Download Price Indexes and the Inflation Rate

Unit 6 Macroeconomics:
GDP and Economic Challenges
Chapters 13.2
Economics
Mr. Biggs
Inflation
The Effects of Rising Prices
Inflation - A general increase in prices.
In the American economy, prices have
mostly risen since World War II.
Purchasing power - The ability to
purchase goods and services.
Inflation can shrink the purchasing
power of money.
For example, in 1954 a Mercedes
Benz 300SL cost $11,000.
In 2011 a Mercedes Benz SLS AMG
cost $183,000.
Price Indexes
Economists do not compare individual
prices, they compare price levels.
Price Index - A measurement that
shows how the average price of a
standard group of goods changes
over time.
For example, a home price index.
Using Price Indexes
Price indexes help consumers and
businesses make economic decisions.
For example, increased savings in
time of inflation.
Governments also use indexes to
make policy decisions.
For example, increasing minimum
wage if purchasing power has been
decreased.
The Consumer Price Index
There are several price indexes, the bestknown index focuses on consumers.
The Consumer Price Index (CPI) - A
measurement that shows how the
average price of a standard group
of goods changes over time.
They measure the price of a standard
group of goods that represent the
“market basket” of an urban consumer.
Market basket - A representative
collection of goods and services.
Price Indexes and the Inflation Rate
Economists also calculate the inflation
rate but the CPI is the index you
will most often hear about.
Inflation rate - The percentage rate of
change in price level over time.
Determining the CPI
To determine CPI, the BLS establishes a
base period to which it can compare
current prices.
Currently, the base period is 1982 – 1984.
The cost of the market basket for that
period is assigned the index number 100.
The BLS determines the CPI for a given
year using the following formula:
Calculating the Inflation Rate
The BLS determines the inflation rate
using the following formula:
Types of Inflation
Inflation rates between 1% - 3%
do not typically cause problems
for an economy.
When the rate exceeds 5%, the
inflation rate itself becomes
unstable and unpredictable.
In order to study long-term trends
in inflation rate, economists
calculate the core inflation rate.
Core inflation rate - The rate of inflation
excluding the effects of food and energy
prices.
Hyperinflation - Inflation that is out of
control.
For example, inflation of 100% causes
your money to lose much of its value
and can lead to an economic collapse.
Causes of Inflation
Economists incorporate the quantity
theory, demand-pull theory, and costpush theory when they try to understand
the inflation process.
The Quantity Theory
Quantity theory - Theory that too much
money in the economy causes inflation.
Demand-Pull Theory
Demand-pull theory - Theory that
inflation occurs when demand for goods
and services exceeds existing supplies.
The Cost-Push Theory
Cost-push theory - Theory that
inflation occurs when producers raise
prices in order to meet increased
costs.
Wage increases are usually the
reason for the increased costs.
Wage-price spiral - The process by
which rising wages cause higher
prices, and higher prices cause higher
wages.
Effects of Inflation
The effects of inflation can be seen
mainly in purchasing power, income,
and interest rates.
Purchasing Power
Inflation can erode purchasing power.
In an inflationary economy, a dollar will
not buy the same number of goods that
it did in years past.
Income
Inflation will erode income if wage
increases do not keep up with inflation.
People on a fixed income will see the
real value of their paycheck steadily
decrease.
Fixed income - Income that does not
increase even when prices go up.
Interest Rates
Savers may lose money if the inflation
rate is higher than their interest rate.
Recent Trends
In the late 1990s and early 2000s, unemployment levels were
low and inflation began to increase (wage-price spiral).
In 2009, prices seemed to be falling and some experts
predicted a period of deflation.
Deflation - A sustained
drop in price level.
In the late 2000s, the
unemployment rate
rose to 10% with less
than 2% inflation.
The
End