| Term | Definition |
|---|---|
| 'Inflation | The rising general level or prices: reduces the purchasing power |
| Deflation | The decrease in the general level of prices or a negative inflation rate |
| Disinflation | Prices increasing at slower rates |
| Who is hurt by inflation? | a) lendersb) savers c) people with fixed incomes |
| Who is helped by inflation? | a) borrowers b) a business where price of production rises faster than the price of the resources |
| Nominal Wage | Wages measured by dollars rather than purchasing power |
| Real Wage | Wage adjusted for inflation |
| Inflation Rate | The percent change in prices from year to year |
| Price Indices | Index numbers assigned to each year that show how prices have changes relative to a specific base year |
| CPI | Price of market basket divided by the price of the market basket in the base year x 100% |
| What does CPI measure? | CPI measures the prices of only the goods and services bought by consumers (not the government too) |
| What does the GDP deflator measure? | The GDP deflator measures the price of all goods produced |
| GDP deflator equation | GDP def = nominal GDP divided by real GDP x 100% |
| What are the 3 problems with the CPI? | 1) Substitution bias – CPI may be higher than what consumers are really paying 2) New products – CPI measures prices but not the increase in choices 3) Product quality – CPI doesn't take into effect the increase or decrease in product quality |
| Inflation rate equation | % change in prices = CPI yr 2 – CPI yr 1 divided by CPI yr 1 x 100% |
| Nominal GDP equation | Nominal GDP =(GDP deflator) (real GDP) divided by 100 |
| Real GDP equation | Real GDP = nominal GDP divided by GDP deflator x 100% |
| First cause of inflation | Government prints too much money- to pay debts- assume velocity is constant – assume output is not affected by amount of money |
| Second cause of inflation | Demand-pull inflation – demand increases prices |
| Third cause of inflation | Cost-push inflation – higher production cost increase the prices |
| Quantity theory of money | Velocity of money is the average times a dollar is spent and re-spent in a year |
| Quantity theory of money equation | M x V =P xY |
| Variables | M = money supply V = velocity P = price level Y = quantity of output |
| Wage-price spiral | Perpetual process -owners increase prices – workers demand raises -high prices cause workers to demand higher raises |
| Real interest rate | Percentage increase in purchasing power that a borrower pays (adjusted for inflation) |
| Real interest rate equation | Real interest rate = nominal interest rate – expected inflation |
| Nominal interest rate | Percentage increase in money thats borrower pays (NOT adjusted for inflation) |
| Nominal interest rate equation | Nominal interest rate = real interest rate + expected inflation |
| Achieving three goals | a) If the gov't focuses too much on limiting, unemployment will go up b) If gov't focuses too much on limiting unemployment, overheats the economy and inflation occurs |