Microeconomics Lesson 6
If the CPI was 207 in 2009 and 225 in 2013, what wage would someone who earned a $50,000 income in 2009 have to earn in 2013 in order to keep her purchasing power constant?
$54,348
If the inflation rate is 6 percent and the nominal interest rate is 4 percent, then the real interest rate is
-2 percent, which is the nominal interest rate minus the inflation rate.
Which of the following causes changes in the CPI to overstate the true inflation rate?
-New product bias -Substitution bias -Increase in quality bias
If a 3-month Treasury bill pays 5.5% and the change in the consumer price index (CPI) is 4.7%, what is the real interest rate (the true return to lending)?
0.8%
The following questions are related to the Wall Stree Journal article/interactive titled, A Brief History of US Inflation Since 1775. 1. From the US Revolutionary War to WWII, inflation swung around much more dramatically than it does today. 2. Many economists, including former Fed Chairman Ben Bernanke, blame the Fed for causing a deflationary spiral during the Great Depression by keeping monetary policy far too loose. 3. Who was the chair of the Federal Reserve Board of Governors that raised interest rates to 20% in the early 1980s to try and tame inflation? 4. In 1974, the economist Herbert Stein called inflation:
1. True 2. False 3. Paul Volcker 4. a Hydra-headed monster.
The following questions are related to the NYT article, A Bank Robbery? Nope, Just Buying Coffee and Groceries in Caracas. 1. Which country is this article about? 2. The government began instituting price controls under which former president? 3. These price controls: 4. Which of the following words best describes what is currently happening in the country? 5. What is the name of the currency in the country?
1. Venezuela 2. Hugo Chavez 3. created some disincentives to produce things in the country. 4. Hyperinflation 5. Bolivar
Deflation
A decline in the price level
Consumer Price Index (CPI)
A measure of the average change over time in the prices a typical urban family of four pays for the goods and services they purchase -Calculated by BLS, employees visit 23,000 stores in 87 cities and record prices of over 200 goods. Basket updated every 2 years (Expenditures (of basket) in current year/Expenditures (of basket) in base year)X100
Price Level
A measure of the average prices of goods and services in the economy
Producer Price Index (PPI)
An average of the prices received by producers of goods and services at all stages of the production process
The price index which is used to measure changes in the cost of living is the
Consumer Price Index (CPI).
Which of the following is not considered one of the potential biases in calculating the consumer price index?
Coverage bias.
Briefly explain whether you agree or disagree with the following statement: "I don't believe the government price statistics. The CPI for 2014 was 205, but I know that the inflation rate couldn't have been as high as 105 percent in 2014."
Disagree. The inflation rate is the percentage increase in the price level from the previous year, not the base year.
During the late nineteenth century in the United States, many farmers borrowed heavily to buy land. During most of the period between 1870 and the mid-1890s, the United States experienced mild deflation. Many farmers engaged in political protests during these years, and deflation was often a subject of their protests. Why would farmers have felt burdened by deflation during this period?
During deflationary periods, the real interest rate exceeds the nominal interest rate, and the real cost of borrowing increases.
Which one of the following is not a measure of the price level?
Government Price Index: an average of the prices paid by the government for goods and services used only by different government agencies.
Suppose that Apple and the investors buying the firm's bonds both expect a 3 percent inflation rate for the year. Further, suppose the nominal interest rate on bonds is 6 percent and the expected real interest rate is 3 percent. Now suppose that a year after the investors purchase the bonds, the inflation rate turns out to be 4 percent, rather than the 3 percent that had been expected. In this situation, investors _________ and borrowers _________.
Lose, Win
GDP Deflator
Measures price level in economy and how prices of all goods are changing
Outlet Bias of CPI
People buy goods from outlet stores and online (CPI accounts for this with "point of purchase" survey)
The nominal interest rate equals the real interest rate ________ the inflation rate.
Plus
An interest rate is the
Price of money; this is important because the ability to borrow and save money allows for economic growth
The internet has ______ the size of menu costs
Reduced
Which of the following steps has not been taken by the Bureau of Labor Statistics (BLS) to reduce the size of the biases in the CPI?
The BLS has expanded the number of stores from which it collects the price information to reduce the coverage bias.
Substitution Bias of CPI
The CPI assumes consumers buy the same things month to month (people substitute cheaper goods as price changes)
In the fall of 2015, Apple introduced a new model of its iPhone. The new model had a faster processor and a better camera than the previous model but sold for the same price. How was the CPI affected by the introduction of the new model of the iPhone? If Apple's new iPhones offer more features for the same price as the previous model, how was the consumer price index affected by the introduction of the new iPhone?
The CPI does not change.
Increase in Quality Bias of CPI
The CPI only looks at the prices of goods, not necessarily the quality of goods (prices may go up because the quality improves (healthcare))
New Product Bias of CPI
The CPI only updated every 2 years (New products not accounted for)
What is the difference between the consumer price index and the producer price index?
The consumer price index is an average of the prices of the goods and services purchased by the typical urban family of four, whereas the producer price index is an average of the prices received by producers of goods and services at all stages of the production process.
Menu Costs
The costs to firms of changing prices
Suppose the economy's consumer price index (CPI) in 2008 was 188 and the CPI in 2009 was 197.
The inflation rate over the period from 2008-2009 was equal to 4.8%
Expected Real Interest Rate
The interest rate adjusted for inflation EIR=Nominal Interest Rate-Expected Interest Rate
Real Interest Rate
The nominal interest rate minus the inflation rate
Inflation Rate
The percentage increase in the price level from one year to the next
Nominal Interest Rate
The stated interest rate on a loan
Adjusting for Inflation
Value in year x = Value in year y X (CPIx/CPIy)
Suppose that the inflation rate turns out to be much higher than most people expected. In that case,
a borrower will gain from the situation while a lender will lose.
What index is used to measure the average prices paid by a typical family? An average of the prices of the goods and services purchased by a typical family is the:
consumer price index (CPI).
Since nominal incomes increase with inflation,
expected inflation does not affect the purchasing power of the average consumer.
All of the following are problems caused by deflation except
firms make higher profits as consumers buy more goods and services.
The difference between a nominal variable and a real variable is that
nominal variables are calculated in current-year prices and the real variables are measured in dollars of the base year for the price index to correct the effects of inflation.
The increase in quality bias in the consumer price index refers to the idea that price increases in the CPI reflect pure inflation, but ______ quality increases. This causes the CPI to ______ the cost of the market basket.
not; overstate
Most economists believe that the biases in the consumer price index cause the CPI to overstate the true inflation rate by about
one−half to one percentage points.
These biases lead economists to believe that CPI is
overstated by .5-1%
Inflation can affect the distribution of income because
people with incomes rising faster than the rate of inflation enjoy an increasing purchasing power, while people with incomes rising more slowly than the rate of inflation are hurt by a decreasing purchasing power.
The broadest measure of the price level that includes all final goods and services is
the GDP deflator.
The difference between the nominal interest rate and the real interest rate is
the nominal interest rate is the stated interest rate whereas the real interest rate is the nominal interest rate minus the inflation rate.
If the economy is experiencing deflation,
the nominal interest rate will be lower than the real interest rate.
If inflation is expected to increase,
the nominal interest rate will increase.
The BLS collects price statistics from traditional full-price retail stores, which do not reflect the prices some consumers pay by shopping at discount stores or on the Internet. This is a description of which bias?
the outlet bias
Changes in the CPI overstate the true inflation rate due to four "biases." If apple prices rise rapidly during the month while orange prices fall, consumers will reduce their apple purchases and increase their orange purchases. Which of the four biases is concerned with this consumer behavior?
the substitution bias
The type of inflation that is a greater problem to society is
unanticipated inflation, since it causes greater redistribution of income between those making payments and those awaiting payments in the future.
Nominal incomes generally increase with inflation because
when inflation is anticipated, average nominal incomes also increase by the same percentage as the rate of inflation
