AP Macroeconomics Inflation

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