Chapter 8 Macro

Price Index

price index=(price/price in base year) x 100

Hyperinflation

-an extremely high rate of inflation (ex. Zimbabwe)

Price Level

-an index of the average price of goods and services throughout an economy

Capital Gains Taxes

-are taxes on the gains realized by selling an asset for more than its purchase price -capital gains arise with not only housing, but also with the sales of stocks, bonds, and other financial securities -inflation combined with a capital gains tax means that most people will be less likely to make these kinds of purchases -one possible solution is to rewrite the tax laws to take account of inflation's effects

Menu Costs

-are the costs of changing prices -ex. restaurants can find it expensive to print new menus when their prices change -changing prices can make regular customers angry enough to take their business elsewhere

Uncertainty about Future Price Levels

-before any revenue arrives from the sales of output, firms have to spend on resources

Long-Term agreements for the foundation of production

-businesses must make promises to deliver payments to workers and lenders -two long-term agreements: wage and loan contracts -when inflation confuses workers and lenders, these essential long-term agreements seem risky and people are less likely to enter into them -inflation can cripple loan markets because people don't know what future price levels will be

GDP deflator

-computing real GDP data -GDP deflator is very broad

Housing Market 2005

-example of price confusion -housing prices were high and rising in 2005; it did not reflect demand, but rather inflation -high prices spurred many builders to develop more houses -when housing prices later fell, many of those builders declared bankruptcy

Calculating a Simple Price Index

-first, determinate typical basket of goods -then, calculate the total price of the basket in a base year and set that base year at 100 (creating an index) -for subsequent years, we add up the new prices for the same basket of goods and then divide by the original basket price to determine the new index number

CPI weights

-housing: 41% -apparel: 4% -communication: 4% -medical care: 7% -food: 15% -transportation: 17%

New Products and Locations

-if the CPI basket doesn't include the latest prices, this price drop is lost -new retail outlets typically offer lower prices than traditional retail stores do -if the BLS continued to check prices only at traditional retail stores, it would overstate the price that consumers actually pay for goods and services

Wealth Redistribution

-inflation can redistribute wealth between borrowers and lenders

Chained CPI

-is a measure of the CPI in which the typical consumer's basket of goods is updated monthly -it is a better indicator of inflation for the typical consumer -it is an effort to measure the upward bias -it accounts for price reductions that typically occur during the first few years after a new product has been introduced

Consumer Price Index (CPI)

-is a measure of the price level based on the consumption patterns of a typical consumer -it is the predominant measure of the general price level -reflects the overall rise of prices for consumers on average

Nominal Wage

-is a worker's wage expressed in current dollars -similar to nominal GDP

Inflation rate (i)

-is calculated as the percentage change in the price level (P) -inflation rate (i) = (P2-P1/P1) x 100

The Reasons Governments Inflate the Money Supply

-large government debts often spur governments to choose to increase the money supply rapidly by printing more money -surprise increases in the money supply can temporarily stimulate an economy toward more rapid growth rates -the short-term economic boost can be very tempting for governments -in order to realize any benefits from inflation, the government has to keep surprising people in the economy

Price Confusion

-market prices are signals (ex. if demand increases, quantity increases, prices rise) -if firms cannot determine which price changes are due to inflation, resources may be misdirected in the economy -if firms always react to pice changes by increasing their output, they run the risk of over-building

Bureau of Labor Statistics (BLS)

-measures reports and inflation data -they estimate the overall price level -each month they go to 38 geographic locations to gather and input price information for over 8,000 goods

The Billion Prices Project (BPP)

-monitors daily price fluctuations of approximately 5 million items sold by roughly 300 online retailers -it is different from the CPI because it tracks the prices of goods that are only sold online, and it does not weight those prices to reflect their importance in a typical consumer basket -in stable environments with low inflation, BPP and CPI are not likely to be very different -when inflation is high, the BPP has the potential to point out meaningful trends in prices long before the CPI data can capture those changes

Deflation

-occurs when overall prices fall; it is negative inflation

Money Illusion

-occurs when people interpret nominal changes in wages or prices as real changes

Quality Changes

-over time, the quality of a good increases, and so does the price -BLS uses an adjustment to account for this

Tax Distortions

-tax laws do not typically account for inflation -one area in which particularly distortionary effects occur is capital gains taxes

Real Wage

-the nominal wage adjusted for changes in the price level -it is more informative because it describes what the worker earns in terms of purchasing power

Output

-the production that a firm creates -in a normal production process, funds must be spent today and then repaid in the future--after the output sells

Shoeleather Costs

-the resources that are wasted when people change their behavior to avoid holding money -these include fuel costs and the time and effort that people expend when they make multiple trips to a bank or ATM

CPI overstates true inflation: 3 concerns

-the substitution of different goods and services -changes in quality -the availability of new goods, services, and locations

The Accuracy of the CPI

-when employees adjust wages for inflation, they generally use the CPI -because the typical basket of consumer goods keeps changing, it is difficult to measure its price -the most common concern is that the CPI overstates true inflation

Substitution

-when prices of a good rises, consumers want to substitute it for a cheaper alternative -this makes CPI calculations difficult because the typical consumer basket changes -when consumers substitute less expensive goods, that change alters the weight of all the goods in the typical consumption basket -without acknowledging this, the CPI would exaggerate the effects of the price increase, leading to upward bias -the BLS used a formula that accounts for this

What is the cause of inflation?

-when the supply of money in an economy grows relative to the quantity of goods and services, then it takes more money to buy any particular good or service -money then becomes less valuable relative to goods and services (this relationship constitutes inflation)

BLS's Goals

1. determine the prices of all the goods and services that a typical consumer buys 2. identify how much of a typical consumer's budget is spent on these particular items