Inflation Flashcards
What is inflation?
It is the sustained increase in the general price level of goods and services in an economy over a period of time.
How is inflation typically measured?
It is typically measured as the percentage change in a price index, such as the Consumer Price Index (CPI) or the GDP Deflator, over a specified period.
What does the consumer price index measure?
Price changes for a fixed “basket” of consumer goods and services (such as food, housing, transportation, and healthcare.), the index reflects only pure price changes
How do you calculate the Consumer Price Index (CPI)?
CPI = (cost of market basket today / Cost of market basket base year) x 100
How do you calculate inflation rate using CPI?
Step 1: Calculate the CPI — CPI = (value of market basket / value of market basket base year) x 100
Step 2: Calculate the percentage change of the CPI indices over time — (CPI current year - CPI previous year) / CPI previous year x 100
Inflation rate is in %
When computing a price index, the base year is
A) the earliest year for which data are available.
B) the most recent year in which the inflation rate was close to zero.
C) the most recent year for which data are available.
D) the year that is chosen as the point of reference for comparison of prices
with other years.
D) the year that is chosen as the point of reference for comparison of prices with other years.
What does GDP deflator measure?
GDP Deflator measures price changes for all goods and services produced domestically (not just a fixed “basket” of consumer goods and services as in CPI)
How do you calculate the GDP deflator?
GDP deflator = (nominal GDP / Real GDP) x 100
What are the steps In Calculating the Inflation Rate using GDP Deflator?
Step 1: Calculate the GDP deflator — GDP deflator = (nominal GDP / real GDP) x 100
Step 2: Calculate the percentage change of the GDP Deflator — Yearly inflation rate = (GDP deflator current year - GDP deflator previous year) / GDP deflator previous year x 100
What is the difference in the definition of GDP deflator and the consumer price index (CPI)?
- GDP deflator measures price changes for all goods and services produced domestically.
- CPI measures price changes for a fixed basket of consumer goods and services.
What is the difference in the coverage of GDP deflator and the consumer price index (CPI)?
GDP deflator: All goods and services in GDP (consumer goods, investment goods, government spending, and exports) – not imported goods and services
CPI: Includes only consumer goods and services (locally made and imported ones) - not investment goods, government spending, or exports.
What is the difference in the basket of goods of GDP deflator and the consumer price index (CPI)?
GDP deflator: No fixed basket - adjusts automatically as the composition of GDP changes.
CPI: Uses a fixed basket of goods and services that is updated periodically.
What is the difference in the use of GDP deflator and the consumer price index (CPI)?
GDP deflator: Measures overall inflation in the economy.
CPI: Tracks cost-of-living changes and adjust wages, pensions, and social benefits.
What is Reducing Purchasing Power?
The value of a person’s money income in terms of the goods and services it can buy is the purchasing power, which varies inversely with the price level.
What is the real income formula?
Real Income = Nominal Income / Price Index
Nominal income refers to income measured in current dollars, without adjusting for inflation
How do you calculate the Changes in Real Income in percentage:
% Δ Real income = % Δ Nominal income - inflation
Changes in real income (in %) reflect changes in nominal income (in %) adjusted for inflation (in %), meaning real income increases only if nominal income grows faster than the inflation rate.
What serious economic problems can high or unpredictable inflation can create?
1 - Uncertainty and Reduced Investment: Uncertainty prevents clear forecasting about future costs, making long-term planning difficult. Uncertainty discourages investment and economic growth.
2 - Redistribution of Wealth: Unexpected inflation benefits borrowers (who repay loans with devalued money) and hurts lenders (who receive money worth less than expected).
Who are the losers during high inflation?
➢ Fixed-Income Earners: People living on fixed incomes that do not adjust for inflation will find their purchasing power reduced (e.g., retirees, pensioners, workers with fixed wages.)
➢ Savers: Those who hold significant amounts cash or low-interest savings accounts and bonds.
➢ Lenders: Inflation erodes the value of their money (e.g., Banks and Bondholders with Fixed-Rate Loans.
Who are the winners during high inflation?
➢Borrowers (Debtors). When inflation rises, the real value of debt decreases, meaning that the amount borrowed becomes cheaper to repay (e.g., homeowners with mortgages, businesses with fixed-rate loans, and governments with large amounts of debt.)
➢ Owners of real assets such as properties (e.g., homes, apartments, office buildings, or land), natural resources (e.g., oil, natural gas), precious metals and Minerals (e.g., gold and silver). Physical assets appreciate in value as inflation increases, making them a hedge against inflation.
➢ Businesses Selling Goods with Rising Prices that can easily increase the prices of essential goods (e.g., a supermarket chain can raise prices on food items every month, but it still pays rent based on last year’s lower prices.
Why does inflation happen?
➢ Supply-push Inflation happens when businesses to increase prices, even if demand remains the same.
▪ Cost push (higher cost of production, such as oil shock; higher wages),
▪ Profit push (for those on monopolies),
▪ Import push (no control on price of imported goods).
➢ Demand pull inflation occurs when total demand for goods and services) rises faster than the economy’s ability to produce them.
▪ Higher spending (higher wages, tax cuts, lower interest rates, large-scale government expenditures, export rising).
➢ Government Policies
▪ Printing too much money to stimulate the economy and jobs
