2.4: Price Indices and Inflation

Question 1

Inflation

Answer 1

Rising feneral level of price; it reduces the “purchasing power” of money; use consumer price index to calculate percent change

Question 2

Why is inflation bad?

Answer 2

Banks don’t lend money and people don’t save which decreases investment and GDP

Question 3

Deflation

Answer 3

Bad because people will hoard money and assests, decreases consumer spending and GDP

Question 4

Disinflation

Answer 4

Prices increasing at slower rates

Question 5

The inflation rate

Answer 5

The percent change in prices from year to year; year 2- year 1/year 1 * 100

Question 6

Prices Indices

Answer 6

Index numbers assigned to each year to show you how prices have changed relative to a specific base year

Question 7

Market Basket

And what it includes

Answer 7

The quantity in the basket must be the same as the base year; only items that consumers would normally purchase.

Question 8

Consumer Price Index Equation

Answer 8

CPI = (price of market basket /price of market basket in base year) * 100

Question 9

Problems with the CPI

Answer 9

Substitution Bias, New Products, Product Quality

Question 10

Substituion Bias

Answer 10

As prices increase for fixed market basket, consumers buy less of these products and more substitutes that may not be part of the market basket leading to the CPI being higher than what consumers are really paying

Question 11

New Products

Answer 11

CPI does not include newest consumer products and CPI measures prices, but not increase in choices

Question 12

Product Quality

Answer 12

CPI ignores both improvements and decline in product quality; CPI may suggest that prices stay the smae though economic wellbeing has improved significantly