Unit 4: Income Consumer Price Index

Inflation Definition: The general increase of prices over time A two-liter of Coca-Cola cost $0.99 in the year you were born (1995). What would that same bottle of Coke cost you today? We’ll calculate the exact answer to this question in a little bit

What Causes Inflation? There are three main theories that describe inflation: The Quantity Theory Demand-Pull Theory Cost-Push Theory

The Quantity Theory This theory says that inflation is caused by too much money in the economy. MV = PT M – amount of money in circulation V – velocity of circulation of that money P – average price level T – number of transactions taking place M P

Demand-Pull Theory This theory says that inflation happens when the demand for goods and services exceeds existing supplies. Examples: – Organic beef is growing in popularity, and there aren’t enough certified organic cows to meet the growing demand ==> price of organic beef goes up – Many people want Jordan’s artwork, but he only makes one of each design ==> price of art increases

Cost-Push Theory This theory says that inflation occurs when the cost of producing goods and services rise and that cost gets passed on to the consumer through higher prices. Examples: – NHL union gains power ==> wages increase ==> hockey team owners’ cost increases ==> you pay more for tickets and goods at the stadium – Natural supply of fish decreases ==> fish prices increase ==> firms’ costs increase ==> you pay more at the store for fish

Purchasing Power Purchasing power describes the ability to buy goods and services Based on the inflation calculator we looked at earlier, how has the purchasing power of $1 changed in your lifetime?

Price Index A price index is a way to illustrate how a regular group of goods and services changes over time. The government uses the Consumer Price Index (CPI) to measure the change in prices of goods and services over time in our economy. They measure a standard set of goods and services called a market basket to track changes in prices over time.

Market Basket The Bureau of Labor Statistics (BLS) measures goods and services called the market basket that most people buy on a monthly basis. The BLS measures these prices every month to track changes. What is in the market basket?

Calculating Inflation-Adjusted Prices Inflation-adjusted price formula: Year 2 price = Year 1 price x (Year 2 CPI / Year 1 CPI)

Calculating Inflation-Adjusted Prices Example 1 Let’s go back to the two-liter of Coke that cost $0.99 in the year you were born (1995). What would that same bottle of Coke cost you today? 2013 price = 1995 price x (2013 CPI / 1995 CPI) = $0.99 x (233.0/152.4) = $1.51 Is this about how much a two-liter of Coke actually costs today?

Calculating Inflation-Adjusted Prices Example 2 In 2005, the median income was $46,326. What would have been an equivalent income in 1960? 1960 price = 2005 price x (1960 CPI / 2005 CPI) = $46,326 x (29.6/195.3) = $7, If the actual median income in 1960 was $5,600, were people earning more or less relative to the time period?

Calculating Inflation-Adjusted Prices Example 3 Let’s compare the median income in 2005 ($46,326) to today’s median income. What is the inflation- adjusted income today (use 2013 information)? 2013 price = 2005 price x (2013 CPI / 2005 CPI) = $46,326 x (233.0/195.3) = $55, If the actual median income in 2013 was $52,100, are people earning more or less relative to the time period?

Calculating Inflation-Adjusted Prices In your groups… Assign a manager, writer & calculator – Manager: get an activity worksheet – Writer & calculator: move the desks into a pod Complete the activity When you have a question, “ask 3 before me”