Chapter 10.2 Flashcards
Inflation
A sustained increase in the general price level
Deflation
A sustained decrease in the general price level
Disinflation
A decrease in the rate of inflation
Consumer price index (CPI)
A measure of the cost of living for the typical household, comparing the value of of a basket of goods and services in one year with the value of the same basket in a base year
How is inflation or deflation determined from the CPI?
Find the change in percentage of the CPI
A positive percentage change in CPI indicates ___
inflation
A negative percentage change in CPI indicates __
deflation
Weighted price index
An index that weights the various goods and services according to their relative importance in consumer spending
Formula for the price index for a specific year
Value of basket in a specific year divided by value of the same basket in base year
What are the steps for constructing a weighted price index?
- Find the value of the basket in current prices for each year
- Divide the value of the basket for each year by the value of the basket in the base year
- The value obtained is the price index for that year
How do you calculate inflation when the price level is presented as a price index?
Subtract the index number of the base year from the index number of any other year
Reasons for why the CPI may be an inaccurate measure of inflation
Different rates of inflation for different income earners
Different rates of inflation depending on regional or cultural factors
Changes in consumption patterns due to consumer substitutions when relative price changes
Changes in consumption patterns due to increasing use of discount stores and sales
Changes in consumption patterns due to introduction of new products
Doesn’t consider changes in product quality
Different methods of calculating CPI between countries
Might not be comparable over time
What are the causes of inflation?
Demand-pull inflation
Cost-push inflation
Demand-pull inflation
Inflation caused by an excess of aggregate demand over aggregate supply at the full employment level of output
Cost-push inflation
Inflation caused by a fall in aggregate supply, resulting from increases in wages or prices of other inputs
Costs of inflation
Redistribution costs
Uncertainty
Effects on savings
International competitiveness
Effects on economic growth
Effects on resource allocation
Unequal distribution of social and personal costs
Groups that may lose from the redistribution costs of inflation
People who receive fixed income
People who receive income that increases slower than inflation
Holders of cash
Savers
Lenders
Groups that may win from the redistribution costs of inflation
Borrowers
Payers of fixed incomes
Payers of incomes that increase slower than inflation
Why might deflation rarely occur in the real world?
Wages of workers don’t ordinarily fall
Large oligopolistic firms fear price wars
Costs of deflation
Redistribution effects
Increases in the real value of debt
Uncertainty
Deferred consumption
High and increasing cyclical unemployment
Risk of a deflationary spiral
Risk of bankruptcies and a financial crisis
Inefficient resource allocation
Policy ineffectiveness
Deferred consumption
When consumers postpone spending in anticipation of lower prices
What is a potential positive effect of deflation?
Lower price levels make exports more attractive to foreign countries, increasing net exports
