Chapter 7: The Price Level and Inflation

goal of CPI is to track prices paid by _______ only

consumers

exclude: assets purchased by _______

consumers (socks, bonds, homes)

resource cost of inflation

consumers, producers, everyone

if inflation is expected by both parties, it should not ______ income (_____ _____)

if inflation is expected by both parties, it should not redistribute income (purchasing power)

accounting for more serious problem: increase in _______ ______ from introducing the goods in the first place is never accounted for at all in the CPI

increase in LIVING STANDARD from introducing the goods in the first place is never accounted for at all in the CPI

CPI overestimates _________

inflation

lenders & borrowers: when you lend money you receive an award, _____ _____

interest payment

annual interest payment formula?

interest rate (payment)/amount you lent

when inflationary expectation are inaccurate, purchasing power is shifted between those obligated to _______ future payments and those waiting to be paid

make

national set _____ _____ is set and specified in nominal wage

minimum wage

2 interest rates associated with every long?

nominal interest rate & real interest rate

when price level rises, inflation rate will be _______

positive

CPI is a measure of ____ _____ in the economy

price level

result: real ____ _____ rises over time

real benefit payment

real income formula

real income= nominal income/price index X 100

real wage formula?

real wage in any year= nominal wage in that year/CPI in that year X 100

excludes: (G): goods & services purchased by ______ _______

government agencies (military equipment, school teacher)

GDP tracks price of goods purchased by _____, investment goods by ____, and _____.

govt, investment goods by businesses, and exports

an inflation rate lower than expected harms ______ and benefits those _______

harms PAYERS and benefits those AWAITING payments

an inflation rate higher than expected harms those _______ payment and benefits the ________

harms those AWAITING payment and benefits the PAYERS

the cost of inflation can?

impose costs on society and us individually

includes: HH purchases of ______ from other _____.

includes: HH purchases of imports from other countries (French cheese, Japanese cars, Mexican tomatoes)

includes: ______ &_____ purchased by consumers as _____ users in GDP (C).

includes: goods & services purchased by consumers as final users in GDP (C).

the inflation myth

inflation makes g&s more expensive, and erode purchasing power of income

how is CPI used?

1. as a policy target 2. index payments 3. to translate from nominal to real values

CPI tracks goods bought by ______ _______

American consumers

consumers?

comparison shopping, costs involved= time

consumer=

shoppers

inflation does not impose cost on _______

society

conclusion: inflation can ______ purchasing power from one group to another, but doesn't directly decrease the average ____ ____ in the economy.

inflation can redistribute purchasing power from one group to another, but doesn't directly decrease the average real income in the economy.

chained CPI

addresses substitution bias by estimating the consumer market basket each month, instead of every 2 years

economist agree the CPI ______ the US inflation rate, called the ______ bias of the CPI

agree the CPI overstates, the US inflation rate, called the upward bias of the CPI

all price levels are measured and calculated and reported as _______ _______.

all price levels are measured and calculated and reported as index numbers

index payments?

indexed payment: payment that is periodically adjusted in proportion with a price index. Set by formula so rises and falls proportionally with CPI. Try to keep purchasing power constant

indexing

any errors have important implication for govt. budget, as well as the economy

producers?

resource costs, boil down to comparison shopping

how the BLS fixed the problem?

1. updating quantities in market basket with a new HH survey every 2 years instead of every 10 2. CPI has taken into account of some changes in quantities when people substitute cheaper for more expensive one

so if official inflation rate is reported at 3%, shows inflation between ____ - ___%

2.0 - 2.5%

BEA reports this price index separately?

GDP price index

approximation rule

%change real= %change nominal - %change price level

real income falls if?

- CPI (price index) stays same & decrease in numerator (nominal income) OR - CPI (price index) rises & nominal income stays same

economist agree CPI overestimate inflation: believe upward bias is ____ - ______% points

.5 - 1.0% points

consequences of CPI bias?

1. calculating real income 2. indexing

an index will always equal to _____ in the base period

100

complied & reported by?

Bureau of Labor Statistics (BLS)

inflation makes CPI fall short of the ______ measure of _______

IDEAL measure of INFLATION

4% increase in lenders dollar means a ___% increase in purchasing power

4%

_____ calculates real GDP directly, by choosing a _____ year and valuing the quantities of each good produced at prices it would sell for in that ____ year

BEA calculates real GDP directly, by choosing a base year and valuing the quantities of each good produced at prices it would sell for in that base year

goods & services that are unimportant in consumer's budget have little weight in _____

CPI

if price doubles so does ______

CPI

most important and widely used measure of prices in US

CPI

CPI - RS (research series): tells us what ______ CPI would have been in past years if been measured as ____ in past as it is today

CPI - RS (research series): tells us what OFFICIAL CPI would have been in past years if been measured as ACCURATELY in past as it is today

growth in discounting: CPI doesn't recognize that a new _______ outlet _______ the prices on many items for people who begin shopping there. As a result, as discount outlets expand into new area, the CPI ________ the inflation rate of food, electronic devices, clothing, and other items sold there

CPI doesn't recognize that a new discount outlet lowers the prices on many items for people who begin shopping there. As a result, as discount outlets expand into new area, the CPI overstates the inflation rate of food, electronic devices, clothing, and other items sold there

changes in quality: CPI falls to fully account for ______ _________ in the g&s in it's market basket, therefore, overestimates how _____ the price of the basket is rising

CPI falls to fully account for quality improvement in the g&s in it's market basket, therefore, overestimates how fast the price of the basket is rising

CPI is reported _____, _____ adjusted, growth rate is reported _____ as well

CPI is reported monthly, seasonally adjusted, growth rate is reported monthly as well

CPI misses the fact that new goods raise ____ ____ we can achieve at any given ______

CPI misses the fact that new goods raise LIVING STANDARDS we can achieve at any given DOLLAR

CPI overstates inflation, benefits are ____, nominal payment rises by more than actual rise in _____ ___.

CPI overstates inflation, benefits are OVER INDEXED, nominal payment rises by more than actual rise in PRICE LEVEL

The GDP price index measures the prices of all g&s that are _____ in the US GDP, the CPI measures the _____ of all g&s bought by US _____.

The GDP price index measures the prices of all g&s that are included in the US GDP, the CPI measures the prices of all g&s bought by US households.

nominal interest rate

The annual percent increase in a lender's dollars from making a loan.

real interest rate

The annual percent increase in a lender's purchasing power from making a loan.

deflation

a decrease in the price level from one period to the next

indexed payment

a payment that is periodically adjusted in proportion with a price index

index

a series of numbers used to track a variable's rise or fall over time

although the BLS has partially fixed the problem, CPI still suffers from _________ _____. That is, categories of goods who prices are rising most rapidly are ______ in CPI market basket and categories of goods who prices are most slowly are _____

although the BLS has partially fixed the problem, CPI still suffers from SUBSTITUTION BIAS That is, categories of goods who prices are rising most rapidly are OVERWEIGHED in CPI market basket and categories of goods who prices are most slowly are UNDER WEIGHED

consumer price index

an index of the cost, through time, of a market basket of goods purchased by a typical household

GDP price index

an index of the price level for all final goods and services included in GDP

when reported as annual rate, the one-month rate is ______

annualized

price level

average level of prices in the economy

GDP price index helps economist track _____ _______ of goods and services included in GDP

average price

exclude: I: purchases by ________

business (raw material, capital equipment)

how can you tell what happens to your purchasing power?

by focusing on real wage

chained CPI: takes into account all ____ in spending due to change in ______ or _____ prices

chained CPI: takes into account all SHIFTS in spending due to change in PREFERENCES or RELATIVE prices

CPI's approach to track cost of the CPI market basket?

collection of g&s that the typical consumer buys

index numbers _______ & ______ info so you can see how things are changing at a glance

compress & simplify

most widely used measure of price level in US?

consumer price index (CPI)

CPI=

cost of market basket in current period/cost of market basket in base X 100

exclude: X: goods & services purchased by other ______

countries (US exports)

low rate of inflation

creeping inflation (price level creeps up slowly so we hardly notice change) can be good for economy

inflation is not the cause of _____, but mechanism that brings it about

decline

excludes: _______ & ______ purchased by anyone other than ______

excludes: goods & services purchased by anyone other than consumers

those obligated to make payment?

gain

important goods such as _____ &_____ have more weight

gas & rent

new technologies: goods using new technology are introduced into BLS market basket only after a _____. ALSO offers _____ a lower ____ alternative for obtaining same service

goods using new tech. are introduced into the BLS market basket only after a lag. ALSO offers consumers a lower cost alternative for obtaining same service

CPI includes price of ______ ______ rather than value of home

housing services

inflation can shift purchasing power away from those who are _______ future payments specified in $1, and toward those who are obligated to _____ such payments

inflation can shift purchasing power away from those who are AWAITING future payments specified in $1, and toward those who are obligated to MAKE such payments

inflation may ______ purchasing power, but does not directly change the average ______ ______ in the economy, when we include ______ &_____

inflation may redistribute purchasing power, but does not directly change the average purchasing power in the economy, when we include buyers & sellers

it is _____ rate (change in _____ ______) lenders & borrowers should care about

it is real rate (change in purchasing power) lenders & borrowers should care about

actually:

market transaction involves 2 parties (buyer & seller)

when price level falls, we have ______ inflation (_______)

negative inflation (deflation)

to translate from nominal to real values?

nominal (measure in # of dollars) real (adjusted for change in dollars purchasing power)

increasing share of workers compensation has been _________ ________, employer contributions to retirement accounts and health insurance

nonwage benefits

inflation imposes an _______ cost on society as a whole and on each of its members

opportunity

inflation can harm _____ ______

ordinary workers

increase in price level reduces purchasing power of any ____ that is specified in _____ terms

payment; nominal

indexing

people have their retirement benefits, wages, interest payments, federal tax brackets adjusted for inflation as determined by CPI

consumer behavior

people tend to substitute goods that have become relatively cheaper in place of goods that have become more expensive

inflation rate

percentage change in the price level from one period to the next

price level rises, then the value of the dollar (______ ______) ______.

price level rises, then the value of the dollar (purchasing power) falls

GDP excludes some _____ that are apart of CPI

prices

GDP includes some _____ CPI ignores

prices

consumer price index is not used to calculate ______ _____

real GDP

if inflation is correctly anticipated and if both parties take it into account, then inflation will not _______ _____

redistribute purchasing power

if there is inflation then it will _____ the purchasing power of money paid back

reduce

Sources of bias in the CPI

substitution bias, new tech, changes in quality, & growth in discounting

CPI - RS (research series)

takes methods currently used to calculate official CPI - including improvements made over last several decades- and applies them back to 1978

the CPI excludes _____ products that tend to drop in price when they first come on to the market. When these products are included, CPI regards them as _____ from existing g&s instead of ______ them they lower the cost of obtaining a given service

the CPI excludes NEW products that tend to drop in price when they first come on to the market. When these products are included, CPI regards them as SEPARATE from existing g&s instead of REORGANIZING then they lower the cost of obtaining a given service

CPI is widely viewed as measuring something else: the cost of _____ a given standard of ____

the cost of ACHIEVING a given standard of LIVING

the upward bias in the CPI depends on what we are trying to _______. If the target cost of typical consumers market basket, then the current upward bias is probably ______ than % point per year. If the target cost of achieving a given standard of living, the upward bias is substantially _________

the upward bias in the CPI depends on what we are trying to MEASURE. If the target cost of typical consumers market basket, then the current upward bias is probably LESS than % point per year. If the target cost of achieving a given standard of living, the upward bias is substantially GREATER

when people must spend time and other resources coping with inflation, they pay an ________ cost- they sacrifice ______ those resources could have produced instead

they pay an opportunity cost-they sacrifice goods & services

to determine CPI market basket the BLS surveys ______ and records their _____ , they use ________ to construct market basket

to determine CPI market basket the BLS surveys families and records their spending, they use spending to construct market basket

to track real wage you must look at the ______ of _______ you earn relative to the ______ _______

to track real wage you must look at the number of dollar you earn relative to the price level

designer to ____ ______ paid by typical consumer

track prices

difference between CPI & GDP price index?

type of g&s covered by each index

substitution bias

until recently CPI almost ignored principal of consumer behavior & CPI assumed consumer bought unchanging amounts, quantities of each g&s

as a policy target?

use CPI to gage if we are meeting goal of stable prices

CPI includes_____ goods and imports

used

GDP leaves out _____ goods and imports

used

includes: HH purchases of _____ goods.

used goods (used cars, computers)

used in this way means CPI has even greater ____ bias, because new g&s create new ways to raise our _______ well being

used in this way means CPI has even greater UPWARD bias, because new g&s create new ways to raise our ECONOMIES well being

index number is calculated as?

value of measure in current period/value of measure in base period X 100

everyone

wealth management

when a payment is indexed and the price index overstates inflation, the real payment ______ over time. Purchasing power is shifted toward those who are ____ and away from rest of _____

when a payment is indexed and the price index overstates inflation, the real payment INCREASES over time. Purchasing power is shifted toward those who are INDEXED and away from rest of SOCIETY

when comparing dollar value over time, we not only care about ______ of ________, but about their ______ _______. Thus we translate nominal values into real values

when comparing dollar value over time, we not only care about number of dollars, but about their purchasing power. Thus, we translate nominal values into real values

when we use CPI-RS to calculate real earning overtime, we ______ the rise in our living standard, because our price index ____ the rise in the cost of achieving a given living standard

when we use CPI-RS to calculate real earning overtime, we UNDERESTIMATE the rise in our living standard, because our price index OVERSTATES the rise in the cost of achieving a given living standard

calculating real income

with errors in each years CPI accumulating over time, total overstatements of price level after few decade is huge

sellers=

work in business

real income is redistributed from ______ to their ______

workers to their employees