Inflation

price index

a measure of the price level

price level

a weighted average of the prices of all goods and services

to try and counter biases, BLS now updates every two years and gathers prices from non-traditional retail stores

also uses the method called the chained CPI (chain weighted CPI helps to overcome the biases assoc. with new products, quality changes and discounted prices) as well as the traditional CPI

other inflation issues:

1. deflation 2. hyper-inflation 3. arbitrariness

who's hurt by inflation?

1. people on fixed incomes 2. savers 3. creditors 4. investors 5. consumers

who is unaffected or helped by inflation?

1. people with flexible incomes (those whose contracts have COLAs) 2. sometimes business owners if they can raise the price before prices of input increase 3. debtors (pay back the loan in cheaper dollars)

four possible biases on the CPI (in relation to COLA):

1. substitution bias 2. increase in quality bias 3. new product bias 4. outlet and internet bias

how do you adjust for price changes?

1. take nominal income and divide it by a price index 2. "x 100"

using the following data from bell-land what was the inflation rate for 2017? year CPI 2015 201 2016 207 2017 215 base year: 2015

3.9%

which of the following would be the best measure of the cost of living?

CPI

the fixed quantity approach:

CPI formula: CPI = $ expenditure in current year x 100/$ expenditure in base year (pi stands for inflation)

the fixed quantity CPI is used the determine the government's cost of living adjustment for COLAs for Social Security

based on the CPI-W which is the CPI for urban wage earners and clerical workers

the substitution bias in the CPI refers to the idea that consumers ______ the quantity of products they buy in response to price, and the CPI does not reflect this and ____ the cost of the market basket.

change; over-estimates

for any given year, the CPI is the price of the basket of goods and services in the

given year divided by the price of the basket in the base year x 100

for which group is the US' inflation rate the least accurate?

households of senior citizens (because health care is a larger part of their budget than the CPI's budget and housing costs are a smaller part)

9 categories of CPI

housing, food, beverages, transportation, medical care, recreation, communication, apparel, education, other goods and services

"we can print however much money we need"

hyperinflation

why isn't the GDP model a good representation for households?

it includes government spending on road construction and businesses buying big machinery and households don't usually make that large of purchases

interest rate formula

nominal i = real i + pi(e) (i stands for interest rate; pi(e): expected inflation)

real income

nominal income adjusted for price changes

cost-push inflation

occurs when prices increase and force businesses to raise prices of goods and services which in turn causing workers to request raises and so on; increase of cost occurs when PPF stays the same (i.e., 1970s)

how does inflation affect your purchasing power?

real income(year wanted) = nominal income(year wanted)/CPI(year wanted) x 100

converting dollars ex.

salary in 2010 dollars = $132,660 (2010) salary in 1960 x (CPI in 2010/CPI in 1960) $18,000 x (218.312/29.6)

CPI

the average of the price of the goods and services purchased by the typical urban family of four

nominal income

the current dollar amount of a persons income

inflation

the rate at which the level is increasing; inflation lowers the purchasing power of everyone, rich and poor

frictional unemployment

unemployment that occurs when people take time to find a job

structural unemployment

unemployment that results because the number of jobs available in some labor markets is insufficient to provide a job for everyone who wants one (robot replacements)

cyclical unemployment

unemployment that rises during economic downturns and falls when the economy improves

suppose that in 2021, all prices in the economy double and that all wages and salaries have also doubled. in 2021 you

were no better or worse off than you were in 2020 as the purchasing power of your salary has remained the same

why does it matter if the CPI is over-estimated?

when it is, the govt. ends up paying out more money than it needs to pay out

demand-pull inflation

when the money supply increases but the real GDP was not; everyone has more money but the same amount of goods and services to buy