week 15 Flashcards
what is consumer price index
measure of the cost of living during a particular period
measures cost of a standard basket of goods and services in a given year
relative to the cost of the same basket of goods and services in the same year
base year changes periodically
what is a price index
measures the average price of a given quantity of goods and services relative to the price of the same goods and services in a base year
what is inflation
measures how fast the average price level is changing overtime
what is rate of inflation
the annual percentage rate of change in the price level
what is deflation
a situation in which most goods or services are falling over time, so that inflation is negtaive
what is a nominal quantity
measured in terms of its current dollar value
what is a real quantity
measured in physical terms
how do you convert a nominal quantity to its real quantity
deflate it
divide a nominal quantity by its price index to express the quantity in real terms
what are real wages
the wage paid to the worker measured in terms of purchasing power
what is indexing
increases nominal quantity each period by the percentage increase in a specified price index
automatically adjusts certain values such as social security payments by the amount of inflation
what is minimum wage
national minimum wage set by gov
increasing minimum wage can contribute to inflation
companies pass on increased labour costs to consumers in the form of higher prices
what is a tight labour markets
a stituation where there is a low level of unemployment and a high level of job vacancies, few workers to fill jobs
causes employers to compete for workers, pushes up wages
increases cost of goods for customers
also causes increased consumer spending as people have more money to spend
sign of a strong economu
what is a tight labour markets
a situation where there is a low level of unemployment and a high level of job vacancies, few workers to fill jobs
causes employers to compete for workers, pushes up wages
increases cost of goods for customers
also causes increased consumer spending as people have more money to spend
sign of a strong economy
how can inflation be overstated
CPI can influence policy decisions
unnecessary increases in gov spending
CPI may overstate cost of living as it is based on a fixed basket of goods
CPI doesn’t account for changes in quality
what are CPI bias changes
CPI measures price changes not quality changes
adjusting for quality is difficult - large numbers of goods and subjective differences
incorporating new goods is difficult, no base price for this years new goods
what are CPI biases
CPI uses a fixed basket of goods
when price of a good increases, consumers buy less and substitute other goods
failing to account for substitution overstates inflation and CPI
what is a GDP price deflator
measures changes in prices for all goods and services
helps compare real economic activity year on year
helps identify how much prices have inflated over a specific time period
what is the formula for the GDP price deflator
nominal GDP / real GDP x 100
what is the difference between GDP price deflator and CPI index
CPI based on fixed basket of goods, misses changes in prices of goods outside basket
GDP isn’t based on fixed basket of goods
changes in consumption patterns or introduction of new goods and services are automatically reflected in deflator
what is price level
a measure of the overall level of prices at a particular point in time as measured by a price index such as CPI
what is relative price
the price of a specific good or service in comparison to prices of other goods and services
increasing relative price encourages consumers to save money on expensive products and search for their substitutes while companies try to bring more products to the market to gain profit
what are the observations about cost of inflation
changes in price do not imply significant inflation
inflation can be high without effecting prices
to counteract price changes, gov policy would have to affect the market for specific goods
to counteract inflation, gov uses monetary and fiscal policy
how do taxes cause distortions
is they are not indexed the distort incentives for people to work, save and invest
lower savings and investment means lower economic growth
income tax treats nominal interest earned on savings as income
after-tax real interest rate falls, making saving less attractive
how does inflation increase the cost of cash
without inflation, cash holds value overtime
when inflation is high, cash loses value
people withdraw cash more frequently, increases processing costs for banks, real cost of inflation
what is unexpected redistribution of wealth
unexpected inflation redistributes wealth
suppose workers salaries are not indexed and inflation is higher, salaries lose purchasing power, employers gain at expense of workers
unexpectedly high inflation benefits borrowers at the expense of lenders
how does inflation interfere with long term planning
makes planning risky
economists agree that low and stable inflation promotes a healthy economy
what are menu costs
costs of adjusting prices
during inflation, necessary to update price lists and posted prices
prices adjust with delay
what is real interest rate
the annual percentage increase in purchasing power of financial assets
what is nominal interest rate
annual percentage increase in the dollar value of an asset
what is the fisher equation
real interest rate = nominal interest rate - inflation
what is the fisher effect
tendency for nominal interest rates to be high when inflation is high and low when inflation is low
what are inflation-protected bonds
pay a real rate of interest plus the inflation rate
what is demand-pull inflation
gov increases spending, increases demand for goods and services which can lead to higher prices
if supply cannot keep up, prices increase causing inflation
what is monetary inflation
increase in money supply causes a decline in value of money, can cause inflation
what is stagflation
when an economy experiences high inflation and stagnant economic growth at the same time
occurs when there are supply side shocks to the economy eg increase in oil prices
how do you reduce stagflation
monetary and fiscal policy can be less effective
need to ease consumer demand without falling into a recession
what was hyperinflation in germany
fell behind with reparation payments
chose to print more banknotes, caused money to become worthless
prices increased rapidly
