Chapter 10.2

Question 1

Inflation

Answer 1

A sustained increase in the general price level

Question 2

Deflation

Answer 2

A sustained decrease in the general price level

Question 3

Disinflation

Answer 3

A decrease in the rate of inflation

Question 4

Consumer price index (CPI)

Answer 4

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

Question 5

How is inflation or deflation determined from the CPI?

Answer 5

Find the change in percentage of the CPI

Question 6

A positive percentage change in CPI indicates ___

Answer 6

inflation

Question 7

A negative percentage change in CPI indicates __

Answer 7

deflation

Question 8

Weighted price index

Answer 8

An index that weights the various goods and services according to their relative importance in consumer spending

Question 9

Formula for the price index for a specific year

Answer 9

Value of basket in a specific year divided by value of the same basket in base year

Question 10

What are the steps for constructing a weighted price index?

Answer 10

1. Find the value of the basket in current prices for each year
2. Divide the value of the basket for each year by the value of the basket in the base year
3. The value obtained is the price index for that year

Question 11

How do you calculate inflation when the price level is presented as a price index?

Answer 11

Subtract the index number of the base year from the index number of any other year

Question 12

Reasons for why the CPI may be an inaccurate measure of inflation

Answer 12

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

Question 13

What are the causes of inflation?

Answer 13

Demand-pull inflation
Cost-push inflation

Question 14

Demand-pull inflation

Answer 14

Inflation caused by an excess of aggregate demand over aggregate supply at the full employment level of output

Question 15

Cost-push inflation

Answer 15

Inflation caused by a fall in aggregate supply, resulting from increases in wages or prices of other inputs

Question 16

Costs of inflation

Answer 16

Redistribution costs
Uncertainty
Effects on savings
International competitiveness
Effects on economic growth
Effects on resource allocation
Unequal distribution of social and personal costs

Question 17

Groups that may lose from the redistribution costs of inflation

Answer 17

People who receive fixed income
People who receive income that increases slower than inflation
Holders of cash
Savers
Lenders

Question 18

Groups that may win from the redistribution costs of inflation

Answer 18

Borrowers
Payers of fixed incomes
Payers of incomes that increase slower than inflation

Question 19

Why might deflation rarely occur in the real world?

Answer 19

Wages of workers don’t ordinarily fall
Large oligopolistic firms fear price wars

Question 20

Costs of deflation

Answer 20

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

Question 21

Deferred consumption

Answer 21

When consumers postpone spending in anticipation of lower prices

Question 22

What is a potential positive effect of deflation?

Answer 22

Lower price levels make exports more attractive to foreign countries, increasing net exports