Lecture 21Outline of Last Lecture I. Basket of GoodsII. Calculate CPIA. Consumer Expenditure SurveyB. Weight the BasketIII. Transitory ShocksIV. CPI CriticismV. Producer Price Index Outline of Current Lecture I. Why do We Care About Inflation?A. Real versus Nominal Interest RatesII. Say’s LawA. Neoclassical ViewIII. Keynesian TheoryCurrent LectureThis lecture first finishes looking at inflation. Inflation, or hyperinflation specifically, often comes from the government printing money as a way to finance various expenditures. This is sometimes phrased as too many dollars chasing too few goods. In other words, the growth in money is not matching the growth in output. A question often asked is when and why do people care about inflation? People only care wen inflationand prices have disproportionate impacts. This is known as redistribution of purchasing power. If prices double the inflation rate is at 100%. People will only care if their income does not match the increase in prices. For example: holding cash causes a loss in real purchasing power. If a saving account has a 1% nominal interest ratebut the inflation rate is 3%, real value is actually lost.It is important to note the difference between real and nominal interest rates. In the example listed above, the nominal rate was 1%. The real interest rate is equal to the nominal interest rate minus the inflation rate. For the above example: 1% - 3%= -2% real interest rate. This means a loss in real value in the long run.Now we are moving onto chapter 11, which focuses on aggregate supply and aggregate demand. The same way in which economists combine consumers and producers into a single market, they want to combine production and prices. This is known as macro-level aggregation. Say’s Law is one way of looking at the supply end of this aggregation. This is known as the neoclassical view. Say’s Law simply says that supply creates its own demand. That is, as long as we produce things someonewill earn an income and spend it, which creates demand. For example: workers get wages and owners of companies earn profits. The value of production directly translates into equal values of demand in this theory. This theory would mean there would not be recessions or recessions. There would be low unemployment and no sustained reduction in real GDP. AGEC 217 1nd EditionThe other school of thought is called the Keynes theory, based on the Keynesian school of thought. Thisview focuses on demand. It says simply that demand will create supply. If there is no demand, then there is no incentive to
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