chapter 16 inflation and the price level

issues with inflation

"noise" in price system distortions of tax system "shoe-leather" costs unexpected redistributions of wealth interference with long-term planning

bureau of labor stats multiplies cpi by...

100 to get rid of decimal point

nominal interest rate (aka market interest rate)

annual percentage increase in the nominal value of a financial asset

real interest rate calculated by

annual percentage increase in the purchasing power of a financial asset; the real interest rate on any asset equals the nominal interest rate on it minus the inflation rate nominal interest rate minus current inflation rate

to calculate inflation rate...

change in price/original price

difference between tendencies in cpi inflation and core inflation

core is less susceptible to short-term fluctuations because food and energy are volatile

deflating a nominal quantity

divide nominal quantity by price index (such as cpi) to express the quantity in real terms

capital depreciation allowance

firm can reduce taxes by taking a fraction of the purchase price of capital as a yearly deductible

indexing

increasing a nominal quantity each period by an amount equal to the percentage increase in a specified price index. This prevents the purchasing power of the nominal quantity from being eroded by inflation

hyperinflation

inflation rate is extremely high, eg above 500

price index

measure of the average price of a given quality of goods or services relative to the price of the same goods or services in a base year

consumer price index (cpi) computed with formula

measure of the cost in a period of a time of a standard basket of goods and services relative to the cost of the same basket in a fixed year (the base year) cost of basket in current year/cost of basket in base year

price level

measure of the overall level of prices at a particular point in time as measured by a price index such as the cpi

fisher effect

nominal interest rates tend to be high when inflation is high and low when inflation is low

inflation-protected bonds

pay a nominal interest rate each year equal to a fixed real rate plus the actual rate of inflation during that year

nominal quantity real quantity

quantity measured in terms of its current dollar value quantity measured in physical terms, eg in terms of quantities of goods and services

core rate of inflation

rate of increase of all prices except energy and food

deflation

situation in which the prices of most goods and services are falling over time so that inflation is negative

quality adjustment bias

statisticians fail to adjust inflation rates adequately for improvements in the quality of goods or services; especially challenging when a completely new good appears

substitution bias

statisticians miss the point that people can switch to less expensive goods

rate of inflation

the annual percentage rate of change in the price level as measured, for example, by the cpi

relative price

the price of a specific good or service in comparison to the prices of other goods and services

real wage

wage paid to workers measured in terms of purchasing power; calculated by dividing nominal wage by cpi for that period

bracket creep

without indexing, inflation that raises nominal incomes forces people to pay a higher percentage in taxes, even though their real incomes are not increasing