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Who Is Making More?

Who Is Making More?. A 2001 graduate of Hiram College got a job that pays $30,000 per year. Thirty years ago, her father started his career with a $7,500 job. Is she making four times as much as her father did?. Who Is Making More?.

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Who Is Making More?

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  1. Who Is Making More? • A 2001 graduate of Hiram College got a job that pays $30,000 per year. • Thirty years ago, her father started his career with a $7,500 job. • Is she making four times as much as her father did?

  2. Who Is Making More? • In order to compare the incomes of two different periods we have to eliminate the effect of inflation. • What happened to prices between 1969 and 2001? • Let’s find out the Consumer Price Index (CPI).

  3. Who Is Making More? • According to Bureau of Labor Statistics (ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt), CPI in 1969 was 36.7. • CPI in 2001 was 177.5. Base year was 1982-84. • If the average price level in 1969 was lower than in 2001, our graduate must not have been three times better off.

  4. Who Is Making More? • In real terms: • She made (30,000/1.775) = $16,901.41 in 1983 dollars. • He made (7,500/.367) = $20,436 in 1983 dollars. • How much was his pay in 2001 dollars? • His pay is (7,500)(1.775/.367) = $36273.84.

  5. How To Calculate The CPI? • Fix the basket a typical consumer will buy. • Find the prices of the items for different years. • Compute the basket’s cost for each year. • Choose a base year. • Calculate the cost of the basket for other years in terms of the base year. • Calculate inflation rates.

  6. CPI Calculation

  7. Problems With CPI • Substitution bias. • Basket changes as a response to relative price changes do not get accounted. • New products. • Basket changes are ignored. • Prices of new products fall before they are included in the new basket. • Quality change. • If the same gadget has higher quality now than in the past but viewed as the same item, an increase in price is not inflationary.

  8. Median Household Income • According to the US Census Bureau, nominal income for a family of four was $24,332 in 1980. In 1997, it was $53,350. • CPI in 1980 was 82.4; in 1997, 160.5. • What happened to median real income? • How would you change your answer if Boskin Commission is right?

  9. Real Median Household Income

  10. http://www.census.gov/acs/www/Products/Profiles/Chg/2003/ACS/Tabular/010/01000US3.htmhttp://www.census.gov/acs/www/Products/Profiles/Chg/2003/ACS/Tabular/010/01000US3.htm

  11. GDP Deflator vs. CPI • Space shuttle costs more to operate. • Deflator is up, CPI unchanged. • Antiques cost more. • CPI is up, deflator unchanged. • Porsche increases the price. • CPI is up, deflator unchanged. • New homes cost more. • Both CPI and deflator up.

  12. Indexation • If payments are automatically corrected for inflation, they are said to be indexed. • COLA • Social Security • TIPS • Variable mortgage rates

  13. Costs of Inflation • Shoe-leather costs • Economizing on cash • More frequent trips to the bank • More bank employees • Efforts to avoid the erosion of purchasing power

  14. Costs of Inflation • Noise in the price system • Is it an increase in the demand for a product or is it a general increase in prices? • Should the supplier increase output or not?

  15. Costs of Inflation • Distortions of the tax system • Depreciation allowance and the replacement cost • Bracket creep

  16. Costs of Inflation • Unexpected distribution of wealth • Real wage down => workers lose, employers gain • Borrowers gain and creditors lose

  17. Costs of Inflation • Interference with long-run planning • Increase uncertainty • Impossible to predict the future

  18. Hyperinflation • Inflation of 500 or more per cent per year. • Germany in early twenties. • Argentina and currency board.

  19. Real and Nominal Interest Rates • If you lend someone $1000 for a year and ask for a 5% interest, you will get $1050 at the end of the year. • If inflation during the year were 10%, the products you could buy with your $1000 at the beginning of the year now costs $1100. • Are you better-off or worse-off?

  20. Real and Nominal Interest Rates • Lenders will always ask a higher interest rate than the expected inflation to earn income. • Nominal interest rates are what the bank quotes, what the car dealer quotes. • Real interest rates are nominal rates corrected for inflation. • i = r + π

  21. Real and Nominal Interest Rates

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