1. AP Macroeconomics Fall 2013
Inflation
AP Macroeconomics Fall 2013

2. Price Level & Real Income
As long as wages rise with price levels, inflation doesn’t cause harm standard of living
Real Wage = Wage rate  100
Price index
Real Income = Income  100

3. Rate of Price Changes Inflation Rate – overall increase per year
Inflation Rate = Price level in year 2 – Price level in base year ● 100
Price level in base year
Real Wage Increase = Wage rate increase – Inflation rate
Significant costs of high inflation rates
Shoe-leather costs – Greater #s of banking transactions
Menu costs – Changing listed prices
Unit-of-account costs – Locked-in contract terms

4. Winners & Losers from Inflation
Interest rate – Extra percentage that borrowers must pay for the use of money
(Most) contracts lock in a fixed rate
Nominal v. real interest rate
Nominal interest rate – inflation rate = Real interest rate
If inflation rate > expected inflation, borrowers win
If inflation rate < expected inflation, lenders win

5. Disinflation Disinflation – Willfully bringing down inflation rates
Our government intervenes when inflation rises above 2%
Government policies can depress the economy

6. Cost-Push Inflation
When universally-important inputs rise in price, this reduces AS and increases price

7. Demand-Pull Inflation
When AD is greater than AS, this pushes up prices

8. Calculating/Measuring Inflation
The price index reflects the aggregate price level
Based on “typical consumption” (market basket)
Price index = Cost of market basket in Year 2 X 100
Cost of market basket in base year
Inflation rate = PI in Year 2 – PI in Year 1 X 100
PI in Year 1

9. Consumer Price Index How costs for families changes over time
Based on
Criticized for not being accurate because of:
Substitutes
Innovation

10. Other Measures
PPI – Measures costs for producers; responds more quickly than CPI
GDP Deflator – Ratio of nominal GDP to real GDP
GDP Deflator = Nominal GDP x 100
Real GDP
All three indexes are closely correlated