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Chapter 13 Inflation

Chapter 13 Inflation. Survey of Economics Irvin B. Tucker. Lecture Slides. What will I study in this chapter?. How the government measures the price level How it computes the rate of inflation The consequences and causes of inflation. What is inflation?.

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Chapter 13 Inflation

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  1. Chapter 13Inflation Survey of EconomicsIrvin B. Tucker Lecture Slides

  2. What will I study in this chapter? How the government measures the price level How it computes the rate of inflation The consequences and causes of inflation

  3. What is inflation? An increase in the general (average) price level of goods and services in the economy

  4. What is deflation? A decrease in the general (average) price level of goods and services in the economy

  5. What is the most widely reported measure of inflation? The Consumer Price Index (CPI)

  6. What is theconsumer price index? An index that measures changes in the average prices of consumer goods and services

  7. Who reports the CPI? The Bureau of Labor Statistics (BLS) of the Department of Labor based on monthly surveys

  8. How is the CPI calculated? “Price collectors” contact retail stores, homeowners, and tenants in selected cities in the U.S. monthly

  9. Which goods and services are included in the CPI? The BLS records average prices for a “market basket” of different items purchased by the typical urban family

  10. Exhibit 13.1 Composition of the CPI Food 13% Transportation 18% Personal insurance 11% Other 8% Health Care 6% Housing 33% Entertainment 5% Education 2% Apparel 4%

  11. What is a base year? A year chosen as a reference point for comparison with some earlier or later year

  12. Does the makeup of the CPI change? As people’s tastes and preferences change, some of the goods and services that go into the basket change

  13. CPI = *CYP = cost of the market basket of products at current-year prices *BYP = cost of the market basket of products at base-year prices CYP BYP X 100

  14. Why is the CPI always 100 in the base year? The numerator and the denominator of the CPI formula are the same in the base year

  15. How is theinflation rate computed? By measuring the percentage change in the official CPI from one year to the next

  16. ARI = *ARI = Annual rate of inflation *CPIY = Consumer price index in given year *CPIPY = Consumer price index in previous year CPIY - CPIPY CPIPY X 100

  17. 13.2

  18. Exhibit 13.3 Consumer Price Indexes and Inflation Rates, Selected Years Year CPI Inflation Rate 1931 15.2 - 1932 13.7 -9.9% 1979 72.6 - 1980 82.4 13.5 2000 172.2 - 2001 177.1 2.8 2002 179.9 1.6 2008 215.3 - 2009 214.5 -0.4 2010 218.1 1.6 18

  19. What is disinflation? A reduction in the rate of inflation 19

  20. Exhibit 13.4 The U.S. Inflation Rate, 1929-2010 20 15 10 Inflation Inflation Rate (percentage change in CPI from previous year) 5 0 Deflation -5 -10 -15 `30 `35 `40 `45 `50 `55 `60 `65 `70 `75 `80 `85 `90 `95 `00 `05 `10 Year 20

  21. Exhibit 13.5 Annual Inflation Rates in Selected Countries, 2010 28.2% 23.5% Inflation rate (percentage change from previous year) 13.2% 12.5% 11.7% 8.8% 3.3% 1.6% 1.16% Congo Venezuela India Iran Egypt Russia China United States Germany Country 21

  22. What are some criticisms of the CPI? Because the market basket may be unrepresentative, it can overstate or understate inflation for certain groups. It does not measure quality Substitutes (the law of demand) are ignored

  23. What does inflation do to people’s nominal income? A general rise in prices will shrink people’s income

  24. What isnominal income? The actual number of dollars received over a period of time

  25. What is real income? The actual number of dollars received (nominal income) adjusted for changes in the CPI

  26. RI = *RI = Real income *NI = Nominal income *CPI = CPI as a decimal or CPI ÷ 100 NI CPI

  27. Percentage change in nominal income Percentage change in real income _ = Percentage change in CPI

  28. Babe Ruth earned $80,000 in 1932. How much did he earn in 2009 dollars? Salary in given year = salary in previous year x CPI in given year CPI in previous year salary in 2010 dollars = $80,000 x 218.1 13.7 = $1,273,577 28

  29. What is wealth? The value of the stock of assets owned at some point in time

  30. How is wealth affected by inflation? Inflation can benefit holders of wealth if the value of their assets increases as prices rise

  31. What will cause your real income to decline? The rate of inflation is greater than the rate at which you’re your nominal income has increased.

  32. What is thenominal interest rate? The actual rate of interest without adjustment for the inflation rate

  33. What is thereal interest rate? The nominal rate of interest minus the inflation rate

  34. How does inflation affect borrowers and savers? They can win or lose depending on the rate of inflation and the rate of interest to which they have agreed.

  35. What is an Adjustable-rate mortgage (ARM)? • A home loan that adjusts the nominal interest rate to changes in an index rate, such as rates on Treasury securities • The current housing crisis resulted from homeowners who were unable to make payments as interest rates increased on their ARMs 35

  36. What are the two basic types of inflation? Demand-pull Cost-push

  37. What isdemand-pull inflation? A rise in the general price level resulting from an excess of total spending (demand)

  38. When does demand-pull inflation occur? When the economy is operating at or near full employment

  39. What iscost-push inflation? A rise in the general price level resulting from an increase in the cost of production

  40. What can cause cost-push inflation? Cost increases for labor, raw materials, construction, equipment, borrowing etc.

  41. Do people’s expectations affect inflation? Yes, expectations can influence both demand-pull and cost-push inflation

  42. How does the U.S. inflation rate compare with other countries? It is lower than some and higher than others

  43. What is hyperinflation? An extremely rapid rise in the general price level

  44. What is awage-price spiral? Increases in nominal wage rates are passed on in higher prices, which, in turn, result in even higher nominal wages and prices

  45. END

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