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 |
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