Chapter 5: Inflation Flashcards
Price level
Average level of prices
Inflation rate
Percentage change in price level
Effects of changes in price level
- Price level rise causes Inflation
- Price level fall causes deflation
Problems with inflation
Unexpected inflation is a problem as it redistributes income and wealth
- Unexpected inflation benefits workers and borrowers
- Unexpected deflation benefits employers and lenders
Consumer Price Index
Measures the average amount paud by the average person fro a ficed basket of goods and services
CPI is defined to be 100 for a period called reference base period
Relation between CPI and inflation
Inflation rate is:
- High when price level is rising rapidly
- Low when price level is rising slowly
- Negative when price level is falling
CPI biases
- New good Bias
- Quality change bias
- Commodity substitution bias
- Outlet substitute bias
New good bias
New goods are often more expensive than the goods they replace
Quality change bias
Price increases could reflect quality improvements
Commodity substitution bias
Substitutes could be a reason for price increase
Outlet substitution bias
If prices rise, people use outlets more frequently
Inflation measurements has an effect on:
- Wages
- Pensions
- Unemployment benefits
- Social security
Aleternatives to CPI
- Chained CPI
- Personal consumption expenditure deflator
- GDP delfator
Chained CPI
Incorporates both new goods and the substitution of one good for another
The cure for inflation
If an increase in nominal GDP causes inflation, recession should do the opposite
