Week 5 Flashcards
what is price level, inflation and inflation rate
§Price level: A measure of the average prices of goods and services in the economy.
§Inflation: The sustained increase in the general level of prices in the economy.
§Inflation rate: The percentage increase in the general price level in the economy from one year to the next.
Consumer price index (CPI):
§The CPI is the most widely used measure of inflation.
§: A measure of changes in retail prices of a basket of goods and services representative of consumption expenditure by typical Australian households in capital cities.
what the ABS’s role in terms of CPI
§The Australian Bureau of Statistics (ABS) surveys households on their spending habits.
–The goods and services typically purchased by households is the ‘market basket’.
–The prices of goods and services in the market basket are given a weight according to their fraction of a ‘typical’ family budget.
The CPI measures
measures the rate of change in the prices of the goods and services in the market basket

Find the 2016 inflation rate

Four sources of bias in the CPI may lead to it overstating the inflation rate
–Substitution bias
–Increase in quality bias
–New product bias
–Outlet bias
measuring inflation
The producer price index (PPI):
§: An average of the prices received by producers of goods and services at all stages of the production process.
§Like the CPI, the PPI tracks the prices of a market basket of goods.
calculate the inflation rate

CPI = expenditures in current yr/ expenditures in base yr x 100
CPI in 2011 = 314/314 x 100 = 100
CPI in 2015= 360/314 x 100 = 114.65
Inflation rate = CPI in current yr- CPI in base yr/ 100 x 100 = 114.65-100/100 x 100=
what happens to purchasing power when prices rise
The purchasing power of the dollar falls
Price indexes, such as the CPI, enable
§adjustments to be made for the effects of inflation, so dollar values can be compared over time.
The 2013 purchasing power equivalent of a $20 000 salary in 1980 can be found

Nominal interest rate and real interest rate
§The stated interest rate on a loan.
§Real interest rate: The nominal interest rate minus the inflation rate.
If the inflation rate is higher than expected
borrowers may gain and lenders receive a lower real interest rate (on a fixed interest rate loan).
The real interest rate provides a better measure of
§the true cost of borrowing and the true return to lending than does the nominal interest rate.
It is possible for the nominal interest rate to be less than the real interest rate when
there’s deflation - rare in australia
When the inflation rate is high, the gap between nominal and real interest rates
often becomes large
Does inflation impose costs on the economy?
Nominal incomes generally rise with inflation
§For the ‘average’ person, nominal wages increase with inflation.
Inflation and the distribution of income
what happens to people on fixed incomes
§People on fixed incomes are likely to experience reduced purchasing power due to inflation.
INflation and distribution of income
what does the extent of distribution depend on
§degree to which inflation is anticipated or unanticipated.
does inflation pose costs on the economy
Problems with anticipated inflation
§Income redistribution, as some people’s income will fall behind anticipated inflation.
§For those holding wealth in paper money.
does inflation pose costs on the economy
Problems with anticipated inflation
menu costs?
Menu costs: The costs to firms of changing prices
does inflation pose costs on the economy
Problems with anticipated inflation
taxes?
Increases taxes paid by those who own income generating assets, such as bonds, shares and deposits, and also increases personal income taxes paid due to ‘bracket creep
Problems with unanticipated inflation
There are winners and losers, depending on whether inflation is higher or lower than anticipated
Problems with unanticipated inflation
those with fixed incomes?
–For example: Those on fixed incomes will lose if inflation is higher than anticipated.