Inflation – Macroecon - Unit 2

Which car costs more?

Inflation is a general increase in prices. When thinking about inflation though, you need to keep in mind …. …. In the good old days ________ were much lower, but _________ were much lower also. To compare costs over time we look at purchasing power – the ability to purchase goods and services. prices wages

To determine which car costs more we look at how many hours you would have to work to earn the money to buy the car. guess 1stguess 3rdguess 2nd 1,2401,6384,696

Full-time student minimum wage 1982 = $_____/hr m/calculators/ppowerus/ 2.25 Who has more purchasing power with her salary? Full-time student minimum wage 2008 = $_____/hr 6.90 $2.25/hr has the same purchase power as $______/hr in

Anticipate... for which teen are these things cheaper? $1.59 $ $ 2.75 $ 1.19 $ $ $ 2.69 $ 2.79 $ $ $ 2.53 $ 5.84 $ $ 3.37 $ 1, of 28

To measure inflation economists study the price level – the cost of goods & services in an economy at any given point in time. We determine what the price level was by creating a price index – a measurement that shows how the average price of a standard group of goods changes over time.

Each month BLS workers look at the prices of a representative basket of _______ and services that most American families buy to see if prices have __________ or __________. The best-known index is the CPI – Consumer Price Index published monthly. goods increased decreased 8 of 28

What’s in our market basket? housing food transportation medical care education & communication recreation apparel other tobacco & personal care products Guess which category we spend the most on and its percentage weight. 42.4% 6.1% 6.2% 5.6% 14.9% 17.6% 3.2% 3.7% Data from Sep. 2008,

CPI How do we calculate the CPI? = updated cost x base period cost 100 CPI for 2008 = $ 440 x $ = _____ 1 st – BLS picks a base year (currently 1984) and assigns it an index of nd – BLS looks at what the market basket of goods costs in the new year divided by the cost in the base year. 200

We then use the CPI INDEX to calculate inflation: = CPI for 2008 x100 Inflation Rate for 2008 = (CPI for 2004) x100 = _____% CPI for CPI for 2007 You’re trying to get at... what percent higher are prices this year? Inflation Rate for (CPI for 2003) (CPI for 2003) 2.7

Inflation between 1% – 3% doesn’t cause problems. Inflation > 5% can cause problems

2008 inflation rate = 4%– 5%

Potential problems with the CPI  Huge variations in prices in different cities  Consumers’ preferences change  Substitution bias – if one thing gets more expensive, then consumers will..... CPI Weighing website showing actual contents of market basket

bowdoin college / academics / economics / courses / economics 100 / resources / powerpoints / 15 of 28

Presidential Pay in Current and Constant Dollars Which President earned more in real money? Which deserved more?

[1] demand-pull inflation – excessive demand, if demand is growing faster than the level of production, prices will increase. A.Causes of Inflation [2] cost push inflation – firms’ costs rise; wage increases, gov’t taxes, exchange rates needed for purchasing materials abroad.

wage-price spiral = an example of cost-push inflation

A. Causes of Inflation [3] money supply increases – with more money floating in the economy people will pay more for goods

B. Costs of Inflation (1) redistributes income – from people who cannot raise prices to those people who do; arbitrary; affects people on fixed income like a pension (2) information skewed – prices change but so does income; hard to know what is relatively a good price or not

(3) competitiveness – if one country’s prices increasing but other country’s prices not, then will impact sales (4) uncertainty – if inflation is varying firms reluctant to invest in new plant and equipment; people reluctant to spend B. Costs of Inflation

Anticipated Inflation – people have built expected inflation into their economic decisions. Unanticipated Inflation – not foreseen; but while some are hurt by unanticipated inflation, others may benefit 25 of 28 C. 2 Types of Inflation

Wells Fargo Bank extends a $50,000 loan to the owner of El Zócalo to put in new kitchen equipment. The loan is to be repaid over the next 10 years. Unanticipated Inflation takes off at 10%. Wells Fargo hurtor made gains or unaffected El Zócalo hurtor made gains or unaffected

Phillips Curve shows trade off between unemployment & inflation increase D. Phillips Curve Inflation Unemployment Phillips Curve Based on the curve above, reducing unemployment will likely __________ inflation.

AP workbook p. 75 & 76, Activity 13 AP workbook p. 81, Act. 15 numbers 1-5 only work with a small group 15 min 28 of 28

Go Back in Time Website with fun activities to do with inflation

Teacher -- Starting Salary, 4-year degree, NC, 1993 Guess: $19,000 Teacher -- Starting Salary, 4-year degree, Chandler, 2007 $34,000 Who has more purchasing power with her salary? teacher in 1993 or 2007? Let’s look at purchasing power of salary. $ 19,000 in 1993 would buy the same as $ 26,944 in of 30