Chapter 12 Flashcards
what is inflation?
A generalized rise in the overall level of prices.
Also described as…
➢ A rise in the cost of living.
➢ A decline in the purchasing power of money.
What is the consumer price index
its a way to see how prices for things people usually buy go up or down over time. In simpler words, it helps us understand if the everyday cost of living is going up or down for the average person.
what is does the term “basket” mean
A metaphor for the list of goods and
services people typically buy.
➢ It’s the food you buy, but also the shelter, education, haircuts, and streaming services you
pay for.
How do you calculate the inflation rate
Price level this year - Price level last year divided by price level last year x 100
what is the inflation rate
The percentage increase in the average price level of goods and services in an economy over a period of time. It measures how much prices have risen, indicating the rate at which the purchasing power of money is declining.
how do you measure inflation
- Find out what people buy.
- Collect prices.
- Tally up the cost of the
basket. - Calculate inflation as the
percentage change in the
prices of the basket.
what is deflation
a generalized decrease in the overall level of prices.
why can deflation be a problem
some people stop buying goods and services in order to wait for them to become cheaper.
what are 3 things CPI misses
- Quality improvements
- New products
- Substitutions
how can quality improvements hide price decreases.
by making a product or service better while keeping the price the same or slightly increasing it. Even if the price doesn’t go down, consumers get more value for their money because they are getting a higher-quality product or service.
why doesn’t CPI account for the reduction in the cost of living due to the introduction of new products.
iPhone replaced many goods and services on which people previously spent lots of money.
➢ Replaced: landline, answering machines, calculators, cameras and film, GPS devices, music players, etc.
What causes the Consumer Price Index (CPI) to make changes in the cost of living seem higher than they actually are?
it tracks the changing price of a fixed basket of goods.
➢ Consumers’ buying patterns change often!
what is Substitution bias
when the price of a good or service increases, consumers might substitute it with a more affordable alternative.
what is the Personal Consumption Expenditure deflator (PCE deflator)
is a way to figure out how prices for things people use in the United States are changing. The basket of goods includes stuff you use, even if you don’t pay for it directly (like medical care paid for by your employer).
what is core inflation
a measure that looks at how the prices of goods and services are changing, but it excludes certain volatile items that might have big price swings. Essentially, it focuses on the more stable, everyday prices to give a clearer picture of the overall trend in inflation.
what is the Producer price index (PPI)
A price index that tracks the prices of inputs into the
production process.
➢ Helps businesses see how the prices that matter to them are changing.
what is the gdp deflator
A price index that tracks the prices of all goods and services produced
domestically.
➢ Used when adjusting the dollar amounts describing what the economy produces.
➢ Used to convert nominal GDP to real GDP.
what is the formula to convert nominal GDP to real GDP.
Nominal GDP divided by Real GDP×100
what is the the inflation adjustment formula
Another time’s dollars × price level today divided by price level in another time
what is a nominal variable
a variable measured in dollars (whose value may fluctuate over time).
what is a real variable
a variable that has been adjusted to account for inflation.
how to Convert nominal variables into real variables
Real value in 2012 dollars = Nominal value in year t dollars × Price level in 2012 divided by Price level in year t
what is the Nominal interest rate
the interest rate stated on a loan or investment without adjusting for inflation
what is the Real interest rate
the interest rate adjusted for inflation
what is the formula for calculating the real interest rate is
Real Interest Rate=Nominal Interest Rate−Inflation Rate
what is the money illusion
the (mistaken) tendency to focus on
nominal dollar amounts instead of inflation-adjusted
amounts.
what are 3 things money illusion can do
- Distort decisions.
➢ What if all prices throughout the economy (including
incomes) rose by 25%? - Lead to mis-pricing.
➢ Make sure you correctly value your home that you bought a
few years ago. - Create nominal wage rigidity.
➢ Employers often choose to stick with last year’s wage.
➢ Money illusion leads workers to feel okay, even though their
real wage fell.
what is money
Money is any asset regularly used in transactions.
what are the three key functions of money services
- Medium of exchange
- Unit of account
- Store of value
what does money is a medium of exchange mean
Used as a medium of exchange whenever you…
➢ Hand it over to buy stuff.
➢ Accept it from your employer in exchange for your work.
what does money is a unit of account mean
Money is a common unit that people use to measure economic value.
➢ Architects use yards to describe distance.
➢ We use dollars to describe prices and record debts.
what does money is a store of value mean
When you save money, you are using money as a store of value.
➢ Shift your wealth to the future (perhaps for retirement).
➢ Other options include:
➢ Storing gold brinks
➢ Fine art
➢ Canned food
what is hyperinflation
extremely high rates of inflation.
what are menu costs
menu costs represent the expenses associated with changing and communicating prices.
what are shoe-leather costs
highlights the inconveniences, additional efforts, and potential expenses that individuals incur as they try to navigate and adapt to the impact of inflation on the value of their money. The term underscores the behavioral changes people make to minimize the effects of rising prices.
what is the inflation fallacy
the mistaken belief that inflation
destroys purchasing power.
