Cost of Living and Inflation Overview

Cost of Living and Inflation

• Nominal vs Real Income

  • Nominal income increases with inflation, while real income declines due to diminished purchasing power caused by the decrease in dollar value.

• Cost-Push Inflation

  • Inflation that arises from a decline in the supply of goods and services, often due to supply shocks, which increase costs for businesses and result in higher consumer prices.

Consumer Price Index (CPI)

• Definition

  • CPI measures the cost of a market basket of goods and services in a specific year as compared to a base period (1982-1984).

• Calculation

  • The Bureau of Labor Statistics (BLS) computes inflation rates by:

    • Identifying relevant goods and services

    • Recording their costs

    • Calculating the total cost of the basket.

Interest Rates

• Nominal vs Real Interest Rates

  • Nominal Interest Rate: The stated percentage without adjustment for inflation.

  • Real Interest Rate: Adjusted for inflation, representing the actual purchasing power.

• Impact on Creditors and Debtors

  • Creditors: Money is repaid with reduced value during inflation.

  • Debtors: Benefit by repaying loans with depreciated money value (e.g., buying a car).

Inflation vs Deflation

• Definitions

  • Inflation: An increase in prices over time.

  • Deflation: A decrease in prices, potentially leading to economic stagnation.

• Consequences of High Inflation

  • High inflation can severely hurt the economy by skyrocketing prices, reducing the currency's usability and value.

Types of Inflation

• Demand-Pull Inflation

  • Arises when demand for goods and services exceeds supply, often linked with rising GDP.

• Cost-Push Inflation

  • Results from increased production costs, maintaining a connection to positive GDP outputs.

Impact on Different Income Groups

• Negative Impact

  • Pensioned railroad workers.

  • Retired business executives reliant on fixed interest income.

  • Unionized automotive assembly-line workers.

• Mixed Impact

  • Commission-based department store clerks.

  • Independent small-town department store owners.

• Positive Impact

  • Heavily indebted farmers who benefit from fixed interest on loans.