Chapter 12 Flashcards
What does the CPI track?
Tracks the average price consumers pay over time for a representative “basket” of goods and services
What are the four steps to measuring inflation?
- Construct a representative basket of goods and services
- Collect prices from the stores where people do their shopping
- Tally up the cost of the basket of goods and services
- Calculate the inflation rate
What is the formula for the inflation rate?
Inflation rate = (price level this year - price level last year) / price level last year
Define real variable.
A variable that has been adjusted to account for inflation
Define nominal variable.
A variable measured in dollars (whose values may fluctuate over time)
What is the formula for present price value (real value)?
= (another time’s dollar) * (current price level / price level in another time)
What is the formula for % change in real value?
=Percent change in nominal value - percent change in prices
What is the formula for real interest rate?
= nominal interest rate - inflation rate
Define money illusion.
The (mistaken) tendency to focus on nominal dollar amounts instead of inflation - adjusted amounts
What are the 3 different measures of inflation for consumers?
- Cost of living adjustments -> CPI
- Target for monetary policy -> personal consumption expenditure deflator
- Forecasting underlying inflation trends -> core inflation (Excluding food and energy)
What are the 2 measures of inflation for businesses?
- Cost of inputs -> Produce Price Index
- Estimating the price of all output and hence real GDP –> GDP deflator
What are the 3 reasons inflation overstates the cost of living?
- unmeasured quality improvements
- new products
- substitution bias
What are the two cost of expected inflation?
- menu cost for sellers
- shoe -leather cost for buyers
What are the two costs of unexpected inflation?
- Confuses the signals that prices send
- redistribution
Define inflation fallacy.
The mistaken belief that inflation destroys purchasing power
