Chapter 8 econ

Quality improvements and inflation

A difficulty involved in measuring inflation is that the quality and features of a product change over time. -when the price of a good or service goes up because of an IMPROVEMENT IN QUALITY , the BLS does not count that price increase as part of the inflation rate. -rapid technological change makes the job of measuring inflation especially difficult since the product changes are rapid and its hard to compare them to the orginal

Average price level

At any time in the economy, the price of some goods and services will be rising, while others will be falling - so when we measure inflation, we are concerned with the extent that OVERALL PRICES ( prices across the economy ), are rising or falling, not with the rise or fall of any particular good or service

Relative price shifts

BLS reports the overall inflation rate and inflation rates for subcategories of goods and services - a RELATIVE PRICE SHIFT happens when the inflation rate of a good or service is significantly higher or lower than the overall inflation rate. -if it's higher, then that good or service is getting more expensive over time relative to other possible purchases. -if it's lower than the overall inflation rate, then it's getting relatively cheaper - the annual inflation rate for all items averaged 2.2 percent in 15 years from 200 to 2015. -but overall this period, prices for college tuition and medical care increased 5.9% and 3.7%, respectively, while prices of personal computers and televisions declined by 14% and 16.4%, respectively

Deflation

DEFLATION is an actual fall in the average price level. In contrast, disinflation is a reduction in the positive inflation rate. Deflation is a problem for two reasons: -first, deflation usually means demand is so weak that businesses must lower their prices to sell goods and services -second, deflation hurts borrowers because they are paying back their loans with more expensive dollars

Expectations and inflation

EXPECTED INFLATION is the inflation rate that consumers and businesses expect will hold for some future period -expected inflation forms the basis for pricing and wage decisions that businesses make -if people expect that the higher rate of inflation will continue, a wage price spiral may occur. -businesses now boost prices and wages faster and faster to stay ahead of expected inflation. -the worst possible case of a wage price spiral is hyperinflation

Calculating percentage change

Economists are concerned with the speed of change over time -the inflation rate measures how fast prices are rising -the rate of change is measured as an ANNUAL PERCENTAGE CHANGE, which is calculatedly follows. % change= (new number - original number / original number * 100.

Inflation rate

INFLATION is defined as a sustained upward movement in the average level of prices. The INFLATION RATE is the annual percentage change in the average price level. - since the CPI tracks the average price level, the inflation rate is also the annual percentage change in the CPI - CPI is published monthly by the BLS

Basics of inflation

Inflation is a problem since it reduces consumers PURCHASING POWER. - if inflation increases, your money buys less and less - one goal of economic policy makers is to keep inflation under control. -the situation where prices are falling, called DEFLATION, is also a situation policy makers try to avoid

Inflation defined

Inflation is the rise and dall in the overall level of prices in the economy as a whole. -the overall price level is an aberage of millions of prices of different goods and services. -inflation is one of the key measures of health of the economy. The economy is in trouble if orices are rising or falling too fast.

Harm from expected inflation

Second is the case of EXPECTED INFLATION, where the actual rate of inflation is equal to the expected rate of inflation . -the problem with anticipated inflation is that it can lead to a wage price spiral due to annual cost of living adjustments (COLA) using union contracts and certain government programs - high levels of inflation increase the COST OF TRANSACTIONS- the time and effort that goes into managing tour money, attempting to earn a rate of return higher than the rate of inflation

Market basket

The AVERAGE PRICE LEVEL in the economy measures how much it costs to buy a MARKET BASKET of common goods and services -the U.S. Bureau of Labor Statistics (BLS) selects the contents of the market basket which represents the goods and services that the typical U.S. household will buy -the BLS gives each item in the market basket a certain weight to represent its relative importance in the typical budget.

Harm from unexpected inflation

The harm from inflation depends on two cases: first is the case of UNEXPECTED INFLATION, which occurs when the actual inflation rate is above the expected inflation rate. -in this case, lenders are harmed since they're being paid back with less valuable dollars. Borrowers benefit from unanticipated inflations.

Globalization and inflation

The inflation rate has been higher for services compared to goods - the main reason goods have become cheaper is GLOBALIZATION. -production of goods has shifted from the U.S. to lower-cost countries such as China -it is much harder to shift the production of services overseas

Market basket contents

The two largest items in the market basket - the cost of housing measured by the owners equivalent rent of primary residence. This is the single biggest part of the market basket. -food consumed at home is the second largest part of the market basket, followed by medical care. The market basket, while not perfect, is a reasonable representation of the spending pattern of an average U.S. household

Real versus nominal dollars

To avoid money illusion, we should use the REAL or INFLATION-ADJUSTED CHANGD. - this is calculated as the percentage increase in dollars minus the inflation rate -the increase without the adjustment for inflation is called the NOMINAL CHANGE - the real or inflation adjusted increase is the nominal percentage change minus the inflation rate

Adjusting for inflation

To compare household income over time, we must adjust the income for the impact of inflation -otherwise, we run the risk of suffering from MONEY ILLUSION -money illusion happens when we compare dollar amounts in different time periods without adjusting for inflation