Inflation is the rise in the general level of prices in an economy.
The face value of money is determined by governments and printed on currency.
The purchasing power of money reflects the amount of goods and services that a given unit of money could be used to acquire.
Money's role as a medium of exchange means that it can be used as a means ^^of payment for goods and services or repayment of debt.^^
Money serves as unit of account or a way to measure how much something is worth.
Money's role as a store of value means ^^that it can be saved and used to purchase goods and services at a future time.^^
Money that has use and value apart from that stemming from its role as money is called commodity money.
Most paper currency in world is fiat money, which is valuable because of government declaration rather than because it can be used for other purposes besides money.
Having inflation does not mean that the prices of each and every good in an economy are rising but rather that the average level of prices in the economy is increasing. Economists use a price index to measure the average level of prices in an economy.
A price index is a measure of the average prices of a given set of goods or services across time.
The fixed set of goods and services is called the market basket, and it includes the types and amounts of goods commonly bought by a typical consumer in a specified time period.
The CPI measures the cost of the market basket in the current year as a percentage of the cost of the same basket of goods and services in the base year. The CPI is the ratio of the cost of the market basket in one year over the cost of the market basket in the base year multiplied by 100.
The CPl tracks the average price level for a typical set or goods and services purchases in the U.S. over time.
CPI values less than 100 imply that prices in that year are lower than in the base year.
CPI values greater than 100 imply that prices in that year are greater than in the base year.
Here for an example, the chart below reports seasonally adjusted December U.S. city average CPI values for each year, using 1982- 84 as the base year.
The values of the price index tell us whether prices are higher or lower in one year relative to the base year.
If the CPI is increasing rapidly, policymakers tend to adjust the wages of government and military workers and the level of government payments to people receiving social security, food stamps, or welfare payments.
A price index allows us to establish an average level of prices at a given point in lime. To assess bow much prices change across time, we compute the percentage change in the price index over time.
^^The inflation rate between two time periods is simply the percentage change in the price index between the periods.^^
Although inflation rates can be computed for any time period, they are usually reported as monthly or annual percent changes.
Disinflation is a period of positive but falling inflation. Disinflation indicates a skewing of the rate of price increase in the economy.
Deflation is negative inflation. Deflation indicates a period of declining prices of goods and services.
When inflation occurs, money that you have saved loses its purchasing power and becomes a poor store of value.
People on fixed incomes lose purchasing power in the face of inflation.
Demand pull inflation arises from increases in aggregate demand.
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Cost push inflation arises from decreases in aggregate supply.
Cost-push inflation comes from reductions in aggregate supply.
Real values are values that have been adjusted for inflation.
Nominal value are values that have not been adjusted tor inflation.
Price indices can be used to translate nominal values to real values that allow us to compare the purchasing power of money over time by adjusting for inflation.
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