Unit 2 Macroeconomic Measures: Inflation and Price Indexes

David's pay last year was $100,000. His pay this year increased to $115,000. The consumer price index increased from 100 to 115 over the same time period. What has happened to David's real income from last year to this year?

David's real income is unchanged

Eight Major Categories in the Consumer Price Index

Food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services

Important facts about mindex numbers

Index numbers have no dollar signs or other units attached to them. the choice of a base year for the index number—that is, the year that is automatically set equal to 100—is arbitrary. It is chosen as a starting point from which changes in prices are tracked.

The base year for the price index is

Indicated with an index number of 100. It's an arbitrary year from which to measure price changes

If the Consumer Price Index was 120 at the end of last year and 125 at the end of this year, Americans experienced:

Inflation and a decrease in the purchasing power of a dollar

The redistribution of purchasing power due to unexpected inflation harms:

Lenders

The rate of inflation or deflation is the percentage rate of change in a price index between two periods

Rate of inflation or deflation = Percentage change in index / Initial value of index

A price index is

The cost of a specific basket of goods and services. A weighted average price of some type of good or service (ex. comsumer prices)

real value

an economic statistic after it has been adjusted for inflation; contrast with nominal value

core inflation index

a measure of inflation typically calculated by taking the CPI and excluding volatile economic variables such as food and energy prices to better measure the underlying and persistent trend in long-term prices

GDP deflator (inplicit price deflator)

a price index for all final goods and services prodced is the ratio of nominal GDP to real GDP

indexed

a price, wage, or interest rate is adjusted automatically for inflation

recession

a significant decline in national output

index number

a unit-free number derived from the price level over a number of years, which makes computing inflation rates easier, since the index number has values around 100

depression

an especially lengthy and deep decline in output

substitution bias

an inflation rate calculated using a fixed basket of goods over time tends to overstate the true rise in the cost of living, because it does not take into account that the person can substitute away from goods whose prices rise by a lot

hyperinflation

an outburst of high inflation that is often seen (although not exclusively) when economies shift from a controlled economy to a market-oriented economy

Inflation makes certain things less valuable in real terms, including:

anything expressed in dollars, such as a fixed monthly pension payment

base year

arbitrary year whose value as an index number is defined as 100; inflation from the base year to other years can easily be seen by comparing the index number in the other year to the index number in the base year—for example, 100; so, if the index number for a year is 105, then there has been exactly 5% inflation between that year and the base year

Inflation and deflation refer to

changes in the average level of prices, not to changes in particular prices

peak

during the business cycle, the highest point of output before a recession begins

trough

during the business cycle, the lowest point of output in a recession, before a recovery begins

The national debt doubled in nominal terms during a time when the GDP Deflator increased from 200 to 300. This implies that the national debt:

has increased in real terms, but it has less than doubled

Suppose the European Union has a Real GDP of 12.2 trillion Euros, and their GDP deflator is 125. What is the European Union's nominal GDP?

15.25 trillion euros

business cycle

the relatively short-term movement of the economy in and out of recession

real value refers to

the same statistic after it has been adjusted for inflation

nominal value of any economic statistic means

the statistic is measured in terms of actual prices that exist at the time

Price Index Formula

Current cost of basket / Base-period cost of basket

If Nominal GDP is $17,000 billion and the GDP deflator is 0.75, then Real GDP is:

$22.67 billion

If Nominal GDP is $16,000 billion and the GDP deflator is 0. 50, then Real GDP is:

$32 billion

simple growth rate formula (percentage change formula)

(Final GDP - Initial GDP) / Initial GDP = Growth of Nominal GDP

To calculate percentage change

(level in new year - level in previous year) divided by level in previous year

_____________________ is the value of what's produced, while _________________ is the quantity of what's produced

Nominal output; real output

cost-of-living adjustments (COLAs)

a contractual provision that wage increases will keep up with inflation

deflation

a decrease in the average level of price

inflation

a general and ongoing rise in the level of prices in an economy

Inflation

a general and ongoing rise in the level of prices in an entire economy

basket of goods and services

a hypothetical group of different items, with specified quantities of each one meant to represent a "typical" set of consumer purchases, used as a basis for calculating how the price level changes over time

adjustable-rate mortgage (ARM)

a loan used to purchase a home in which the interest rate varies with market interest rates

Producer Price Index (PPI)

a measure of inflation based on prices paid for supplies and inputs by producers of goods and services

GDP deflator

a measure of inflation based on the prices of all the components of GDP

International Price Index

a measure of inflation based on the prices of merchandise that is exported or imported

Employment Cost Index

a measure of inflation based on wages paid in the labor market

Consumer Price Index (CPI)

a measure of inflation calculated by government statisticians based on the price level from a fixed basket of goods and services that represents the purchases of the average consumer

quality/new goods bias

inflation calculated using a fixed basket of goods over time tends to overstate the true rise in cost of living, because it does not take into account improvements in the quality of existing goods or the invention of new goods

deflation has a

negative inflation; means most prices in the economy are falling

Implicit price deflator formula

nominal GDP / real GDP

nominal value

the economic statistic actually announced at that time, not adjusted for inflation; contrast with real value