Studied by 6 people
Inflation
the rising general level of prices that reduces the purchasing power of money.
When there is inflation
each dollar of income will buy fewer goods than before
Is high inflation good or bad?
in general, it is bad becasuse banks do not lend and people do not save. It lowers investment and GDP
Deflation
decrease in general prices (negative inflation rate). Bad because people will hoard money and assests which will decrease consumer spending and GDP.
Disinflation
prices increasing at slower rates
how do we measure inflation
government tracks prices of “market baskets” which include the same goods and services
Two ways to measure inflation over time
the inflation rate and price indicies
the inflation rate
the percent change in prices from year to year
price indicies
index numbers assigned to each year that show how prices have changed relative to a specific base year
What is the market basket
a basket of goods and services that is set (but does change over time). includes items that consumers would normally purchase
how to calculate the price of the market basket
add up all prices in a basket in a given year. Quantity must be the same as the base year.
Consumer price index (CPI)
the most common measurement of inflation for consumers in the US
CPI= ((price of current year market basket)/(price of market basket in base year)) *100
3 problems with CPI
substitution bias
new products
product quality
Substitution bias
as prices increase for the fixed market baskets, consumers buy less of these products and more substitues that may not be apart of the market basket.
Results in a CPI that could be higher than what consumers are paying.
New products
the CPI market basket may not include the newest consumer products. CPI measures price but not the increase in choices.
Product quality
the CPI ignores both improvements and decline in product quality. CPI may suggest that prices stay the same even though the economic well being has improved significantly
The government role is
to prevent unemployment and prevent inflation at the same time
If they focus on inhibiting one factor, they other one with rise
Good rates uig
U: 4-6%
I: 1-4%
GDP growth: 2.5-5%
worry rates of uig
U: 6.5-8%
I: 5-8%
GDP growth: 1-2%
bad rates of uig
U: 8.5% or more
I: 9% or more
GDP growth: .5% or less
Hurt by inflation
Lenders- people who lend money at fixed intrest rates
people with fixed incomes
savers
helped by inflation
borrorwers- people who borrow money
a business where the price of the product increases faster than the price of resources
Nominal wage
wage measured by dollars rather than purchasing power
ex: $5/hr $15/day
real wage
wage adjusted for inflation
(if there is inflaition, you must ask your boss for a raise)
how does high inflation rate diver people from productive activities
menu costs
shoe leather costs
unit of account costs
menu costs
it costs money to change listed prices.
Ex: businesses update menu, signs, etc.
Shoe leather costs
costs that people incur to minimize their cash holdings during times of high inflation.
the costs of transactions increase. People reduce their real money holdings so they must spend time and effort making additional trips to the bank. (More applicable to older times like when there were no credit cards and you had to take out money from the bank every time you went food shopping)
Unit of account costs
money doesn’t reliably measure the value of goods and services.
Leads to efficient use of resources because of uncertainty caused by changes in currecncy value.
