Inflation and GDP Deflator

Question 1

Consumer Price Index (CPI)

Answer 1

survey of buying habits every 6-8 years, typical bundle bought by urban working family in a month, tracks prices of a bundle based on the base year (year of the survey)
- rises proportionally, starts at 100

Question 2

CPI equation for year x

Answer 2

(cost of bundle year x)/(cost of bundle in base year)X100

Question 3

GDP deflator equation for year x

Answer 3

(year x nominal GDP)/(year x real GDP)X100

Question 4

GDP deflator

Answer 4

tells about how much prices have risen from the base year to year x

Question 5

Inflation rate (definition)

Answer 5

the % increase in the price index over a 1 year period

Question 6

Inflation (formula)

Answer 6

(CPI year 1- CPI year 2)/(CPI year 2)

- can use either price index

Question 7

CPI vs. GDP Deflator

Answer 7

CPI bundle is consumer goods, deflator bundle is everything the economy produces

• exception: imports from other countries are in CPI bundle, deflator bundle is 100% US made
• use CPI to find cost of living

Question 8

How inflation rate overestimates

Answer 8

1) substitution bias will make the cost of living inflate less than calculated
2) both measures omit new goods
3) quality improvement misidentified as inflation (if a new car is better quality than the old model, not inflation)

Question 9

Principle

Answer 9

amount lent initially

Question 10

interest payment

Answer 10

money you get back on the principle

Question 11

interest rate formula

Answer 11

(interest payment)/(principle)X100

Question 12

real interest rate

Answer 12

nominal interest rate- rate of inflation

Question 13

job of the FED

Answer 13

keep inflation steady

Question 14

when is it better to borrow

Answer 14

when real interest rate is low

Question 15

when is it better to lend

Answer 15

when real interest rate is high