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ECON NOTES 9/29

Deflation

  • Definition: Deflation refers to a decrease in the general price level of goods and services.

  • Economic Impact: Deflation is considered dangerous because it can lead to severe economic downturns, characterized by:

    • Unemployment: As prices fall, businesses may cut back on production, leading to job losses.

    • Decreased Production: A sustained period of deflation can result in a stagnant economy with little to no production taking place.

Hyperinflation

  • Definition: Hyperinflation is an extremely high and typically accelerating inflation rate.

  • Historical Examples: Notable instances of hyperinflation include:

    • Argentina: Known for its significant hyperinflation crisis.

    • Zimbabwe: Experienced extreme hyperinflation with dramatic price increases.

    • Weimar Republic (post-World War I Germany): Another significant case of hyperinflation.

    • Post-Soviet Union: The economic turmoil following the collapse of the Soviet Union also resulted in high inflation.

Stagflation

  • Definition: Stagflation is a combination of stagnation and inflation, featuring:

    • Rising Unemployment: Growing joblessness as the economy stagnates.

    • Rising Inflation: Simultaneous increase in the cost of living.

  • Current Context: Discussion on whether current economic conditions resemble stagflation, which poses significant challenges for policymakers.

Consumer Price Index (CPI)

  • Purpose: The CPI is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care.

  • Importance: It allows comparisons of dollar amounts over time, showing how the value of money changes.

    • Example: The value of the dollar in 1930 differs significantly from today, impacting economic contexts such as inflation and cost adjustments.

Cost of Living Adjustments (COLA)

  • Definition: Social Security checks and other payments are adjusted for inflation to maintain the purchasing power of recipients.

  • Significance: The government adjusts the amount of Social Security payments to reflect the inflation rate, ensuring that recipients can afford the same goods and services over time.

  • Terminology: COLA (Cost of Living Adjustment) is commonly used to refer to these adjustments in payments, which may also extend to salaries and rents.

Indexation

  • Definition: Indexation is the process of adjusting dollar amounts based on the CPI to reflect real value changes over time.

  • Formula for Adjustment:

    • \frac{\text{amount today}}{\text{CPI today}} = \frac{\text{amount last year}}{\text{CPI last year}}

    • Can also be applied regionally, such as:

    • \frac{\text{amount today}}{\text{amount in Minnesota}} = \frac{\text{amount last year}}{\text{CPI in Minnesota}}

  • Practical Use: This formula indicates the need for adjustments when comparing monetary values across different times or locations due to changes in the price level.

Example Calculation

  • Scenario: Evaluating how $220 in 1985 compares to 1986 based on CPI changes.

    • CPI in 1985: 90

    • CPI in 1986: 105

  • Calculation:

    • To find 1986 equivalence:

    • \text{Value in 1986} = \frac{220}{90} \times 105

    • Result: Approximately $6.67 in 1986.

Real vs. Nominal Values

  • Definition of Nominal: Refers to values measured in current prices, not accounting for inflation.

  • Definition of Real: Adjusted for inflation, indicating the purchasing power.

    • Example: To find real GDP, nominal GDP is adjusted with a deflator.

  • Applications:

    • Real Wages: Salary in current dollars divided by CPI gives real wages reflecting actual purchasing power.

  • Importance of CPI: It is crucial in converting nominal values to real values in economic analysis, ensuring accurate comparisons over time.