AP EXAM: Unit 2 (IV-VII)

Question 1

Define price index.

Answer 1

The price index measures changes in the general price level over time.

Question 2

Define consumer price index.

Answer 2

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.

Question 3

What’s the CPI used for?

Answer 3

Used to calculate the inflation rate or the rate of change in the average price level of consumer goods

Question 4

How to calculate CPI

Answer 4

Price of basket of goods in current year divided by price of the basket in base year times 100

Question 5

How is inflation rate measured?

Answer 5

As a rate of change in the CPI between two periods of time.

Question 6

Inflation rate formula

Answer 6

CPI in Y2 - CPI in Y1 divided by CPI in Y1 times 100

Question 7

Problems with high inflation

Answer 7

1. Real income decreases (lower standard of living)
2. Real interest rates (increase highly)

Question 8

Real interest rate formula

Answer 8

RIR = NIR - Inflation rate

Question 9

What is an interest rate?

Answer 9

The price of money

Question 10

Formula for change in real income

Answer 10

Change in real income = Change in NI - Inflation rate

Question 11

Who is benefited from high inflation?

Answer 11

Borrowers who are borrowing money at a fixed rate (essentially paying less than what it’s worth)
–> Also: lenders lending at a flexible rate

Question 12

Who is hurt from high inflation?

Answer 12

Lenders who are lending money at a fixed rate (getting paid less than what it’s worth)
–> Also: borrowers borrowing at a flexible rate

Question 13

What are the shortcomings of CPI?

Answer 13

Substitution bias
- Actual impact of inflation overstated as individuals chose to substitute high priced items for lower priced items

Question 14

Effects of inflation

Answer 14

1. Redistribution of wealth
   - Businesses like inflation, consumers are hurt by inflation
2. Erodes country’s competitiveness
3. Creates perpetuating cycle about fears of inflation, driving consumers and producers to spend more now, only for value to decrease anyways

Question 15

What is nominal GDP?

Answer 15

Measures how much money is spent on a country’s output in a year

Question 16

What is real GDP?

Answer 16

Measures the value of a nation’s output in prices from a base year

Question 17

Relationship between inflation and real/nominal GDP

Answer 17

–> Inflation increases, rGDP will be less than nGDP
–> Inflation decreases, rGDP will be more than nGDP

Question 18

Why is GDP not a good indicator of a country’s real output?

Answer 18

Nominal GDP can change when prices change

Question 19

What causes nGDP to increase?

Answer 19

The quantity of output increases or when prices increase

Question 20

Nominal GDP growth rate formula

Answer 20

Y2 Nominal GDP - Y1 Nominal GDP / Y1 Nominal GDP x 100

Question 21

Real GDP growth rate formula

Answer 21

Y2 Real GDP - Y1 Real GDP / Y1 Real GDP x 100

Question 22

What is the GDP deflator?

Answer 22

The GDP deflator price index is a measure of inflation indicating how much the average price level has changed since the base year.

Question 23

GDP deflator price index formula

Answer 23

Nominal GDP divided by Real GDP x 100

Question 24

Real GDP formula

Answer 24

Nominal GDP / GDP Deflator price index x 100

Question 25

What is the business cycle?

Answer 25

An economic model made to show the fluctuations in an economy’s aggregate output

Question 26

Phases of the business cycle

Answer 26

1. Expansion
2. Peak (turning point, increase –> decrease)
3. Recession
4. Trough (turning point, decrease –> increase)