What is the main problem with using
GDP as a measure of Economic
Growth?
We are tracking how much we spend to show how
much our production is increasing.
If prices change from year to year, how do we know if
our economy is actually growing?
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INFLATION
Country and TimeZimbabwe, 2008
Annual Inflation Rate79,600,000,000%
Time for Prices to Double24.7 hours
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What is Inflation?
Inflation is rising general level of prices and
it reduces the “purchasing power” of
money
Examples:
•It takes $2 to buy what $1 bought in 1987
•It takes $6 to buy what $1 bought in 1970
•It takes $24 to buy what $1 bought in 1913
When inflation occurs, each dollar of income
will buy fewer goods than before
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How is inflation measured?
The government tracks the prices of specific “market
baskets” that include the same goods and services.
There are two ways to look at inflation over time:
The Inflation Rate- The percent change in prices from
year to year
Price Indices- Index numbers assigned to each year that
show how prices have changed relative to a specific
base year.
Examples:
• The U.S. inflation rate in 2014 was 0.8%.
• The Consumer Price Index for 2014 was 235 (base
year 1982). This means that prices have increased
135% since 1982.
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Consumer Price Index (CPI)
The most commonly used measurement of inflation for
consumers is the Consumer Price Index (CPI)
Here is how it works:
• The base year is given an index of 100
• To compare, each year is given an index # as well
CPI =
Price of market basket
Price of market
basket in base year
x 100
1997 Market Basket: Movie is $6 & Pizza is $14
Total = $20 (Index of Base Year = 100)
2009 Market Basket: Movie is $8 & Pizza is $17
Total = $25 (Index of 125)
•This means inflation increased 25% b/w ’97 & ‘09
•Items that cost $100 in ’97 cost $125 in ‘09
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Consumer Price Index (CPI)
Calculate CPI using the following information
2000 is the Base year
Year
Market Basket
CPI
2000
2002
2004
2006
2008
2010
2015
$50
$75
$85
$100
$120
$115
$135
100
150
170
200
240
230
270
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Who cares about CPI?
CPI can be used to calculate the inflation rate from one
year to the next, which is then used to get real GDP
Inflation
=
Rate
CPI Yr 2—CPI Yr 1
CPI Yr 1
x 100
Calculate how the inflation rates change each year
using the CPI’s on the previous slide.
CPI
Year
100
2000
N/A
150
2002
50%
170
2004
13%
200
2006
18%
240
2008
20%
230
2010
-4%
270
2015
17%
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Inflation and GDP
Nominal GDP- GDP that is expressed in the
current year’s dollar value
Real GDP- GDP that has been adjusted for
inflation to show the impact of changes in
price level
To calculate Real GDP:
Real GDP= (Nominal GDP/Price Index) X 100
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Three Causes of
Inflation
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3 Causes of Inflation
1. The Government Prints TOO MUCH
Money
You get too many dollars chasing too
few goods
2. Demand- Pull Inflation
DEMAND PULLS UP PRICES!!!
3. Cost-Push Inflation
Higher production costs increase prices
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The Wage-Price Spiral
A Perpetual Process:
1.Workers demand raises
2.Owners increase prices to
pay for raises
3. High prices cause workers
to demand higher raises
4. Owners increase prices to
pay for higher raises
Practice
Good
Avg. Price 2003
Avg. Price 2013
3.23
Avg. Price
2008
3.68
1 Gallon MILK
1 Gallon Gas
1.92
1.74
3.33
Cell Phone
2 liter Coke
59
1.25
73
1.59
98
2
Pet Food
Bread (lb)
Ground Beef (lb)
20.50
.97
2.46
31.50
1.41
2.99
58.62
1.38
3.58
Chicken (lb)
1.03
1.30
1.52
Eggs (dz)
Coffee (lb)
Juice (16oz)
1.19
2.76
1.96
1.83
3.66
2.55
2.02
4.94
2.43
3.50
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The Business Cycle
The national economy goes up and down like a roller
coaster over time
Real
GDP
Inflation
Unemployment
Peak
Real GDP
Trough
Full
Employment
Recession
(Contraction)
Recovery
(Expansion)
Time
A recession is 6 month period of decline in Real GDP.
(If really bad…then depression)
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