Ch. 7 Inflation
Inflation
An INCREASE in the general (average) price level of goods and services in the economy
Consequences of Inflation
Inflation decreases the purchasing power of the dollar
Criticisms of the CPI
1) CPI may understate the true rate of inflation for some groups -Senior Citizens (Health care) 2) CPI may overstate the true rate of inflation due to Substitution Bias -Consumers may buy fewer items whose prices is increasing rapidly, and buy more items whose price is not increasing rapidly =By substituting, consumers are not paying the higher prices, so they are not negatively affacted by them
Inflation's Impact on Specific groups
1) Savers (Lenders) suffer from unexpectedly high inflation, since it decreases the real interest rate -Savers (Lenders) would not get the increase in purchasing power that they expected when they first out money in savings 2) People with fixed income lose from inflation -A fixed income means you get the same dollar amount every pay period -This fixed amount will buy less and less over time if there is inflation 3) Borrowers gain from inflation -Borrowers pay back their loans with money that buys less per dollar than the money they first borrowed
Deflation
A DECREASE in the general (average) price level of goods and services in the economy
Disinflation
A decrease in the rate of inflation -Prices rise, but not by as great a percentage as the previous time period
Consumer Price Index (CPI)
Measures changes in the average prices of consumer goods and services
Nominal Income
The actual number of dollars received during a time period
Real Income *refer to the notes for formula and examples!!!
The actual number of dollars received during a time period adjusted for inflation -Changes in real income measures changes in purchasing power
Nominal Interest Rate
The annual increase in MONEY received from savings
Real Interest Rate
The annual increase in PURCHASING POWER received from savings -Real Interest=Nominal interest rate-inflation rate =The higher the inflation rate, the lower the real interest rate =The real interest rate CAN BE NEGATIVE if inflation is greater than the nominal interest rate over the loan period
Inflation Rate *Refer to the for formulas
The percentage change in some price index (usually the CPI) from one year to the next
