AP EXAM: Unit 2 (IV-VII) Flashcards
Define price index.
The price index measures changes in the general price level over time.
Define consumer price index.
Measures the change in income a consumer would need in order to maintain the same standard of living over time under a new set of prices.
What’s the CPI used for?
Used to calculate the inflation rate or the rate of change in the average price level of consumer goods
How to calculate CPI
Price of basket of goods in current year divided by price of the basket in base year times 100
How is inflation rate measured?
As a rate of change in the CPI between two periods of time.
Inflation rate formula
CPI in Y2 - CPI in Y1 divided by CPI in Y1 times 100
Problems with high inflation
- Real income decreases (lower standard of living)
- Real interest rates (increase highly)
Real interest rate formula
RIR = NIR - Inflation rate
What is an interest rate?
The price of money
Formula for change in real income
Change in real income = Change in NI - Inflation rate
Who is benefited from high inflation?
Borrowers who are borrowing money at a fixed rate (essentially paying less than what it’s worth)
–> Also: lenders lending at a flexible rate
Who is hurt from high inflation?
Lenders who are lending money at a fixed rate (getting paid less than what it’s worth)
–> Also: borrowers borrowing at a flexible rate
What are the shortcomings of CPI?
Substitution bias
- Actual impact of inflation overstated as individuals chose to substitute high priced items for lower priced items
Effects of inflation
- Redistribution of wealth
- Businesses like inflation, consumers are hurt by inflation - Erodes country’s competitiveness
- Creates perpetuating cycle about fears of inflation, driving consumers and producers to spend more now, only for value to decrease anyways
What is nominal GDP?
Measures how much money is spent on a country’s output in a year
What is real GDP?
Measures the value of a nation’s output in prices from a base year
Relationship between inflation and real/nominal GDP
–> Inflation increases, rGDP will be less than nGDP
–> Inflation decreases, rGDP will be more than nGDP
Why is GDP not a good indicator of a country’s real output?
Nominal GDP can change when prices change
What causes nGDP to increase?
The quantity of output increases or when prices increase
Nominal GDP growth rate formula
Y2 Nominal GDP - Y1 Nominal GDP / Y1 Nominal GDP x 100
Real GDP growth rate formula
Y2 Real GDP - Y1 Real GDP / Y1 Real GDP x 100
What is the GDP deflator?
The GDP deflator price index is a measure of inflation indicating how much the average price level has changed since the base year.
GDP deflator price index formula
Nominal GDP divided by Real GDP x 100
Real GDP formula
Nominal GDP / GDP Deflator price index x 100
What is the business cycle?
An economic model made to show the fluctuations in an economy’s aggregate output
Phases of the business cycle
- Expansion
- Peak (turning point, increase –> decrease)
- Recession
- Trough (turning point, decrease –> increase)
