Inflation Flashcards
What is inflation, and what is similar to, but not considered, inflation?
Inflation is the general rise of prices or the CPI throughout an entire economy
Inflation is similar to, but not the same as, increases of relative prices.
What is the increase in relative prices and how does it differ from inflation?
The increase of relative prices would be the increase of a price change in a specific good compared to others.
Inflation is the price change for the entire economy
How do you calculate inflation?
Inflation (% change) = (P yr2 - P yr1) / (P yr 1)
What is the CPI and how is it different from the cost of living?
Consumer Price Index is the price of a fixed basket of goods and services that represents the average purchases of a family of four
It differs from the cost of living b/c it is just a numerical representation of current pricing, where as the cost of living represents the cost of a persons consumption to equal overall utility
How does the substitution bias effect the CPI?
The substitution bias says that CPI tends to overstate the overall rise in prices b/c it does not take into account consumers substituting goods as relative prices increase
Aside for the substitution bias, what is the quality/new goods bias, and provide an example?
The rise in prices over time tends to overstate the rise in cost of living b/c it does not account for improvements/higher quality goods.
Pretend cereal companies set a new standard of adding in 12 vitamins and minerals. After a year the CPI says cereal prices have gone up 5% but it would be misleading to say cereal prices have inflated due to increased quality.
What is deflation?
A time when the purchasing power of money increases
When do we typically see inflation in the business cycle, why does it occur, and what relationship does unemployment have with inflation?
We typically see inflation during times of economic expansion.
It occurs because unemployment is low, the overall demand for goods is high, and wages are increasing with the expansion of the economy
When do we typically see deflation in a business cycle, and what relationship does unemployment have with inflation?
Deflation occurs during an economic contraction/recession
It occurs because unemployment has increased, which leads to an overall decrease in demand for goods and lower prices.
What is the average expected inflation rate during an economic expansion?
2 - 4 %
