Inflation (I) A rise in overall price level Inflation rate is the % of inflation against some Base Year.

Types of Inflation Demand-Pull Inflation Consumers want more goods and services (good) Excessive spending by consumers expecting future inflation (less good) Over-employment and wage inflation due to excessive growth (bad)

Types of Inflation cont. Cost-Push Inflation Cuts in supply due to things like natural disaster (supply shock) Political disasters like boycotts A natural reduction in resources Political Inflation Governments trying to print there way out of debt.

Negatives of Inflation Consumption of G and S reduced (decrease in C) Savings lose value (retirement accounts…) Domestic inflation reduces foreign investments Currency will appreciate hurting exports Fixed income recipients hurt Lending is reduced Long term investments hurt Labor conflict (as employees demand wage increases Panic buying may set in “Capital Flight” can exist with the wealthy looking for more stable assets to invest in over seas

Who does it help? Everyone who is already in debt finds it easier to pay the bill…

Measuring the Price Level The consumer price index (CPI) is a measure of the overall cost of the goods and services bought by a typical consumer. The Bureau of Labor Statistics reports the CPI each month. It is used to monitor the changes in the cost of a basket of goods over time.

Calculating for % change over time… New Data – Old Data Old Data X 100 = Rate of Change or % Change CPI Current Year – CPI Base Year CPI Base Year X 100 = Inflation CPI Year 2 – Old CPI Year 1 CPI Year 1 X 100 = Inflation Rate for Year 2

Practice Calculate the Consumer Price Index and the Inflation Rate: Basket of goods in 2003 costs $1,200. The same basket in 2004 costs $1,236. CPI = ($1,236/$1,200)  100 = 103. * Prices increased 3 percent between 2003 and 2004.

Does CPI Measure Cost of Living? No… The CPI is an accurate measure of the selected goods that make up the typical bundle, but it is not a perfect measure of the cost of living.

Problems w/ CPI Substitution bias Basket does not reflect consumers’ reaction to price change Chained CPI (the wave of the future… maybe…) Introduction of new goods Some new products require fewer dollars to maintain same standard of living Unmeasured quality changes

GDP Deflator The GDP deflator reflects the prices of all goods and services produced domestically Nominal GDP Real GDP X 100 = GDP Deflator Nominal GDP CPI X 100 = Real GDP