPI) do?

Keep track of average prices received by producers

What does the first index of the Producer Price Indexes

crude materials

What does the second index of the Producer Price Indexes

covers intermediate goods

What does the third index of the Producer Price Indexes

finished goods

What does the PPI primarily include?

producer prices in mining, manufacturing, and agricultrue

GDP deflator

a price index that refers to all goods and services included in GDP.

What does the GDP deflator value reflect?

both price changes and market responses to those price changes.

What is GDP deflator is used to do?

adjust nominal GDP for changing price levels

What is real GDP in year t formula

Real GDP in year t = Nominal GDP in year t/ price index = Nominal GDP in year t/ GDP deflator

Price stability

absence of significant changes in the average price level

What are the unemployment concerns ?

There might be a trade-off between inflation and unemployment

What are the quality changes?

From year to year, there are quality improvements in the basket of goods.

What are the new products?

New products change the content of the basket of goods we buy.

Demand-Pull inflation

results from excessive pressure on the demand side of the economy

Cost- Push inflation

results from higher production costs putting pressure on suppliers to push up prices

Cost-of-living-adjustment (COLA)

automatic adjustments of nominal income to the rate of inflation

Adjustable-rate- mortgages (ARMS)

mortgages that adjust the nominal interest rate to changing rates of inflation.