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