1 Inflation Economics for Today by Irvin Tucker, 6 th edition ©2009 South-Western College Publishing

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

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?

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

5 What is deflation? A decrease in the general (average) price level of goods and services in the economy

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

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

8 What is the Consumer Price Index? It measures changes in the average prices of consumer goods and services

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

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

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

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

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

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

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

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

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

18 How is the inflation rate computed? By measuring the percentage change in the official CPI from one year to the next

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

20 Consumer Price Indexes and Inflation Rates YearCPIInflation Rate %

The U.S. Inflation Rate Inflation Deflation

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

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

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

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

26 RI = NI CPI *RI = Real income *NI = Nominal income *CPI = CPI as a decimal or CPI ÷ 100

27 %  in real income %  in nominal income %  in CPI = _

28 What is wealth? The value of the stock of assets owned at some point in time

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

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

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

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

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

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

35 What are the two basic types of inflation? Demand-pull Cost-push

36 What is demand-pull inflation? A rise in the general price level resulting from an excess of total spending (demand)

37 When does demand- pull inflation occur? When the economy is operating at or near full employment

38 What is cost-push inflation? A rise in the general price level resulting from an increase in the cost of production

39 What can cause cost- push inflation? Cost increases for labor, raw materials, construction, equipment, borrowing etc.

40 Do people’s expectations affect inflation? Yes, expectations can influence both demand-pull and cost-push inflation

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

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

43 How does the U.S. inflation rate compare with other countries? It is lower than some and higher than others

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%

45 END