Topic 5_ Measuring the Price Level Flashcards
Price level
measure of the average prices of g/s in the economy
since this includes 1000s of prices, it is composed as an index
Inflation
a general increase in the prices of g/s over time
Inflation Rate
the percentage invrease in the price level from one year to the next
Inflation Rate formula
current year price level- previous year price level
DIVIDED BY previous year price level
MULTIPLED BY 100
Pc - Pl / Pl x 100
3 sources of inflation
Demand Pull
more demand in g/s ( supply nd demand)
Cost Push
increases in costs of production (prices raised)
-WORKERS demand higher wages, so this also increases prices (Wage-Price spiral)
Central Banks Printing too much money
a monetary expansion leads to increasing output, decreasing interest rate, increasing price level; long term it only increases in price level
Wage price spiral
this happens in response to cost push inflation, and can also cause more inflation
as prices in the eocnomy rise, workers demand higher wages, they are actually an input to production and when they are paid mor eprices rise even more
THIS IS CALLED THE WAGE PRICE SPIRAL
3 measures of price level
The GDP deflator
The PPI
The CPI
The GDP deflator
broadest measure of the price level, includes the price of all final g/s produced in the country
FORMULA: NOMINAL GDP/REAL GDP x 100
PPI
the producer price index
includes all the prices of g/s recieved by producers in all stages of production (INTERMEDIATE GOODS and raw materials)
CPI
measure of the changes in the cost of living
includes the price of g/s purchased by consumers
GDP deflator in the base year
the formula is nominal gdp/real gdp x 100 and in the base year the nominal gdp= real gdp so in base year it is just 100
why is gdp deflator not the best measure of price level that reflects cost of living
because, a lot of goods households consumer are imported
and because gdp deflator includes goods that households dont buy ( capital goods bought by factories)
How to calcualte nominal gdp
p x q in a given year * 100
how to clauclate real gdp
BASE YEAR PRICE
quantity x base year price* 100
why is it important if ppi rises
the prices of goods to firms rising means that cost push inflation may be upcoming and that this will future impact whaat prices g/s sold ot consumers
What can ppi warn us about
movements in cpi!
WHAT Is the average of the prices of g/s purchased by a typical hosuehold
it is essentially a typical ‘basket’ of goods and services bought by any household
how is cpi calculated
1) stat canada surveys consumers to determine what is in the typical shopping basket
2) stat canada collects data on prices of all g/s
3) They use the prices to compute the TOTAL COST of the basket (choose a base year QUANTITY)
4)Compute the cpi index via formula
Cost of basket in current year/ Cost of basket in base year x 100
5) Inflation rate is calculated
L-F/F x 100 of
CPI today-CPI last yeyar/CPI last year * 100
CPI formula
cost of basekt in current year/ Cost of basket in base year x 100
what are the units of cpi
no units, because they are index numbers
what is cpi intended to measure
measure changes in price level over time
cpi formula
CPI current year/ CPI base year x 100
inflation rate formula for cpi
cpi this year - cpi last year/ cpi last year *100
why does cpi overestimate the changes in price
1 substitution bias
2 new product bias
3increase in quality bias
4 outlet bias
cpi substitiuton bias
over time, some prices will rise faster than others
sub rule: consumers tend to buy goods that are comparatively cheaper
CPI DOES NOT ACCOUNT FOR SUBS bc it uses a fixed basket of goods an services
so CPI overestimates cost of living bc the fixed quantity has gone down
what do we fix when we calc cost of basket in cpi
the AMOUNT (quanity) of good bought
this affects us late rin sub rule
CPI new product bias
cpi relies on a fixed basket year over year
if a new cheaper products replace an old expensive products, the CPI will MISS decrease in cost and conseuqently OVER ESTIMATE the cpi
CPI quality bias
over ime,most products in cpi improve in quality!!!
therefore, the increase in prices of these products partly refelct their imporved quality AND also are partially pur inflation
cpi once again overinflates cost of living
CPI outlet bias
when prices rise, consumers will change where they buy stuff, switchin to warehouse sotres w LOWER PRICES
COSTCO
CPI does not account for these changes bc i uses fixed basket of g/s
CPI overestiamtes cost of living
Because of 4 issues in cpi (outlet, sub, quality, new product) how much does cpi overestimate true inflate rate by
0.5-1%
THIS IS VERY IMPORTANT bc welfare payments and contract have costo f living adjusted based on CPI
How to use price indexes to adjust for inflation
value in a pasts dollars x CPI current year/CPI last year
Nominal variable
measured in dollars, whos value fluctuates over time
Real variable
a variable that has been adjusted to account for inflation; measuredin dollars for the base year for the price index
REAL VBL = nominal vbl/Price index x 100
REAL vs nominal interest rates
REAL int rate ~= Nominal Interest rate-Inflation Rate
Interst rate
cost of borrownig money expressed a percenteng of the amount borrowed
nominal interest rate
stated interest rate without correction for inflation
MEASURES THE RETURN IN DOLLARS
Real interset rate
interest rate iin terms of changes in the purchasing power
FOCUSES ON WHAT YOU CAN BUY WIHT THOSE DOLLARS
WHich is better real int rate or nominal int rate
real OFC bc real accounts for purcahsing poewer of dollars not just the amount of dolalrs
what is real interest rate a true measure of
THE TREUC OST OF BORROWING nad the TRUE return of lending
on a chart of nominal interest rate and real interest rate, what is the distance bw the two ?
RATE OF INFLATION
