Inflation
Inflation is a continual rise in the price
level.
Inflation
– From 1800 until World War II, the U.S.
inflation rate and price level fluctuated.
– Since World War II, the rate fluctuated, but the
movement of the price level has been
consistently upward.
Chapter 6
Inflation Since 1900
Measurement of Inflation
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Inflation is measured with changes in price
indexes.
Price index – a number that summarizes
what happens to a weighted composite of
prices of a selection of goods over time.
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Creating a Price Index
A price index is calculated by dividing the
current price of a basket of goods by the
price of the basket in a base year then
multiplying by 100.
Price of basket in current year
Price index =
X 100
Price of basket in base year
A Simple Year-to-Year Market
Basket Comparison
Basket of Goods
Prices
2003
2004
Expenditures
2003
2004
10 pairs of jeans
$20.00/pr. $25.00/pr.
$200
$200
12 flannel shirts
15.00/ea. 20.00/ea.
180
240
105
100 lbs. Apples
0.80/lb.
1.05/lb.
80
80 lbs. Oranges
1.00/lb.
1.00/lb.
80
80
$540
$675
Total Expenditures
Price index in 2003 =
$675
X 100 = 125
$540
Real-World Price Indexes
The GDP Deflator
Real-world price indexes include the PPI,
the CPI, and the GDP deflator.
The GDP deflator (gross domestic product
deflator) is an index of the price level of
aggregate output or the average price of the
components in GDP relative to a base year.
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The GDP Deflator
Another price index is the chain-type price
index for GDP which uses a GDP deflator
with a constantly moving base year.
The GDP Deflator
The GDP deflator is the measure of
inflation most economists favor since it
includes the widest number of goods.
The Consumer Price Index (CPI)
The Consumer Price Index (CPI)
The consumer price index (CPI) measures
the prices of a fixed "basket" of consumer
goods.
It is weighed according to each component's
share of an average consumer's
expenditures.
Many economists believe that the CPI as
currently constituted, overstates inflation by
one percentage point.
To avoid some of the problems of the CPI,
some policymakers have been focusing on the
personal consumption expenditure (PCE)
deflator.
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The Consumer Price Index (CPI)
Personal consumption expenditure (PCE)
deflator – a measure of prices of goods that
consumers buy that allows yearly changes
in the basket of goods that reflect actual
consumer purchasing habits.
Composition of CPI
Food and beverage (16.4%)
Housing (40.5%)
Apparel (4.2%)
Transportation
(16.6%)
Other (5.0%)
Medical care (6.0%)
Education and
Communication (5.4%)
Recreation (5.9%)
The Producer Price Index (PPI)
Real and Nominal Concepts
The producer price index (PPI) is an index
of prices that measures average change in
selling prices received by domestic
producers of goods and services over time.
It gives an early indication as to where
inflation is headed.
Nominal output is the total amount of
goods and services measured at current
prices.
Real output is the total amount of goods
and services produced, adjusted for price
level changes.
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Real and Nominal Concepts
The “real” amount is the nominal amount
divided by the price index.
It is the nominal amount adjusted for inflation.
real output =
nominal output
X 100
price index
Expected and Unexpected
Inflation
Expectations of inflation play an important
role in the inflation process.
Inflationary expectations can accelerate large
inflation.
Expected and Unexpected
Inflation
Expected and unexpected inflation affects
behavior differently.
Expected inflation is inflation people
expect to occur.
Unexpected inflation is inflation that
surprises people.
Costs of Inflation
Inflation may not make a nation poorer.
It can redistribute income from those who
do not raise their prices to those who do.
It can reduce the amount of information that
prices are supposed to convey.
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Costs of Inflation
Costs of Inflation
Inflation is usually accepted by
governments as long as it stays at a low
level.
What worries policymakers is hyperinflation.
Hyperinflation – exceptionally high levels of
inflation of, say, 100 percent or more a year.
The U.S. has not experienced hyperinflation
since the Civil War (1861-65).
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