Inflation Understanding & Measuring Inflation

INFLATION Economic condition of Average Prices Rising Jeans $ => Jeans$ GDP increases => output remained the SAME All economic numbers must be adjusted for inflation –Real numbers – adjusted for inflation –Nominal numbers – NOT adjusted for inflation

Consumers notice when their paychecks start to buy less!

Historical Inflation Germany: “hyperinflation” after World War I –Currency became worthless USA:Late 1970s—Oil Crisis-- 13% USA: low inflation since 1985 [ %] underUSA speed limit: target for inflation is well under 3.0%

Some factors: Technology & Globalization DeflationStagflation

Your life has not yet seen significant inflation (in USA) We have enjoyed low inflation for almost 30 years! WHY? Some factors: Technology & Globalization

Notice how inflation Increased in the 1970’s

Calculating % Change You buy a stock at $8 per share It is now at $10 per share What % gain did you make? Formula is: [(Ending Price – Beginning Price) / Beginning Price] * 100 (10-8)/8 * 100 = +25%

What is in the CPI’s Basket? 17% Transportation 15% Food and beverages Medical care 6% Recreation 6% Apparel 4% Other goods and services 4% 42% Housing 6% Education and communication

Measuring Inflation Consumer Price Index (CPI) measures inflation –Pick a base year which = 100 Uses a market “basket” of goods & services –Government prices it monthly –Compares cost of the new basket to old basket CPI = Current Price of Basket Price of Basket in Base Year X 100 = CPI Index Example: 2005 $ $12 ($12/$10) X 100 = 120 Use 2005 as the base year CPI = is the CPI Index for 2007

Worksheet Creating an Index

Day 2

Problems with CPI Substitution Bias New goods Unmeasured quality changes Housing Measurement Basket must “evolve” with the market

The Most Popular Movies of All Times, (Inflation Adjusted)

Adjusting numbers for inflation Convert Babe Ruth’s wages in 1931 to 2005 dollars: 1931 Salary = $ 80,000 CPI = CPI = X $80,000 = 1,026,316 (2005 dollars) CPI Index (2005) Base Year Index (1931) X Old Dollar Value = 2005 dollars

Calculating a CPI Index (video)

Practice Test

Key Concepts for lecture Inflation Defined Historical Inflation Rates Consumer Price Index (CPI) Adjusting numbers for inflation