Chapter 7 03 03 2014 09 10 00 consumer Which items to include Price level average level of prices in the economy When price level rises the value of the dollar purchasing power falls Index numbers in general Index a series of numbers each one representing a different period o value of measure in current period value of measure in base period x 100 o an index will always 100 in the base period Consumer price index designed to track the prices paid by the typical o Prices paid by consumers only Final goods like in GDP Used household items like cars and computers not in GDP not in GDP Imported goods like French cheese and Japanese cars Only tracks goods and services not assets stocks bonds homes How much weight for each item o CPI market basket the collection of goods and services that the typical consumer buys How we track the change in average price level in a given month Things that have a smaller effect tobasco sause weight less things that have a larger effect gasoline rent weight more Tracking and reporting the price level o CPI cost of market basket in current period cost of market basket in base period July 1983 x 100 From price index to inflation Price index measure of price level in economy Inflation rate measure of how fast the price level is changing Deflation when the price level falls ex Great Depression How the CPI is used As a policy target price stability low inflation rate To index payments o Indexed payment periodically adjusted so that it rises and falls by the same percentage as a price index o Makes up for any loss of purchasing power caused by inflation To translate from nominal to real values Real values and adjustment for inflation nominal wage the number of dollars you earn real wage purchasing power of your wage o real wage in any year nominal wage in that year CCPI in that year x 100 o real value nominal value price index x 100 Real GDP and the price index GDP price index helps economists track the average price of goods and services included in GDP GDP index includes goods and services consumed by businesses government and exports by other countries where the CPI does not GDP index excludes imports and used goods unlike the CPI which includes them The redistributive cost of inflation Inflation can shift purchasing power away from those who are awaiting future payments specified in dollars and towards those who are obligated to make such payments o Example people pay a fixed mortgage nominal household benefits o Example people sign a contract to receive a fixed minimum wage for a few years business benefits Approximation rule Over any period the percentage change in a real value Real is approximately equal to the percentage change in the associated nominal value Nominal minus the percentage change in the price level P o Real Nominal P if inflation is correctly anticipated and if both parties take it into account then inflation will not redistribute purchasing power nominal interest rate the percentage increase in the lender s dollars each year from making the loan real interest rate the percentage increase in the lender s purchasing power each year from making the loan in lender s purchasing power in lender s dollars Rate of inflation Real interest rate Nominal interest rate Rate of inflation When inflationary expectations are inaccurate purchasing power is shifted between those obliged to make future payments and those waiting to be paid An inflation rate higher than expected harms those awaiting payment and benefits the payers an inflation rate lower than expected harms the payers and benefits those awaiting payment 03 03 2014 09 10 00 03 03 2014 09 10 00
View Full Document
Unlocking...