1. Inflation

2. Inflation Deflation Disinflation Consumer Price Index
An increase in the general (average) price level of goods and services in the economy
Deflation
A decrease in the general (average) price level of goods and services in the economy
Disinflation
A reduction in the rate of inflation
Consumer Price Index
The most widely reported measure of inflation
It measures changes in the average prices of consumer goods and services

3. Reporting and Calculation
The Bureau of Labor Statistics (BLS) reports CPI
Price collectors contact retail stores, homeowners, and tenants in selected cities in the U.S. monthly
Goods and Services are Included in the CPI
The BLS records average prices for a “market basket” of different items purchased by the typical urban family
Composition of the CPI
Food
Housing
Apparel
Transportation
Health Care
Entertainment
Education
All other goods
13%
33% 4%
18% 6% 5% 2% 8%

4. Reporting and Calculation
The makeup of the CPI changes as people’s tastes and preferences change, some of the goods and services that go into the basket change
Computing CPI
Current year prices are compared to prices of a similar basket of goods and services in a base year
Base year: a year chosen as a reference point for comparison with some earlier or later year
CPI is set to 100 in the base year
CPI =
cost of the market basket of products at current-year prices
cost of the market basket of products at base-year prices
X 100

5. Computing Inflation Rate
The percentage change in the official CPI from one year to the next
Inflation
Rate
CPI - CPIPY
CPIPY
X 100 =
CPIY is the Consumer price index in given year
CPIPY is the Consumer price index in previous year
Inflation
Rate
CPI2006 – CPI2005
CPI2005
X 100 =
Inflation
Rate
201.5 – 195.3
195.3
X 100 =
3.2%

6. Consumer Price Indexes and Inflation Rates
Year
CPI
Inflation Rate
1931
15.2 -
1932
13.7
-9.9%
1979
72.6
1980
82.4
13.5
2000
172.2
2001
177.1
2.8
2002
179.9
1.6
2005
195.3
2013
233.0
2014
236.7
Year
CPI
Inflation Rate
2000
172.2
3.4%
2001
177.1
2.8
2002
179.9
1.6
2003
184
2.3
2004
188.9
2.7
2005
195.3
3.4
2006
201.6
3.2
2007
207.3
2008
215.3
3.8
2009
214.5
-0.4
2010
218.1
Where to find the current inflation rate?

7. Inflation Rate (percentage change in CPI from previous year)
The U.S. Inflation Rate 20 15 10
Inflation 5
Inflation Rate (percentage change in CPI from previous year) -5
Deflation
-10
-15
`30 `35 `40 `45 `50 `55 `60 `65 `70 `75 `80 `85 `90 `95 `00 `05 `10
Year

8. Inflation Impacts Income
Criticisms of the CPI
It can overstate or understate for certain groups
Does not measure quality
Substitutes are ignored
A general rise in prices will shrink people’s income
Inflation Impacts Income
Nominal Income
The actual number of dollars received over a period of time
Real Income
The actual number of dollars received (nominal income) adjusted for changes in the CPI

9. Real Income Calculation
Calculating Real Income
Nominal Income
CPI
Real Income =
X 100
Year
CPI
Base=1982
Nominal Income
Real Income
Real Income Calculation
1980
82.4
$30,000
$36,408
($30,000 / 82.2) * 100
2000
172.2
$40,000
$23,229
($40,000 / 172.2) * 100
2006
201.6
$45,000
$22,321
($45,000 / 201.6) * 100
The “Real Income” is now in 1982 dollars
While “Nominal Income” is going up over the years this person can not purchase the same level of goods and services in 2006 compared to 1980

10. Percentage Change in Real Income_
%  in nominal income
%  in CPI
%  in real income = 2% _ 3% = 5%
Real income increases when the rate of inflation is greater than a percentage increase in nominal income 3% _
-1% = 2%
Real income declines when the rate of inflation is greater than a percentage increase in nominal income

11. Wealth Wealth and Inflation
The value of the stock of assets owned at some point in time
Wealth and Inflation
Inflation can benefit holders of wealth because the value of their assets tend to increase as prices rise

12. Inflation Affects Borrowers and Savers
Nominal Interest Rate
The actual rate of interest earned over a period of time
Real Interest Rate
The nominal rate of interest minus the inflation rate
Nominal Rate 7% 7%
- Inflation Rate 3% - 9% -
Real Rate 4%
-2%
In the right example above, savers receive a nominal interest rate of 7% with inflation of 9% during the loan term causing saver purchasing power to decline by 2%
Borrowers receive 2% increase in purchasing power
Bankers have a great fair of inflation, it devalues a loan contract

13. Two basic types of inflation
Demand-pull
Cost-push
Demand-pull Inflation is a rise in the general price level resulting from an excess of total spending (demand)
When the economy is operating at or near full employment
Cost-push inflation is a rise in the general price level resulting from an increase in the cost of production
Cost increases for labor, raw materials, construction, equipment, borrowing etc.
Expectations can influence both demand-pull and cost-push inflation
Hyperinflation: An extremely rapid rise in the general price level
Wage-price spiral: Increases in nominal wage rates are passed on in higher prices, which, in turn, result in even higher nominal wages and prices