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