Candy Auction RECORD DATA Round 1 Round 2

Candy Auction RECORD DATA Round 1 Round 2
Several pieces of candy are going to be auctioned in class today. There will be two rounds of auctioning, and four different students will be given fake money each round. Whoever offers the highest bid for each piece of candy will win it. (All bids must be rounded to the nearest full dollar amount.) RECORD DATA Record all transaction prices in the tables below. Round 1 Round 2 Piece of Candy Price Paid 1) 2) 3) 4) 5) 6) TOTAL Piece of Candy Price Paid 1) 2) 3) 4) 5) 6) TOTAL If using a whiteboard as your projecting surface, you can record each price by writing directly on these tables. If you write directly onto the screen, be sure to click “Skip Sample” since you will not need it. Otherwise, you can just hand write these charts on a convenient part of your whiteboard for reference. (Project this slide while conducting the auction.) See Sample Skip Sample

Candy Auction RECORD DATA Round 1 Round 2
Several pieces of candy are going to be auctioned in class today. There will be two rounds of auctioning, and four different students will be given fake money each round. Whoever offers the highest bid for each piece of candy will win it. (All bids must be rounded to the nearest full dollar amount.) RECORD DATA Record all transaction prices in the tables below. Round 1 Round 2 Piece of Candy Price Paid 1) 2) 3) 4) 5) 6) TOTAL Piece of Candy Price Paid 1) 2) 3) 4) 5) 6) TOTAL $ 9 $ 14 $ 7 $ 17 These are just sample numbers. Be sure to use the ones you get during the auction for your calculations. $ 7 $ 20 $ 8 $ 21 $ 8 $ 13 $ 9 $ 11 $ 48 $ 96

Candy Auction MARKET BASKET 1) 2) 3) 4) 5) 6)
When economists want to see how prices have changed over time, they use a system of calculation that utilizes a hypothetical market basket. A market basket is a set of consumer goods and services that is used to compare changing price levels over time. What six items were in our classroom’s market basket? 1) 2) 3) 4) Write down the names of the six pieces of candy that you used. It works best if all six are different. Candy variety packs work great. 5) 6)

CALCULATE THE PRICE INDEX
Candy Auction CALCULATE THE PRICE INDEX A price index measures the cost of purchasing a market basket in a given year. The base year always has a price index of (In our case the base year is Round 1.) Finding the price index for a year that is not the base year, such as Round 2, will tell us how much prices have increased or decreased since the base year. Use the following formula to calculate the price index for Round 2. Round 2 Price Index = Cost of Market Basket in Base Year Cost of Market Basket in Round 2 X 100 Be sure to use the numbers from your auction for this calculation. A sample is included for your convenience. See Sample Skip Sample

CALCULATE THE PRICE INDEX
Candy Auction CALCULATE THE PRICE INDEX A price index measures the cost of purchasing a market basket in a given year. The base year always has a price index of (In our case the base year is Round 1.) Finding the price index for a year that is not the base year, such as Round 2, will tell us how much prices have increased or decreased since the base year. Use the following formula to calculate the price index for Round 2. Round 2 Price Index = Cost of Market Basket in Base Year Cost of Market Basket in Round 2 X 100 Round 2 Price Index = 48 96 X 100 These are just sample numbers. Round 2 Price Index = (2 x 100) =

CALCULATE THE INFLATION RATE
Candy Auction CALCULATE THE INFLATION RATE Now that we know the price indexes for each round, we can calculate the inflation rate. The inflation rate is the percentage change in a price index. Use the following formula to calculate the inflation rate between Round 1 and Round 2. (Remember, the “Round 1 Price Index” is equal to 100 because it is the base year.) Inflation Rate = Round 1 Price Index Round 2 Price Index - Round 1 Price Index X 100 Be sure to use the numbers from your auction for this calculation. A sample is included for your convenience. See Sample Skip Sample

Candy Auction CALCULATE THE INFLATION RATE Now that we know the price indexes for each round, we can calculate the inflation rate. The inflation rate is the percentage change in a price index. Use the following formula to calculate the inflation rate between Round 1 and Round 2. (Remember, the “Round 1 Price Index” is equal to 100 because it is the base year.) Inflation Rate = Round 1 Price Index Round 2 Price Index - Round 1 Price Index X 100 Inflation Rate = 100 X 100 These are just sample numbers. Inflation Rate = (1 x 100) = %

Candy Auction CALCULATE THE INFLATION RATE Why do you think prices were higher in Round 2 than in Round 1? Allow students time to write down their answers. The most important answer to get students to understand is that prices were higher because more money was in “circulation” in Round 2. In fact, since money in circulation should have doubled in Round 2, it is likely that inflation is exactly 100%, just like in the sample.

“Inflation” Learning Targets
Knowledge 5 Understand how inflation causes prices to change over time. Reasoning 3 Explain why a small, but positive, inflation rate is desirable. Skill 2 Calculate data regarding inflation.

Consumer Price Index (CPI)
The most important measure of prices in the United States is the Consumer Price Index (CPI), which uses a market basket for its calculations. This slide is a follow-up to the Candy Auction warm-up activity. Thus, this description of the CPI simply adds to what the students learned from the Candy Auction and the related slides. It is important to note that there are other price indexes, most notably the producer price index (PPI) and the GDP deflator. The CPI measures consumer price changes, the PPI measures producer price changes, and the GDP deflator measures price changes in all aspects of a country’s economy. Only the CPI is included in this slideshow due to its primary importance, and due to length and time constraints. Feel free to add these two other concepts to your students knowledge if desired.

The most important measure of prices in the United States is the Consumer Price Index (CPI), which uses a market basket for its calculations. 1) The market basket consists of items the average family of four would purchase in a city. You can ask students to think of specific purchases that would go in each category.

The most important measure of prices in the United States is the Consumer Price Index (CPI), which uses a market basket for its calculations. 1) The market basket consists of items the average family of four would purchase in a city. CPI 2) The base years are Thus, the CPI is roughly 100 in these years. You can note to students that the CPI has steadily increased over time.

The most important measure of prices in the United States is the Consumer Price Index (CPI), which uses a market basket for its calculations. 1) The market basket consists of items the average family of four would purchase in a city. Inflation CPI 2) The base years are Thus, the CPI is roughly 100 in these years. 3) The percentage change in the CPI is the inflation rate. Note that as long as the inflation rate is positive, the CPI will increase. The notable exception can be seen in 2009.

The most important measure of prices in the United States is the Consumer Price Index (CPI), which uses a market basket for its calculations. 1) The market basket consists of items the average family of four would purchase in a city. Inflation CPI 2) The base years are Thus, the CPI is roughly 100 in these years. 3) The percentage change in the CPI is the inflation rate. 4) Steep growth in the CPI (notice the 1970s) is accompanied by high inflation rates.

It is generally considered that these four events cause inflation.
Causes of Inflation It is generally considered that these four events cause inflation. Economists still debate the specific causes of inflation, but most reasons fall into one of these four categories.

Causes of Inflation It is generally considered that these four events cause inflation. 1) Money Supply Increases Prices will increase if “too many dollars are chasing too few goods.” This is the reason why inflation occurred in the opening activity. More dollar bills were handed out in Round 2, effectively increasing the supply of money. This is also the answer to why a country cannot just print more money to pay its bills, which is a question that gets asked quite often by beginning economics students. If money exceeds the potential level of output of goods and services, its value will drop.

Causes of Inflation It is generally considered that these four events cause inflation. 1) Money Supply Increases Prices will increase if “too many dollars are chasing too few goods.” 2) Money Demand Decreases This has the same effect as having more money in the economy.

Causes of Inflation It is generally considered that these four events cause inflation. 1) Money Supply Increases Prices will increase if “too many dollars are chasing too few goods.” 2) Money Demand Decreases This has the same effect as having more money in the economy. Draw the Graph 3) Aggregate Demand Increases When people want to buy more goods, prices will rise, which is called demand-pull inflation.

Causes of Inflation It is generally considered that these four events cause inflation. 1) Money Supply Increases Prices will increase if “too many dollars are chasing too few goods.” AD AS 2) Money Demand Decreases This has the same effect as having more money in the economy. AD2 3) Aggregate Demand Increases When people want to buy more goods, prices will rise, which is called demand-pull inflation. The increase in price on the graph represents an increase in the aggregate price level, which is inflation. Allow students time to copy this onto the graph on their note sheets.

Causes of Inflation It is generally considered that these four events cause inflation. 1) Money Supply Increases Prices will increase if “too many dollars are chasing too few goods.” 2) Money Demand Decreases This has the same effect as having more money in the economy. Draw the Graph 3) Aggregate Demand Increases When people want to buy more goods, prices will rise, which is called demand-pull inflation. 4) Aggregate Supply Decreases If production costs increase in an economy, the supply decreases, which is cost-push inflation.

Causes of Inflation It is generally considered that these four events cause inflation. 1) Money Supply Increases Prices will increase if “too many dollars are chasing too few goods.” AD AS AS2 2) Money Demand Decreases This has the same effect as having more money in the economy. 3) Aggregate Demand Increases When people want to buy more goods, prices will rise, which is called demand-pull inflation. The increase in price on the graph represents an increase in the aggregate price level, which is inflation. Allow students time to copy this onto the graph on their note sheets. 4) Aggregate Supply Decreases If production costs increase in an economy, the supply decreases, which is cost-push inflation.

Costs of Inflation Inflation does, in fact, make some people better off, but inflation is generally considered to have several costs associated with it.

Costs of Inflation Inflation does, in fact, make some people better off, but inflation is generally considered to have several costs associated with it. 1) Lenders and borrowers can be positively or negatively affected by unexpected inflation. Even though it is not defined on the slide, the definition for “unexpected inflation” should be obvious. Define it for students if necessary. See Example Skip Example

Costs of Inflation Inflation does, in fact, make some people better off, but inflation is generally considered to have several costs associated with it. 1) Lenders and borrowers can be positively or negatively affected by unexpected inflation. Suppose a bank charges an interest rate of 7% on a loan. The expected inflation rate is 5%. This means the bank expects to make a real profit of 2% (7% - 5%). Even though it is not defined on the slide, the definition for “expected inflation” should be obvious. Define it for students if necessary.

Costs of Inflation Inflation does, in fact, make some people better off, but inflation is generally considered to have several costs associated with it. 1) Lenders and borrowers can be positively or negatively affected by unexpected inflation. Suppose a bank charges an interest rate of 7% on a loan. The expected inflation rate is 5%. This means the bank expects to make a real profit of 2% (7% - 5%). Suppose there is unexpected inflation, adding another 1% to inflation (6% total). The bank will now make a profit of just 1%. Inflation hurt the bank!

Costs of Inflation Inflation does, in fact, make some people better off, but inflation is generally considered to have several costs associated with it. 1) Lenders and borrowers can be positively or negatively affected by unexpected inflation. Suppose a bank charges an interest rate of 7% on a loan. The expected inflation rate is 5%. This means the bank expects to make a real profit of 2% (7% - 5%). Suppose there is unexpected inflation, adding another 1% to inflation (6% total). The bank will now make a profit of just 1%. Inflation hurt the bank! Borrowers, in this case, expected to pay a real interest rate of 2% (7% - 5%).

Costs of Inflation Inflation does, in fact, make some people better off, but inflation is generally considered to have several costs associated with it. 1) Lenders and borrowers can be positively or negatively affected by unexpected inflation. Suppose a bank charges an interest rate of 7% on a loan. The expected inflation rate is 5%. This means the bank expects to make a real profit of 2% (7% - 5%). Suppose there is unexpected inflation, adding another 1% to inflation (6% total). The bank will now make a profit of just 1%. Inflation hurt the bank! Borrowers, in this case, expected to pay a real interest rate of 2% (7% - 5%). This is just one example of how some people win and some people lose. You can do a similar example on the board, but show the bank making more money and the borrower having to pay more. This example helps students understand that if prices rise, it means somebody on the other end is receiving more income. Thus, there certainly are winners and losers when it comes to inflation. Borrowers now only pay a real interest rate of 1% instead of 2%. Borrowers won!

Costs of Inflation Inflation does, in fact, make some people better off, but inflation is generally considered to have several costs associated with it. 1) Lenders and borrowers can be positively or negatively affected by unexpected inflation. 2) Because inflation reduces the value of money, people avoid holding it. The increased costs of transactions are shoe-leather costs. They are called shoe-leather costs because of the wear and tear on people’s shoes as they run around making numerous transactions.

Costs of Inflation Inflation does, in fact, make some people better off, but inflation is generally considered to have several costs associated with it. 1) Lenders and borrowers can be positively or negatively affected by unexpected inflation. 2) Because inflation reduces the value of money, people avoid holding it. The increased costs of transactions are shoe-leather costs. 3) Menu costs are the costs of changing prices. High inflation causes this to happen frequently. These costs include paying labor to change price tags, printing fees, and the costs of supplies for displaying prices.

Costs of Inflation Inflation does, in fact, make some people better off, but inflation is generally considered to have several costs associated with it. 1) Lenders and borrowers can be positively or negatively affected by unexpected inflation. 2) Because inflation reduces the value of money, people avoid holding it. The increased costs of transactions are shoe-leather costs. 3) Menu costs are the costs of changing prices. High inflation causes this to happen frequently. 4) Unit of account costs are when inflation makes money a less reliable unit of measurement.

Inflation and Unemployment
The inflation rate and the unemployment rate are two economic indicators that are strongly connected. The concepts discussed on these slides are extremely complex. This is a very simplified explanation of how inflation and unemployment are related. If nothing else, students should know that there is a generally negative relationship between inflation and unemployment.

The inflation rate and the unemployment rate are two economic indicators that are strongly connected. 1) The business cycle shows that there is a short-run tradeoff between inflation and unemployment.

The inflation rate and the unemployment rate are two economic indicators that are strongly connected. 1) The business cycle shows that there is a short-run tradeoff between inflation and unemployment. a) If either inflation or unemployment is high, the other is generally low.

The inflation rate and the unemployment rate are two economic indicators that are strongly connected. 1) The business cycle shows that there is a short-run tradeoff between inflation and unemployment. SRPC a) If either inflation or unemployment is high, the other is generally low. b) The short-run Phillips curve graphically demonstrates this. Notice how all of the points follow a regular trend line. Each dot represents one year from the 1960s. During the 1960s this relationship seemed very simple. Notice how low rates for one variable meant high rates for the other variable.

The inflation rate and the unemployment rate are two economic indicators that are strongly connected. 1) The business cycle shows that there is a short-run tradeoff between inflation and unemployment. a) If either inflation or unemployment is high, the other is generally low. b) The short-run Phillips curve graphically demonstrates this. SRPC2 2) If inflation is expected, however, the entire curve shifts upwards. Each dot represents one year from the 1970s. When inflation becomes embedded in expectations, it shifts the short-run Phillips curve upward. This happens because expected inflation causes total inflation to be higher at every level of unemployment. SRPC1 During the 1970s it was discovered that expected inflation could effectively raise inflation rates without lowering the unemployment rate.

The inflation rate and the unemployment rate are two economic indicators that are strongly connected. 1) The business cycle shows that there is a short-run tradeoff between inflation and unemployment. LRPC SRPC1 SRPC2 SRPC3 a) If either inflation or unemployment is high, the other is generally low. b) The short-run Phillips curve graphically demonstrates this. 2) If inflation is expected, however, the entire curve shifts upwards. Each dot represents one year from The LRPC tells us that there is no long-run tradeoff between inflation and unemployment. This tradeoff only exists in the short run. The natural rate of unemployment is actually the point at which the acceleration of inflation is zero. This is actually how the natural rate of unemployment is calculated. This is such an important point that this level (around 5.6% in the U.S.) is called the Non-Accelerating Inflation Rate of Unemployment (NAIRU). 3) Thus, the long-run Phillips curve is a vertical line at the natural rate of unemployment (near 6% in the U.S.).

The inflation rate and the unemployment rate are two economic indicators that are strongly connected. 1) The business cycle shows that there is a short-run tradeoff between inflation and unemployment. LRPC SRPC1 SRPC2 SRPC3 a) If either inflation or unemployment is high, the other is generally low. b) The short-run Phillips curve graphically demonstrates this. 2) If inflation is expected, however, the entire curve shifts upwards. This is true because unemployment rates below the natural level will always cause inflation. Once this inflation gets embedded in people’s expectations, still keeping the unemployment rate below the natural rate will cause unexpected inflation on top of this expected inflation. Thus, the inflation rate increases even higher. And even though unemployment might drop in the short run, there is no way to keep it so low without causing this spiral of inflation to continue. The only way to restore the inflation rate to low levels is to experience extended unemployment until inflation is no longer embedded in people’s expectations. 3) Thus, the long-run Phillips curve is a vertical line at the natural rate of unemployment (near 6% in the U.S.). 4) Attempts to keep unemployment too low result in ever-increasing inflation.

Controlling Inflation
If inflation becomes embedded in expectations, it needs to be dealt with. This painful process of reducing expected inflation is called disinflation.

If inflation becomes embedded in expectations, it needs to be dealt with. This painful process of reducing expected inflation is called disinflation. 1) If the unemployment rate is too low, it will lead to increasing inflation.

If inflation becomes embedded in expectations, it needs to be dealt with. This painful process of reducing expected inflation is called disinflation. 1) If the unemployment rate is too low, it will lead to increasing inflation. 2) Thus, to reduce inflation, the unemployment rate must be kept above the natural rate.

If inflation becomes embedded in expectations, it needs to be dealt with. This painful process of reducing expected inflation is called disinflation. 1) If the unemployment rate is too low, it will lead to increasing inflation. 2) Thus, to reduce inflation, the unemployment rate must be kept above the natural rate. 3) High unemployment is painful, but necessary to reduce inflation.

If inflation becomes embedded in expectations, it needs to be dealt with. This painful process of reducing expected inflation is called disinflation. 1) If the unemployment rate is too low, it will lead to increasing inflation. 2) Thus, to reduce inflation, the unemployment rate must be kept above the natural rate. 3) High unemployment is painful, but necessary to reduce inflation. 4) It is possible, however, for both inflation and unemployment to be high, which is called stagflation. The U.S. was only able to get out of this stagflation by first dealing with the inflation. In order to reduce inflation, it had to be removed from expectations. This meant severe unemployment had to exist while the economy purged itself of these expectations. (Stagflation itself in the 1970s has been attributed to the oil crisis. This effectively caused a decrease in the aggregate supply curve (negative supply shock)--described on the slides for “Causes of Inflation”--which caused inflation and high unemployment.) From the U.S. experienced painful stagflation. Unemployment was above the natural rate (about 6%) and inflation was above the 2% - 3% target.

If inflation becomes embedded in expectations, it needs to be dealt with. This painful process of reducing expected inflation is called disinflation. 1) If the unemployment rate is too low, it will lead to increasing inflation. 2) Thus, to reduce inflation, the unemployment rate must be kept above the natural rate. 3) High unemployment is painful, but necessary to reduce inflation. 4) It is possible, however, for both inflation and unemployment to be high, which is called stagflation. 5) The tools used by policy makers to control inflation are fiscal policy and monetary policy.

Optimal Rate of Inflation
Because of all the problems associated with inflation, the ideal rate is near zero, but still slightly positive.

Because of all the problems associated with inflation, the ideal rate is near zero, but still slightly positive. 1) Some countries have had problems with severe inflation, which is called hyperinflation. Episodes of hyperinflation throughout history have shown that bartering will replace currency if inflation is severe enough. Also, all of the costs of inflation are magnified at such high rates. Yes, that is an inflation rate of 3,000%! Argentina, along with several South American countries, suffered inflation so bad that people refused to use cash in transactions.

Because of all the problems associated with inflation, the ideal rate is near zero, but still slightly positive. 1) Some countries have had problems with severe inflation, which is called hyperinflation. 2) In modern U.S. history, inflation has never been above 14%.

Because of all the problems associated with inflation, the ideal rate is near zero, but still slightly positive. 1) Some countries have had problems with severe inflation, which is called hyperinflation. 2) In modern U.S. history, inflation has never been above 14%. 3) Keeping inflation around 2% - 3% avoids almost all costs of inflation. IDEAL INFLATION

Because of all the problems associated with inflation, the ideal rate is near zero, but still slightly positive. 1) Some countries have had problems with severe inflation, which is called hyperinflation. 2) In modern U.S. history, inflation has never been above 14%. 3) Keeping inflation around 2% - 3% avoids almost all costs of inflation. 4) If inflation is below 0%, it is called deflation. This means money becomes more valuable over time. IDEAL INFLATION Deflation Deflation

Because of all the problems associated with inflation, the ideal rate is near zero, but still slightly positive. 1) Some countries have had problems with severe inflation, which is called hyperinflation. 2) In modern U.S. history, inflation has never been above 14%. 3) Keeping inflation around 2% - 3% avoids almost all costs of inflation. 4) If inflation is below 0%, it is called deflation. This means money becomes more valuable over time. IDEAL INFLATION The explanation here is simplified. The most important thing for students to understand is that deflation is very undesirable, so policy makers are willing to accept a small inflation rate as long as it is positive. By ensuring positive inflation rates, the Fed is able to alter interest rates to affect change in the economy. If deflation occurs at substantial levels, the economy can slip into a liquidity trap, meaning monetary policy has no effect because it is zero bound. Deflation Deflation 5) Deflation must be avoided since people will not loan money if it is better just to hold it.

Prices Then and Now DIRECTIONS
Each question lists an item that has been on sale for several decades, along with an “old” price and a current price. Use your knowledge of the Consumer Price Index (CPI) and inflation to determine if the item is cheaper or more expensive today (in real terms). (a) Complete this version if you feel you need the teacher to work with you on this topic. (b) Complete this version if you feel you have a fairly good understanding of this topic. (c) Complete this version if you feel this topic is easy.

“Inflation” Learning Targets
Knowledge 5 Understand how inflation causes prices to change over time. Reasoning 3 Explain why a small, but positive, inflation rate is desirable. Skill 2 Calculate data regarding inflation.

Resources Data for CPI percentage distribution (2013) Historical CPI data in the U.S. Data on Argentina inflation rates Data on U.S. inflation rates

Candy Auction RECORD DATA Round 1 Round 2

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