1 / 40

CHAPTER 7 “Inflation”

MACROECONOMICS: EXPLORE & APPLY by Ayers and Collinge. CHAPTER 7 “Inflation”. Learning Objectives. Describe inflation rates in the U.S. and other countries. Discuss the cost of inflation that cause low inflation to be a macroeconomic goal.

talib
Download Presentation

CHAPTER 7 “Inflation”

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. MACROECONOMICS: EXPLORE & APPLYby Ayers and Collinge CHAPTER 7“Inflation”

  2. Learning Objectives • Describe inflation rates in the U.S. and other countries. • Discuss the cost of inflation that cause low inflation to be a macroeconomic goal. • Compute, interpret, and use a price index to compute a real value.

  3. Learning Objectives • Identify problems with price indexes and efforts to improve them. • (E&A) Explain how people respond to inflation, and how that affects its measurement.

  4. 7.1THE GOAL OF LOW INFLATION • Alongwith economic growth and high employment, low inflation is the third fundamental goal of the economy. • Inflation is a persistent increase in the price level. • The price level refers to the prices of goods and services, when considered in the aggregate.

  5. The Goal of Low Inflation • The inflation rate is the annual percentage increase in the price level. • In the U.S., as long as the inflation rate from year to year stays at around 3% per year, Americans are satisfied that the goal of low inflation has been accomplished. • If the inflation rate is above 3%, people expect the government to take action to “fight” inflation.

  6. The U.S. Inflation RateSelected Years

  7. The U.S. Inflation RateSelected Years

  8. The U.S. Inflation RateSelected Years

  9. Inflation – A World-WidePhenomenon • The CIA estimates that the average inflation in the world in 2000 was 25%. • Most of these severely high rates occurred in developing countries. • The developing countries inflation rates ranged between 5% and 60% as compared to the range in developed countries which was between 1% and 3%. • Political instability can result from severe inflation

  10. Inflation Rates in Selected Countries

  11. Inflation Rates in Selected Countries

  12. Deflation and Disinflation • When the inflation rate is negative, deflation is said to occur. • This would happen if the price level declined from one year to the next. • Deflation is not an economic goal. • Historically, widespread falling prices and poor economic performance seem to go hand in hand. • Disinflation means that the rate of inflation declines, and is different than both inflation, and deflation.

  13. 7.2THE HARM FROM INFLATION • Energy and food prices are subject to wide fluctuations caused by temporary shifts in their supply. • Excluding food and energy prices from the computation of the inflation rate reveals what is termed core inflation.

  14. Inflation hurts those on fixed incomes. Inflation hurts lenders. Inflation increases the opportunity cost of search time for cheaper substitute goods. Inflation motivates businesses to offer new products. Inflation might motivate business to trim the amount of product rather than raise its price. The Harm from Inflation

  15. Anticipated and Unanticipated Inflation • Anticipated inflation is expected by the public. • In theory, everyone is able to defend themselves against losses imposed by anticipated inflation. • Unanticipated inflation is inflation that catches the public by surprise. • Borrower’s gain by unanticipated inflation, while lenders lose.

  16. Indexing to Offset Inflation’s Effects • Indexing is a solution to offset the problems created by unanticipated inflation. • Automatically adjusting the terms of an agreement to account for inflation is referred to as indexing.

  17. 7.3MEASURING INFLATION • A price index measures the average level of prices in the economy. • There are several price indexes. • The consumer price index. • The producer price index. • The GDP chain-type price index • The GDP deflator.

  18. Measuring Inflation – The Consumer Price Index • The CPI measures prices of typical purchases made by consumers living in urban areas. • The base period used in the CPI is an arbitrary selected initial time period against which other time periods are compared. • The base period index number always equals 100.

  19. Measuring Inflation – The Consumer Price Index The Inflation rate is calculated by taking the percentage change in the CPI as follows: Inflation Rate = [change in price index / initial price index] multiplied by 100

  20. Measuring Inflation – The Consumer Price Index • The collection of goods and services used in the calculation of the CPI is called the market basket. • The market basket represents a sampling of the items that consumers buy that make up a significant portion of their budget. • There are 200 specific items that make up the CPI. • Each item is assigned a weight that reflects its importance in the consumers’ budgets.

  21. CPI Market Basket Expenditure Categories

  22. Cost of market basket at current prices Cost at market basket at base period prices X 100 Computing a Price Index • The CPI measure the increase in the price of the market basket between the current year and the base period. • The simplified formula for the CPI is:

  23. Nominal Versus Real Values • A nominal interest rate is the payment from a borrower to a lender, expressed in percentage terms. • A real interest rate measure the percentage payment in terms of purchasing power. Real interest rate = nominal interest rate – inflation rate

  24. Price Indexes for Other Purposes • The Producer Price Index (PPI) focuses on the prices received by U.S. producers, as measured by the revenue they receive. • The prices in the PPI are those received by producers no matter who makes the initial purchase, whether it be another firm or consumer.

  25. Price Indexes for Other Purposes • The GDP chain-type price index is computed in a manner similar to the GDP deflator. • The difference is that the real chained GDP is used in the calculation. GDP chain-type = nominal GDP/real chained GDP

  26. Price Indexes for Other Purposes • The term chain weight comes about because the GDP chain-type price index links quantities (weights) in two successive years. • It then moves forward a year and does that link again, and so forth. • This continuous linking , for two years at a time forms a chain, hence the name.

  27. Price Indexes for Other Purposes • The GDP deflator is a type of price index called an implicit price deflator. • An implicit price deflator takes current quantities and calculates what they would have cost at prices prevailing during the base period. GDP deflator = Value of current quantities at current period prices Value of current quantities at base period prices

  28. Recent Changes to the CPI • Prior to 1999, the CPI was calculated using fixed-weights throughout the market basket. • Fixed-weights do not take into account that people change their consumption patterns when prices rise. • When the price level rises people substitute relatively cheaper goods for goods that have become relatively more expensive.

  29. Recent Changes to the CPI • The inaccuracy in the CPI cause by using fixed weights is termed the substitution bias. • The substitution bias causes inflation to be overstated. • A new CPI was established in 2002 called the Chained weight CPI (C-CPI).

  30. 7.4 EXPLORE & APPLYLiving the Life of Inflation • The CPI is used in three ways. • As an economic indicator. • To convert nominal values to real values. • To adjust selected monetary payments upward as prices increase. • Hyperinflation is inflation that is out of control.

  31. Living the Life of Inflation • The rule of 72 is used to compute the approximate time it takes for a rate to double. • To compute how long it would take for an inflation rate to double the equation would be… 72/the inflation rate

  32. Living the Life of Inflation

  33. inflation inflation rate indexing Consumer Price Index Producer Price Index GDP chain-type index GDP deflator nominal value real value Key Terms

  34. Test Yourself • Which of the following best fits the definition of inflation? • A one-time increase in a few prices. • A one-time increase in many prices. • A sustained increase in a few prices. • A sustained increase in many prices.

  35. Test Yourself 2. The core inflation rate excludes • energy prices. • the price of medical care. • food prices. • both food and energy prices.

  36. Test Yourself 3. The goods and services included in the computation of the CPI are referred to as the _____________________ . • base year. • fixed weights. • market basket. • price level.

  37. Test Yourself 4.How is inflation computed? • The inflation rate equals the value of a price index. • The inflation rate equals the value of a price index. • By the following computation: (change in price index/initial value of price index multiplied by 100). • By the following computation: change in price index multiplied by the initial value of price index.

  38. Test Yourself 5. When the real value of GDP is computed by the government • the CPI is used. • the PPI is used. • The GDP deflator or the chained-type price index is used. • no price index is necessary because the real and nominal values of GDP are always identical.

  39. Test Yourself 6. The substitution bias causes the CPI to? • overstate the effects of inflation. • understate the effects of inflation. • more accurately reflect the effects of inflation. • be nearly useless as a measure of inflation.

  40. The End! Next Chapter 8 “A Framework for Macroeconomic Analysis"

More Related