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1 Inflation Economics for Today by Irvin Tucker, 6 th edition ©2009 South-Western College Publishing
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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
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3 What puzzles will I learn to solve? What is the inflation rate of your college education? Can a person’s income fall even though they received a raise? What would Babe Ruth’s salary be worth today? Can an interest rate be negative?
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4 What is inflation? An increase in the general (average) price level of goods and services in the economy
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5 What is deflation? A decrease in the general (average) price level of goods and services in the economy
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6 What is disinflation? A reduction in the rate of inflation
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7 What is the most widely reported measure of inflation? The Consumer Price Index
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8 What is the Consumer Price Index? It measures changes in the average prices of consumer goods and services
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9 Who reports the CPI? The Bureau of Labor Statistics (BLS) of the Department of Labor
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10 How is the CPI calculated? Price collectors contact retail stores, homeowners, and tenants in selected cities in the U.S. monthly
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11 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
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12 Composition of the CPI Food Housing Apparel Transportation Health Care Entertainment Education All other goods 13% 33% 4% 18% 6% 5% 2% 8% Economic Report of the President, 2006
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13 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
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14 How is the CPI computed? Current year prices are compared to prices of a similar basket of goods and services in a base year
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15 What is a base year? A year chosen as a reference point for comparison with some earlier or later year
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16 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
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17 CPI = CYP BYP *CYP = cost of the market basket of products at current-year prices *BYP = cost of the market basket of products at base-year prices X 100
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18 How is the inflation rate computed? By measuring the percentage change in the official CPI from one year to the next
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19 ARI = CPI - CPIPY CPIPY *ARI = Annual rate of inflation *CPIY = Consumer price index in given year *CPIPY = Consumer price index in previous year X 100
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20 Consumer Price Indexes and Inflation Rates YearCPIInflation Rate 193115.2- 193213.7-9.9% 197972.6- 198082.413.5 2000172.2- 2001177.12.8 2002179.91.6 2005195.3- 2006201.63.2
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21 30 35 40 45 50 55 6065 The U.S. Inflation Rate 1929 - 2006 70 20 10 5 15 75 8085 90 95 00 05 -5 -10 -15 0 Inflation Deflation
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22 What are some criticisms of the CPI? It can overstate or understate for certain groups Does not measure quality Substitutes are ignored
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23 What does inflation do to people’s income? A general rise in prices will shrink people’s income
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24 What is nominal income? The actual number of dollars received over a period of time
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25 What is real income? The actual number of dollars received (nominal income) adjusted for changes in the CPI
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26 RI = NI CPI *RI = Real income *NI = Nominal income *CPI = CPI as a decimal or CPI ÷ 100
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27 % in real income % in nominal income % in CPI = _
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28 What is wealth? The value of the stock of assets owned at some point in time
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29 How is wealth affected by inflation? Inflation can benefit holders of wealth because the value of their assets tends to increase as prices rise
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30 What will cause your real income to decline? The rate of inflation is greater than your rate of income
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31 How does inflation affect borrowers and savers? They can win or lose depending on the rate of inflation and interest
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32 What is the interest rate? Interest per year as a percentage of the amount loaned or lent
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33 What is the nominal interest rate? The actual rate of interest earned over a period of time
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34 What is the real interest rate? The nominal rate of interest minus the inflation rate
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35 What are the two basic types of inflation? Demand-pull Cost-push
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36 What is demand-pull inflation? A rise in the general price level resulting from an excess of total spending (demand)
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37 When does demand- pull inflation occur? When the economy is operating at or near full employment
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38 What is cost-push inflation? A rise in the general price level resulting from an increase in the cost of production
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39 What can cause cost- push inflation? Cost increases for labor, raw materials, construction, equipment, borrowing etc.
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40 Do people’s expectations affect inflation? Yes, expectations can influence both demand-pull and cost-push inflation
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41 What is hyperinflation? An extremely rapid rise in the general price level
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42 What is a wage-price spiral? Increases in nominal wage rates are passed on in higher prices, which, in turn, result in even higher nominal wages and prices
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43 How does the U.S. inflation rate compare with other countries? It is lower than some and higher than others
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44 U.S.IranCosta Rica China Germany HaitiVenezuelaZimbabweRussia 1,016.7% 14.6% 14.2% 13.6% 11.5% 9.7% 3.2% 1.8% 1.5%
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45 END
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