Macro lecture 2

Overview of CPI (Consumer Price Index)

The Consumer Price Index (CPI) is often reported in the financial news and has gained more attention post-COVID.
Before COVID, inflation was relatively low and people were concerned over minor increases (e.g., 0.03%).
CPI measures the overall cost of goods and services purchased by consumers, which include necessities and discretionary items.

Necessities: Essential goods/services for daily living (food, gas, personal care).
Discretionary: Non-essential goods/services (concert tickets, luxury items).

Calculated by taking the price of a basket of goods/services in the current year and dividing it by the price in a base year:
- Example: CPI in 2024 is calculated using prices from a chosen base year (e.g., 2023).
- The formula is: ( \text{CPI} = \left( \frac{\text{Price of basket current year}}{\text{Price of basket base year}} \right) \times 100 )
Inflation rate = Percentage change in CPI from one period to another:
- Formula: ( \text{Inflation Rate} = \left( \frac{\text{CPI current year} - \text{CPI previous year}}{\text{CPI previous year}} \right) \times 100 )

Excludes volatile items (food and energy) to provide a clearer picture of underlying inflation trends.
Helps to identify inflation trends that are less affected by short term fluctuations in food and energy prices.

Measures the cost of goods/services bought by firms as opposed to consumers.
Used to understand inflation through the producer's perspective, indicating inflation pressure from the supply side.

Some prices are "sticky," meaning they don't change easily in response to supply or demand fluctuations (e.g., wages).
Price rigidity can lead to prolonged periods of inflation or deflation depending on macroeconomic conditions.

Substitution Bias: Doesn’t consider consumers switching to cheaper alternatives when prices of goods rise.
Introduction of New Goods: CPI may underestimate inflation when new products are introduced or industries evolve.
Unmeasured Quality Change: Fails to account for improvements in product quality that enhance value (e.g., tech devices).

GDP Deflator: Reflects the price level of all domestically produced goods and services, not just consumer purchases.
CPI: Focuses solely on consumer purchasing behavior with a fixed basket of goods.

Inflation trends can now be observed linked to significant events (e.g., 1970s stagflation, COVID impacts).
Consumer expectations and sentiment can drive spending behavior; fearful consumers often cut spending, which can lead to recessionary trends.

Throughout economic history, wage adjustments often align with inflation rates to maintain purchasing power.
Issues such as inflationary pressures require businesses to balance wage increases with overall profitability.

Real vs Nominal Interest Rates: Real interest rate accounts for inflation while nominal does not. Formula: ( \text{Real Interest Rate} = \text{Nominal Interest Rate} - \text{Inflation Rate} )
Indexation: Adjustment of wages or payments (e.g., Social Security) to counteract inflation effects, ensuring real value is preserved over time.

Economic cycles can induce volatility in prices, leading to inflationary spikes or periods of deflation.
Demand scenarios affect prices significantly (e.g., supply chain constraints and commodity price fluctuations).

Quiz preparation emphasized; resources and eligibility for homework submission discussed.
Next classes will link these foundational concepts to monetary policy and inflation's broader economic roles.