1. Inflation: Measuring the Cost of Living
AP Macroeconomics

2. Most lattes she could buy Opportunity cost of 1 latte
Money—money—money!
Most gas she could buy
Most lattes she could buy
Opportunity cost of 1 latte
10 gallons
5 cups
2 gallons
$20 allowance per week for gas ($2/gallon) and venti mochiaccino café lattes ($4/cup)
1 gallon of gas uses 10% of her income.
1 cup of latte uses 20% of her income.
What happens if her income doubled and so did the price of gas and the price of a latte?

3. Most lattes she could buy Opportunity cost of 1 latte
Money—money—money!
Most gas she could buy
Most lattes she could buy
Opportunity cost of 1 latte
10 5 gallons
cups
2 gallons
$20 allowance per week for gas ($2/gallon) and venti mochiaccino café lattes ($4/cup)
1 gallon of gas uses 10% 20% of her income.
1 cup of latte uses 20% 40% of her income.
Now, what if the price of gas and café lattes doubles, while her income stays the same?

4. Inflation Rise in the general level of prices.
Results in fewer goods and services being purchased
Reduction of purchasing power of the dollar

6. Low Inflation AD increases Workers increase spending Workers hired
Production expands
Producers make high real profits
Wages raise slower than prices

7. Unemployment increases
Prices rise rapidly
Real income decreases
Fewer goods purchased
Unemployment increases
Economy suffers
High Inflation

8. Grand Poobah for a Day 1950’s television game show “Queen for the Day”
Contestants took turns describing their lives of tragedy, hardship, and sorrow
Audience voted for the most deserving
Winner crowned queen for the day
Today you will play to become the “Grand Poobah for a Day”

9. Rules of the Game 12 students will compete
Given a role card
60 seconds to “perform” role for class
Class will score each contestant
After all have presented we will determine the Grand Poobah for the day
Any questions? Let’s begin!

10. Spectrum to analyze contestants
Lucy
Mayor
Helga
Mr. Class
Priscilla
Lawrence
Bernie
Elmer
Peter
Jerome
Jerry
Theresa
Suffers most from inflation
Benefits most from inflation
Neutral
(neither suffers nor benefits)

11. Anticipated & Unanticipated Inflation
Unanticipated inflation hurts
Fixed-income receivers
Savers
Creditors
Unanticipated inflation helps
Flexible-income receivers
Debtors
What about anticipated inflation?

12. Demand-Pull Inflation
People are willing and able to buy more output than the economy can produce
Excess demand bids up the prices of limited output
“Too many dollars chasing too few goods”
SRAS
aPL
AD1 AD
rGDP

13. Cost-Push Inflation Supply-side cost shocks Wage-price spiral
Increase in business tax

14. ECB’s Inflation Monster
Watch for different types of inflation.
What’s the deal with deflation?

15. Inflation Rate
Percentage of the change in the price level from one period to the next.
The inflation rate reflects how fast prices are changing.

16. Deflation
A persistent fall in the average level of prices in the economy
“Good” deflation: improvements in the supply side of the economy and/or increased productivity
“Bad” deflation: the demand of the economy declines, includes a decrease in real output

17. Disinflation
A falling rate of inflation

18. Economic Costs of Inflation
Shoe-leather costs
Menu costs
Unit of account costs
Activity 2.5

19. A Brain Break…
You start with $1000 in investments that do the following: fall 50%, go up 80%, fall 50%, go up 80%, fall 50%, and up 80%. How much money have you made?

20. The Consumer Price Index
The consumer price index (CPI) is a measure of the overall cost of the goods and services bought by typical consumers.
It’s a number used to reflect the changes in the prices.
It includes the “C” of the GDP plus used goods purchased by families.
The Bureau of Labor Statistics reports the CPI each month. 2

21. Uses for the CPI
Policy Target: The goal is to have stable prices, which means low inflation.
COLA: earn appropriate pay raises.
Translate prices from nominal to real: we can compare apples to apples.

22. CPI since 1950

23. November 18, 2016.

24. November 18, 2016.

25. How the Consumer Price Index Is Calculated
Fix the Basket: Determine what prices are most important to the typical consumer.
The Bureau of Labor Statistics (BLS) identifies a market basket of 400 goods and services the typical consumer buys.
The BLS conducts monthly consumer surveys to set the weights for the prices of those goods and services. 4

26. What’s in the CPI’s Basket?5% 5%
Housing
Food/Beverages
Transportation
Medical Care
Apparel
Recreation
Other
Education and
communication 6% 5% 6%
40%
17%
16% 10

27. How the Consumer Price Index Is Calculated
Find the Prices: Find the prices of each of the goods and services in the basket for each point in time. 5

28. How the Consumer Price Index Is Calculated
Compute the Basket’s Cost: Use the data on prices to calculate the cost of the basket of goods and services at different times. 6

29. How the Consumer Price Index Is Calculated
Choose a Base Year and Compute the Index:
Designate one year as the base year, making it the benchmark against which other years are compared.
Compute the index by dividing the price of the basket in one year by the price in the base year and multiplying by 100.
Beige book for examples pp December 1999 CPI (68.3% higher than July 1983). December 1960 CPI was 29.8 (29.8% of the prices in 1983) CPI is 100. 7

30. How the Consumer Price Index Is Calculated
CPI= 7

31. How the Consumer Price Index Is Calculated
Compute the inflation rate: The inflation rate is the percentage change in the price index from the preceding period. 8

32. The Inflation Rate
The annual inflation rate is calculated as follows:

33. Basket of goods in 1998 costs $1,200.
Calculating the Consumer Price Index and the Inflation Rate: An Example
Base Year is 1998.
Basket of goods in 1998 costs $1,200.
The same basket in 2000 costs $1,236.
CPI = ($1,236/$1,200) X 100 = 103.
Prices increased 3 percent between 1998 and 2000.
Your turn! Please complete activity 2-4. 9

37. CPI of selected years, 1960-2015 Year Consumer Price Index 1960 29.8
1965
31.8
1970
39.8
1975
55.5
1980
86.3
1985
109.3
1990
130.7
1995
152.4
2000
172.2
Year
Consumer Price Index
2005
195.3
2010
218.1
2013
233.0
2015
237.6

38. Price Indexes for Selected Goods and Services
Year
Overall
Food
Shelter
Transportation
Medical Care
Apparel
1950
24.1
25.4 NA
22.7
15.1
40.3
1955
26.8
27.8
25.8
18.2
42.9
1960
29.6
30.0
25.2
29.8
22.3
45.7
1965
31.5
32.2
27.0
31.4
24.6
47.3
1970
38.8
39.2
35.5
37.5
34.0
59.2
1975
53.8
59.8
48.8
50.1
47.5
72.5
1980
82.4
86.8
81.0
83.1
74.9
90.9
100.0
1985
107.6
105.6
109.8
106.4
113.5
105.0
1990
130.7
132.4
140.0
120.5
162.8
124.1
1994
148.2
144.3
160.5
134.3
211.0
133.4
2000
174.0
167.3
171.4
157.7
264.1
125.3
2004
187.4
187.9
191.0
164.8
311.6
121.2
2006
203.5
194.5
201.7
188.5
336.0
116.1
2009
212.7
218.6
217.4
169.6
373.2
122.5
2016
241.9
248.1
291.4
196.2
499.7
130.3

39. Problems in Measuring The Cost of Living
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. 12

40. Problems in Measuring The Cost of Living
Substitution bias
Introduction of new goods
Unmeasured quality changes 13

41. Hyperinflation Hungary in 1946: $1 US = 3 x 1022 pengös
Germany 1920s: price level rose 1,300,000,000,000x
Nicaragua 2/86 to 3/1991: 11,895,866,143%
Serbia 2/93 to 1/94: 156,312,790%

43. November 18, 2016.

44. January 11, 2017.