Inflation Part 3.

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Presentation transcript:

Inflation Part 3

The USA has experienced an average inflation rate of 2.22% per year. Prices in 2016 are 84.0% higher than in 1990. Bottom Line: $100 in 1994 is equivalent to $184 in 2016 The inflation rate in 2016 was 1.26%.

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!

Review: CPI Price Index Measurement of Consumer Inflation Consumer Market Basket of goods/services -1999 90 -2000 100 -2001 110 -2002 115 -2003 110 Year CPI Index Pick a base year [(Ending Index – Beginning Index) / Beginning Index] * 100

Calculating a CPI Index (video) http://www.youtube.com/watch?v=XxkDhGlMqko

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

Adjusting numbers for inflation Ending Index (2005) Base Year Index (1931) X Old Dollar Value (1931) = 2005 dollars 1931 Salary = $80,000 CPI = 15.2 1931 CPI = 195 2005 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

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

Practice Problem Year CPI Index 1994 146 2016 236 1994 146 2016 236 CPI in 2016 CPI in 1994 * 1994 USD value = 2016 USD value 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?

Practice Test