Download Inflation and Unemployment Day 1

Inflation and
Unemployment
By: Lauren, Raunak, Paul, Hussein, and
Thomas
Inflation
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Inflation - A general increase in the price of
goods and services in an entire economy
over time.
Ex. Canada has an annual inflation rate of
3% this year, some prices falling, rising, and
remaining constant

Deflation – A general decrease in the
level of prices.
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Contd…
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To explain why Canadian government stress
the goal of price stability, let’s examine
Inflation in detail, how it is measured, and its
implications for the economy.
The Consumer Price Index.
Limitations of CPI (Consumer Price Index.)
The GDP Deflator.
Inflation’s Effects.
Consumer Price Index

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It is a measure of price changes for a typical basket
of consumer products. (see chart)
Item weights – The proportions of each good in the
total cost of the basket of consumer good in total
cost of the basket of consumer goods used to
calculate CPI.
Base year – The survey year used as a point of
comparison in subsequent years.
A typical price index includes many more items.
Modal distribution of other basic needs in Fig 11.2
Figure 11.1 Simple Consumer
Price Index.
Nominal vs. Real Income.

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Nominal Income – Income expressed in
current dollar.
Real Income – Income expressed in constant
base – year dollars. Measures the purchasing
power of the household over time.
Real Income = nominal income
CPI
Contd…
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Cost of Living – The amount consumers must
spend on the entire range of goods and
services they buy.
E.g.  a consumer’s monthly income
increases from $1000 to $1050 in a year
when CPI rises from 1.0 to 1.10. If the
consumer’s own monthly purchases roughly
correspond to those in the representative
“Shopping Basket,” he can evaluate the
personal impact of inflation.
Limitation of the CPI.
Consumer Differences:
CPI may not apply to consumer’s individual
cost of living because individual consumption
patterns not always match with those of the
typical urban households.

Limitations of the CPI.
Changes in Spending Patterns.
 Changes in consumption patterns are ongoing and gradual.
 E.g.  More cell phones and CD players were steadily bought in
the 1990s. As prices rise consumers tend to buy fewer items.
These products have too high a weight in the CPI basket,
meaning that the index overstates the rate of inflation.
Product Quality.
A product’s tremendous improvement in quality may change an
individual’s standard of living but it will not be reflected in the CPI.
(E.g. – Medicines or stereos).
The GDP Deflator
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An indicator of price changes for all goods
and services produced in the economy, and
weights them in terms of the economy’s total
output.

GDP deflator receives less publicity than then
CPI. The results of the two indicators (GDP
deflator and CPI) give similar but not identical
estimates of inflation.
Fig 11.3 – Simple GDP Deflator.
Nominal vs. Real GDP.
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Nominal GDP – Gross Domestic Product
expressed in current year.
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Real GDP – Gives an indication of the
purchasing power of an entire economy.

Real GDP = Nominal GDP / GDP Deflator
Fig 11.4 Finding Real Gross Domestic Product.
INFLATION’S EFFECTS.
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If household ↑ but Inflation ↑ at a higher rate,
then household’s purchasing power ↓.
If household ↑ and inflation rate ↑
proportionally, then household maintains
purchasing power.
Cost – of – living adjustment clauses (COLA)
 Provisions for income adjustment to
accommodate changes in price level, which
are included in wage contracts.
EFFECT’S CONT.
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Fully Indexed Incomes  Nominal incomes
that automatically increases by the rate of
inflation.
Partially Indexed Incomes  Nominal
incomes that increases by less than the rate
if inflation.
Fixed Incomes Nominal incomes that
remain fixed at some dollar amount
regardless of the rate of inflation.
EFFECT’S CONT.
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Nominal Interest rate: The interest rate
expressed in money terms.
Real interest rate: The nominal interest rate
minus the rate if inflation.
Real interest rate = Nominal interest rate –
inflation rate.
Nominal interest rate = desired real
interest rate + inflation premium.
 THANKS
FOR YOUR
TIME……..BABY