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Overall Price Level and GDP

• Price Level Comparison

  • Price level can be measured using Nominal GDP vs Real GDP.

    • Nominal GDP: Calculated using current output at current prices.

    • Real GDP: Calculated using current output at constant prices (fixed).

• GDP Change Factors

  • Increase in GDP can result from:

    • Rising prices.

    • Increased quantities of output.

    • A combination of both.

  • Adjusting for inflation through Real GDP allows for more consistent economic analysis.

GDP Deflation and Price Indices

• GDP Deflation Calculation

  • GDP deflated (2019): 100

  • GDP deflated (2020): 171

  • These deflators are not price indexes but reflect the overall price levels across the economy.

  • Price level reflects a general measurement, not specific prices (e.g., it doesn't state milk is $5).

• Importance of Percentage Change

  • Percentage change of price indices indicates inflation.

  • Formula for calculating inflation:

    • [ Inflation = \frac{PriceIndex_{2020} - PriceIndex_{2019}}{PriceIndex_{2019}} \times 100 ]

    • Example: Calculate inflation between 2019 and 2020 using GDP deflator values.

Federal Reserve and Inflation Targets

• The Federal Reserve's Role

  • Aims for stable prices and maximum employment.

  • Monitors inflation closely, targeting around 2% inflation rates.

  • Uses GDP deflator to gauge inflation trends based on consumption data (68% of GDP).

• Historical Perspective on Inflation

  • Inflation trends observed throughout the 1970s due to geopolitical issues (Middle East oil crises and Vietnam War).

  • Economic adjustments led by figures like Paul Volcker aimed to control inflation, resulting in the recession then stabilized prices.

Perception of Prices Before and After COVID

• Comparison of consumer price perceptions:

  • Prices of essentials (such as eggs) surged during COVID leading to inflation perceptions outpacing actual CPI data.

  • Historical context of CPI index examines how pre-COVID prices are considered <br>

    • Prices do not revert to pre-COVID norms but stabilize at new higher levels.

• Factors Contributing to Increased Price Perception

  • Inflation due to compounded growth over several years (2% increases may feel larger).

  • Consumers reflect negatively on past prices vs current inflated prices.

Economic Correlations with GDP

• GDP's Significance and Correlations

  • GDP correlated with measures of well-being (e.g., life expectancy, education, crime rates).

  • High GDP correlates with better life quality indicators like lifespan, schooling availability, and lower crime rates.

  • High-income countries can afford better education and resources compared to poorer nations.

• The complexity of GDP

  • Includes both positive (service production) and negative (war expenditure) factors, making it a flawed measure of welfare.

Consumer Price Index (CPI) Overview

• Introduction to CPI

  • CPI measures the cost of a basket of goods/services purchased by a typical consumer.

  • Reflects shifts in consumer behavior and spending habits over time.

• Determining the Consumer Basket

  • Bureau of Labor Statistics (BLS) surveys aim to reflect typical consumer spending.

  • 42-45% of consumer spending directed towards rent/housing, illustrating the primary cost pressures for consumers.

Calculation of CPI

• Steps in Calculating CPI

  1. Fix the Basket: Determine what goods/services a typical consumer would buy.

  2. Find Prices for Basket Items: Track prices over time.

  3. Compute Cost of the Basket: Calculate total cost based on fixed quantities.

  4. Select a Base Year: Establish a base year for comparison.

  5. Calculate CPI: Compare basket prices relative to base year to derive CPI values.

• Practical Example of CPI Calculation

  • Different years to assess costs based on a detailed list of products (e.g., hot dogs and hamburgers) and their changing prices over time.

  • Highlight how price fluctuations reflect larger economic trends.

Problems and Limitations of CPI

• Issues with CPI Calculation

  • Substitution Bias: CPI does not adjust quickly to consumer substitutions for cheaper alternatives; therefore, inflation may be overstated.

  • If a product's price rises significantly, consumers may switch to cheaper substitutes, which CPI may not account for immediately.

  • CPI calculates based on static baskets while consumer preferences may rapidly change.

• Need for Updates

  • Ongoing relevance and timely updates of the basket are crucial to accurately measure cost of living changes.

  • Technological advances (e.g., smartphones) must be incorporated regularly into CPI calculations to maintain accuracy.