1 Inflation ©2006 South-Western College Publishing

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

3 What is the most widely reported measure of inflation? The Consumer Price Index

4 What is the Consumer Price Index? The CPI is an index that measures changes in the average prices of consumer goods and services

5 Who reports the CPI? The Bureau of Labor Statistics (BLS) of the Department of Labor

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

7 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

8 Composition of the CPI Food Housing Apparel Transportation Medical Care Entertainment Education & communication All other goods 15.7% 40.9% 4.4% 17.1% 5.8% 6.0% 5.8% 4.3% Economic Report of the President, 2005

9 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

10 How is the CPI computed? Current year prices are compared to prices of a similar basket of goods and services in a base year

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

12 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

13 How is the inflation rate computed? The annual inflation rate is computed as the percentage change in the official CPI from one year to the next

The U.S. Inflation Rate

The Most Popular Movies of All Time, Inflation Adjusted

16 What is disinflation? A reduction in the rate of inflation

17 What are some criticisms of the CPI? It can overstate or understate the impact of inflation for certain groups Does not measure quality Substitutes are ignored

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

19 What is nominal income? The actual number of dollars received over a period of time

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

21 What will cause your real income to decline? The rate of inflation is greater than your rate of income

22 How does inflation affect borrowers and savers? They can win or lose depending on the rate of inflation and interest

23 What is the interest rate? Interest per year as a percentage of the amount loaned or lent

24 What is the nominal interest rate? The actual rate of interest earned over a period of time

25 What is the real interest rate? The nominal rate of interest minus the inflation rate

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