1. Inflation Part 3

2. Inflation erodes purchasing power
Prices in 2016 are 84.0% higher than in 1990
The USA has experienced an average inflation rate of 2.22% per year.
Era of low inflation

3. Why Inflation is Bad? Difficult for Business to plan for future
price goods/services unclear
Investment becomes difficult
Lowers value of U.S. currency
Lowers purchasing power (real value of money)
Raises long term interest rates
10-year Gov’t Bond = 2.30%
Bond buyers would need more nominal interest!

4. Review: CPI Price Index
CPI = Measurement of Consumer Inflation
Year CPI Index
Price a Consumer Market
Basket of goods/services to
calculate price index
Pick a
base year

5. Calculating a CPI Index (video)

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

7. Practice Test

8. Adjusting numbers for inflation
Using 2 CPI price indices, you can adjust #’s for inflation between years
2000 = = 200
$10,000 in 2000 would be worth _______ in 2010 dollars
Ending Year Index (2010)
Starting Year Index (2000)
X Starting Dollar Value (2000) = $ Value in 2010 dollars
200
150
X $10,000 = $13,333 in 2010 dollars

9. Why top Athletes get Richer!
1931 Salary = $80, CPI =
CPI =
Convert Babe Ruth’s wages in 1931 to 2005 dollars:
195
15.2
X $80,000 = 1,026,316 (2005 dollars)
Conclusion:
Top baseball players earn 16 times more in real terms than players from 1931
Ending Index (2005)
Starting Year Index (1931)
X Starting Dollar Value (1931) = Salary in 2005 dollars

10. Practice Problem Year CPI Index 1994 146 2016 236
What was the inflation rate from 1994 to 2016?
You made $500,000 year in 1994, what is the equivalent pay in 2016?
You made $70,000 in 2016, what is the equivalent pay in 1994?
+61.0%
$808,000
$43,000
CPI in 2016
CPI in * 1994 USD value = USD value
[(Ending Index – Beginning Index) / Beginning Index] * 100

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