Lecture 18Outline of Last Lecture I. Implicit ReasonsII. Labor Market Minimum WageIII. Long-Term UnemploymentA. Frictional UnemploymentB. Structural UnemploymentIV. Wages and Productivity V. Policies Affecting Unemployment Outline of Current Lecture I. InflationA. Definition of InflationB. Examples of InflationII. Consumer Price IndexIII. How to Calculate InflationIV. Example ProblemCurrent LectureThis lecture starts a new chapter that focuses on inflation. Inflation is the general and ongoing rise in the level of prices in the economy. Inflation is not the change in a single price. The inflation rate is given as a percentage. The normal inflation rate is around 2%. Hyperinflation occurs when the inflation rate is above 50%.Below is a table that shows a comparison of USA prices from 1970 versus 2012 for various items. This table shows how prices have increased over time.Item 1970 20121 lb. Ground Beef $0.66 $3.24Movie Ticket $1.55 $7.96House $23,000 $185,000New Car $3,000 $30,000The Consumer Price Index (CPI) is based upon the bundle of common goods and services that a “typical” household consumes. The question is what items should be put into this basket and how important is each item. The actual CPI has over 80,000 items in its basket. Larger items such as housing, gas/energy prices, and cars are included. These items are of high importance, due to the fact that they are generally not substitutable. Smaller items such as food or shoes have substitues that are easy to find, making them lower on the importance level. AGEC 217 1nd EditionThere are 4 general steps to calculate inflation.1. Define the Basket: What items are in it?2. Calculate the total spending in each period3. Choose the base year for the price index: rescale the values so the price index= 100 in the base year4. Calculate the inflation as a percent change in the price indexWhen calculating the price index, it is the quantities that are fixed. An example calculation is shown in the table below. Period 3 is the base year. P=price and Q=quantityItem Period 1 Period 2 Period 3 Period 4Burger P=$3Q= 20P=$3.20Q= 20P=$3.10Q= 20P=$3.50Q= 20Aspirin P=$10Q= 1P=$10Q= 1P=$10Q= 1P=$10Q= 1Movies P=$6Q= 5P=$6.50Q= 5P=$7.00Q= 5P=$7.50Q= 5Total Spending Sum of P x Q$100$106.50 $107 $117.50Price Index 100/1.07=93.4106.5/1.07=99.5Need to make 100107/X = 100X=1.07117.50/1.07=109.8To find the inflation rate as a percent: Price index 2- price index 1/price index 1 X
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