Download Inflation

Inflation
What is Inflation?
• The general upward movement in
the average level of prices of the
goods and services in an economy
What is Deflation?
• The general decrease in the
average level of prices of the
goods and services in an
economy
What the state of Inflation/Deflation
around the world?
www.nationmaster.comeco_inf_200&int=-1
How is Inflation measured?
Consumer Price Index (CPI)?
A measure of the cost
of a fixed “market
basket” of consumer
goods and services
Refer to EconEd Link handout – Statistics CPI
www.bls.gov
www.bls.gov/news.release/cpi.t01.htm
©1999 South-Western College Publishing
Consumer Price Index (CPI)
[CPI measures cost of living relative to a base year[100]
The CPI is a market basket of 364 items at 21,000
establishments in 91 cities that the typical
householder buys. It does not include exports
because we do not buy exports but does include
imports. About 55% of the CPI is services.
What is actually measured in this
market basket?
http://www.bls.gov/news.release/cpi.t02.htm
How is the CPI calculated?
CPI =
Value of the market basket
in the current period
x 100 = PRICE INDEX
Value of the market basket in
the base period
(See Handout)
http://inflationdata.com/Inflation/Consumer_Price_Index/CurrentCPI.asp
Consumers in this economy buy only two goods–hot dogs & hamburgers.
Step 1. Fix the basket. What percent of income is spent on each.
Consumers in this economy buy a basket of:
4 hot dogs and 2 hamburgers
Step 2. Find the prices of each good in each year.
Year
Price of Hot Dogs
Price of Hamburgers
2001
$1
$2
2002
$2
$3
Step 3. Compute the basket cost for each year.
2001 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4), so $8
2002 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6), so $14
Step 4. Choose one year as a base year (2001) and compute the CPI
2001 ($8/$8) x 100 = 100
2002 (14/$8) x 100 = 175
Step 5. Use the CPI to compute the inflation rate from previous year
2002 (175/100 x 100 = 175%) or to get actual % (175-100)/100 x 100 =75%
(42%) 18. Suppose that a typical consumer buys the following quantities of these
three commodities in 2000 and 2001.
Commodity
Food
Clothing
Shelter
Quantity
5 units
2 units
3 units
2000 per Unit Price
$6.00
$7.00
$12.00
2001 per Unit Price
$5.00
$9.00
$19.00
Which of the following can be concluded about the CPI for this individual from
2000 to 2001?
a. It remained unchanged.
c. it decreased by 20%
b. It decreased by 25%.
d. It increased by 20%
e. It increased by 25%.
(Answer)
Year 1 [2000]: [5 food x $6 = $30; 2 clothing x $7 = $14; 3 shelters x $12 = $36,
for dollar value of $80. CPI = 100 ($80/$80 x 100 = 100 for 2000)]
Year 2 [2001]: [5 food x $5 = $25; 2 clothing x $9 = $18; 3 shelters x $19 = $57,
for value of $100. CPI =125 ($100/$80 x 100 = 125% for 2001)]
So, the CPI increased by 25%.
If the value of the CPI equals
120, what does this mean?
• The fixed market basket of goods costs
20% more than in the base period of time
Does the makeup of the CPI
change?
As people’s tastes and preferences
change, what goes into the basket
will change
The price of G/S in the base year of
1984. How could measuring the
CPI be distorted?
©1999 South-Western College Publishing
1962 Prices v. 2006 Prices
• Tuition at MIT - $1,500
• Starting salary - $6,000
[college graduate]
• FICA of 3.125 of $4,800
[$150 maximum]
• Top marginal tax rate of 91% of
incomes over $200,000.
• New house for $10-15,000 [2.5
times the income of a new
college graduate]
• Coke - 10 cents
• Movies - .50
• 1962 Chevy - $1,500
• Tuition at MIT - $32,300
• Starting salary - $44,000 [college
[college graduate]
• FICA of 7.65 of $94,600
[$7,237 maximum]
• Top marginal tax rate of 35% of
incomes over $326,450
• New median house price is
$218,000 [5 times the income of
today’s college grads]
• Coke - 60 cents
• Movies - $7
• 2006 Chevy - $23,000
2006 Corvette $58,000
62 Corvette $2,995
Dollar Figures From Different Times
Babe Ruth made $80,000 in 1931. That would
be equivalent to $1 million today. [Barry Bonds
gets $18 million a year]
President Herbert Hoover’s salary in 1931
was $75,000. That would be equivalent to
$900,000 today. George Bush is being
paid $400,000 a year. President Kennedy
was paid $100,000 in 62 [$650,000 today] $80,000=$1 M
Who is the Richest American Ever?
John D. Rockefeller’s [1839-1937] wealth would be worth
$200 billion in today’s money, or 4 times that of Bill Gates.
Although Rockefeller was worth $200 billion, he could not
watch TV, play video games, surf the internet, or send email
to his grandkids. For most of his life, he could not use AC,
travel by car or plane, use a telephone to call friends, or take
advantage of antibiotics to prolong & enhance life.
Perhaps the average American today is richer than
the richest American a century ago.
GDP Deflator – more broad
GDP Deflator includes prices
for all goods that we produce:
1.What householders are buying
2.What businesses are buying
3.What the government is buying
4.What foreigners are buying
[does not include imports because
we don’t produce imports]
GDP Deflator Compared to the CPI
[CPI is normally higher.]
Who measures inflation?
The Bureau of
Labor Statistics
www.bls.gov
©1999 South-Western College Publishing
What are the effects of
unexpected inflation?
• Inflation redistributes income
– some people win – the ones getting the higher
prices (think oil/gas companies)
– Some people lose – the ones paying the
higher prices (think YOU!)
Who wins and who loses from
inflation?
• Debtors win
– Borrowers pay back loans with inflated dollars
(dollars that are worth less)
• Creditors lose
– Lenders are paid back with inflated dollars
(dollars that are worth less)
More winners and losers of inflation
• Those on fixed incomes lose
– Income does not keep up with prices - standard of living goes
down.
– Exception – if fixed income is INDEXED to inflation (CPI)
• Savers often lose
– If prices rise faster than the rate of interest they are getting from
their savings (investment) then they lose purchasing power
• Government sometimes wins
– Government wins – Biggest debtor in the World (Debtors WIN!)
– Government loses – surplus in savings, increase in salaries and
other prices paid
• Menu costs of inflation
– Individuals and business must allocate resources to keep up with
changing prices – increases transaction costs
• Inflation and uncertainty
– Do I spend today, or save? Prices going up or not? What is happening to
my purchasing power? ARRRGGHH!