Ch.12 - Inflation

Question 1

What is inflation?

Answer 1

A generalized rise in the overall general prices

Question 2

What is the Consumer Price Index?

Answer 2

An index that tracks the average price consumers pay over time for a representative “basket” of goods & services

Question 3

What is inflation rate? How do you calculate it?

Answer 3

The annual percentage increase in the average price level

Inflation Rate = ((Price Level this year - Price Level last year) / Price level last year) X 100

Question 4

What is deflation?

Answer 4

A generalized decrease in the overall level of prices

Question 5

What is substitution bias?

Answer 5

The overstating of inflation that occurs because people substitute towards goods whose prices rise by less

Question 6

What is indexation?

Answer 6

Automatically adjusting wages, benefits, tax brackets, and the like to compensate for inflation

Question 7

What is the Producer Price Index?

Answer 7

A price index that tracks the prices of inputs into the production process

Question 8

What is GDP deflator? How do you calculate it?

Answer 8

A price index that tracks the price of all goods and services produced domestically

GDP Deflator = (Normal GDP / Real GDP) X 100

Question 9

What is core inflation?

Answer 9

The change in prices of goods and services, except for those from the food and energy sectors.

Question 10

What is a Nominal Variable? What is a Real Variable?

Answer 10

Nominal Variable: A variable measured in dollars (whose value may fluctuate over time)

Real Variable: A variable that has been adjusted to account for inflation

Question 11

What is Nominal Interest Rate? What is Real Interest Rate?

Answer 11

Nominal Interest Rate: The stated interest rate without a correction for the effects of inflation

Real Interest Rate: The interest rate in terms of changes in your purchasing power

Question 12

What is the money illusion?

Answer 12

The (mistaken) tendency to focus on nominal dollar amounts instead of inflation-adjusted amounts

Question 13

What is Nominal Wage Rigidity?

Answer 13

Reluctance to cut nominal wages

Question 14

What is hyperinflation?

Answer 14

Extremely high rates of inflation

Question 15

What are the 2 costs of expected inflation?

Answer 15

1. Creates menu costs for sellers
   (The marginal cost of adjusting prices)
2. Creates shoe-leather costs for buyers
   (The costs incurred trying to avoid holding cash)

Question 16

What are the 2 costs of unexpected inflation?

Answer 16

1. Confuses signals that prices send
2. Inflation redistributes from savers & lenders to borrowers

Question 17

What is the inflation fallacy?

Answer 17

The (mistaken) belief that inflation destroys purchasing power