Chapter 9 - Inflation

Question 1

Basket of goods and services

Answer 1

Things people buy

Question 2

Percentage change equation

Answer 2

(Level in new year - level in previous year) / level in previous year

Question 3

Base year

Answer 3

Starting point from which we measure inflation. Always equal to 100

Question 4

Index numbers

Answer 4

Have values around 100, are easier for estimating, unit free numbers

Question 5

Inflation

Answer 5

Overall and ongoing rise in prices in an economy. Not related to change in relative prices or supply and demand changes

Question 6

Rate of inflation

Answer 6

Percentage change of price levels over time

Question 7

Consumer price index (CPI)

Answer 7

Prices in a fixed basket of goods and services that represents the purchases of the average family of four

Question 8

Cost of living

Answer 8

Cost for a person to feel that their consumption provides an equal level of satisfaction or utility

Question 9

Substitution bias

Answer 9

Inflation rate calculated using a fixed basket of goods over time tends to overstate the true rise in the cost of living, because it does not take into account that the person can substitute away from goods whose prices rise by a lot

Question 10

Two problems with measuring cost of living

Answer 10

Substitution bias and quality/new goods bias

Question 11

Quality/new goods bias

Answer 11

Inflation rate calculated using a fixed basket of goods over time tends to overstate the true rise in cost of living, because it does not take into account improvements in the quality of existing goods or the invention of new goods

Question 12

8 components of CPI

Answer 12

Food, housing, apparel, transportation, medical care, recreation, education, and others.

Question 13

Core inflation index

Answer 13

Calculated by taking the CPI and excluding volatile economic variables. Useful for the government, shows underlying trends

Question 14

Difference between CPI and core inflation index

Answer 14

CPI helps households understand cost of living. Core inflation index helps government make important policy changes

Question 15

Producer price index (PPI)

Answer 15

Prices paid for supplies and materials by producers of goods and services

Question 16

International price index

Answer 16

Prices of merchandise that is exported or imported

Question 17

Employment cost index

Answer 17

Wage inflation in the labor market

Question 18

GDP deflator

Answer 18

Includes all the components of GDP

Question 19

Deflation

Answer 19

Negative inflation

Question 20

Hyperinflation

Answer 20

Extremely high rates of inflation

Question 21

Typical rate of inflation

Answer 21

2-4%

Question 22

Three problems with inflation

Answer 22

Unintended redistributions of purchasing power, blurred price signals, and difficulties in long-term planning

Question 23

Unintended redistributions of purchasing power

Answer 23

Decreases value of cash, investments with nominal returns suffer, wages sometimes don’t keep up, pensions don’t account for inflation

Question 24

Blurred price signals

Answer 24

Prices are messengers about demand and supply, inflation blurs those signals, can create more of a chance for surpluses or shortages

Question 25

Problems in long term planning

Answer 25

Have to consider what money can buy in the future when the rate of inflation cannot be known with certainty, businesses can suffer or gain from inflation, hard for businesses to plan further in advance

Question 26

Indexing

Answer 26

Price, wage, or interest rate is adjusted automatically with inflation

Question 27

Cost of living adjustments (COLAs)

Answer 27

Guaranteed wages would keep up with inflation in unions

Question 28

Adjustable rate mortgage (ARM)

Answer 28

Interest rate on loan varies with the rate of inflation

Question 29

Indexing in government

Answer 29

Moving into higher tax bracket, Social Security payments