ECON201 Chapter 12 Macroeconomics: Inflation and Money

Vocabulary flashcards covering key definitions, mathematical formulas, and concepts from Chapter 12 on measuring inflation, price indices, adjustments, and the functions and costs of money.

Inflation

A generalized rise in the overall level of prices, also described as an increase in the cost of living or a decline in the purchasing power of money.

Consumer Price Index (CPI)

An index that tracks the average price consumers pay over time for a representative "basket" of goods and services typically bought by households.

Inflation Rate

The annual percentage increase in the average price level, calculated using the formula: $\text{Inflation rate} = \frac{\text{Price level this year} - \text{Price level last year}}{\text{Price level last year}} \times 100$

Base Year

An arbitrary reference year chosen when constructing a price index, where the cost of the basket is scaled to $100$ to track price level changes over time.

Deflation

A generalized decrease in the overall level of prices across an economy.

Substitution Bias

The overestimation of the cost of living by the Consumer Price Index that occurs because people substitute toward goods whose prices rise by less.

Personal Consumption Expenditure (PCE) Deflator

A price index tracking consumer inflation whose basket includes items consumed but not directly paid for out of pocket (such as employer-provided medical care), adjusting for substitution bias.

Core Inflation

A measure of inflation that excludes volatile food and energy prices, used by forecasters to identify the underlying trend in price changes.

Producer Price Index (PPI)

A price index that tracks the prices of inputs into the production process, helping businesses monitor changing production costs.

GDP Deflator

A price index tracking the prices of all goods and services produced domestically, calculated as: $\text{GDP deflator} = \frac{\text{Nominal GDP}}{\text{Real GDP}} \times 100$

Nominal Variable

An economic variable measured in current dollar amounts without adjusting for the effects of inflation.

Real Variable

An economic variable that has been adjusted for inflation to reflect constant purchasing power in terms of base-year dollars.

Inflation Adjustment Formula

The mathematical formula used to convert dollar amounts across different time periods: $\text{Today's dollars} = \text{Another time's dollars} \times \frac{\text{Price level today}}{\text{Price level in another time}}$

Nominal Interest Rate

The stated interest rate paid on savings or charged on borrowing without correction for the effects of inflation.

Real Interest Rate

The interest rate measured in terms of changes in purchasing power, approximated by: $\text{Real interest rate} = \text{Nominal interest rate} - \text{Inflation rate}$

Money Illusion

The mistaken tendency to focus on nominal dollar amounts instead of inflation-adjusted, real amounts.

Money

Any asset regularly used in transactions, fulfilling the three key functions of medium of exchange, unit of account, and store of value.

Medium of Exchange

A function of money where it is widely accepted to buy goods and services or received in exchange for work, eliminating the need for barter.

Unit of Account

A function of money serving as a standard common unit used to measure economic value, quote prices, and record debts.

Store of Value

A function of money that allows purchasing power to be transferred from the present into the future.

Hyperinflation

Extremely high and accelerating rates of inflation that severely erode all three functions of money.

Menu Costs

The marginal resources and costs incurred by businesses to change and update posted prices.

Shoe-Leather Costs

The costs and effort incurred by individuals and firms attempting to minimize holding cash during times of inflation.

Inflation Fallacy

The mistaken belief that inflation destroys purchasing power, which overlooks that nominal wages and salaries also tend to rise along with prices.