Microeconomics and Macroeconomics FCS 3450 Spring 2015 Unit 2

What is inflation? Prices rising and the purchasing power of the dollar declining Concept 5: Inflation

What is inflation rate? The percentage increase in prices over a period of time Examples The inflation rate for a group of products or services Medical care : 2.5% : 154.9% Food and beverages : 1.4% : 76.9% The inflation rate for all products and services : 1.5% : 75.6%

Relationship Between Inflation Rate and the Value of Your Dollar The higher the inflation rate, the less the value of your dollars over time. YearsAnnual Inflation Rate of 2% Annual Inflation Rate of 6% Annual inflation Rate of 15% 591 cents75 cents50 cents 1082 cents56 cents25 cents 4045 cents10 cents0.3 cents Value of $1 given specific inflation rates and years

Calculation of Purchasing power of a dollar after any given amount of years Y n = the purchasing power of one dollar after n years I a = annual inflation rate n = number of years Y n = ( 1 ) n 1+ia

Inflation Examples At 2% annual inflation rate, how much will $1 be worth in 5 years?

Effects of Inflation Escalating inflation Prices rise at an increasing rate 3%, 4%, 5%, 6% Disinflation Prices rise at a decreasing rate. 6%, 5%, 4%, 3% Deflation Prices decline 2009

How do we know what the inflation rate is? Inflation rates are computed using Consumer Price Index (CPI) Bureau of Labor Statistics (BLS) collects monthly price data on over 100,000 items at 85 location from 19,000 retail establishments. The prices collected form the Consumer Price Index (CPI) The CPI is weighted by commodities’ relative importance in the average consumer’s budget

Consumer Price Index (CPI) Year CPI For more information on CPI visit:

Comparing Inflation Rate from Year to Year i AB = inflation rate from year A to year B CPI A = CPI for year A CPI B = CPI for year B i AB = CPI B -1 CPI A