Download Economics: Principles and Applications, 2e by Robert E. Hall & Marc

Economics: Principles and
Applications, 2e
by Robert E. Hall &
Marc Lieberman
© 2001 South-Western, a division of Thomson Learning
The Monetary System,
Prices, and Inflation
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The Monetary System
•History of the Dollar
•Why Paper Currency Is Accepted as a Means
of Payment
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The Monetary System
Unit of Value
A common unit for measuring how much
something is worth.
Means of Payment
Anything acceptable as payment for goods and
services.
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The Monetary System
In 1790, Congress created a new unit of value
called the dollar.
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The Monetary System
Federal Reserve System
The central bank and national monetary
authority of the United States.
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The Monetary System
The earliest means of payment were precious
metals and other valuable commodities such
as furs or jewels. These were called
commodity money.
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The Monetary System
Fiat Money
Anything that serves as a means of payment
by government declaration.
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The Monetary System
The real force behind the dollar--and the
reason that we are all willing to accept these
green pieces of paper as payment--is its longstanding acceptability by others.
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Measuring the Price
Level and Inflation
•Index Numbers
•The Consumer Price Index
•How the CPI Has Behaved
•From Price Index to Inflation Rate
•How the CPI Is Used
•Real Variables and Adjustment for Inflation
•Inflation and the Measurement of Real GDP
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Measuring the Price
Level and Inflation
Price Level
The average level of dollar prices in the
economy.
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Measuring the Price
Level and Inflation
Index
A series of numbers used to track a variable’s
rise or fall over time.
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Measuring the Price
Level and Inflation
Consumer Price Index (CPI)
An index of the cost, through time, of a fixed
market basket of goods purchased by a
typical household in some base period.
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Measuring the Price
Level and Inflation
Inflation Rate
The percent change in the price level from one
period to the next.
Deflation
A decrease in the price level from one period to the
next.
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Measuring the Price
Level and Inflation
The CPI is used in three major ways:
•As a Policy Target
•To Index Payments
•To Translate from Nominal to Real Values
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Measuring the Price
Level and Inflation
Indexation
Adjusting the value of some nominal payment
in proportion to a price index, in order to keep
the real payment unchanged.
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Measuring the Price
Level and Inflation
Nominal Variable
A variable measured in current dollars.
Real Variable
A variable measured in terms of purchasing
power.
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Measuring the Price
Level and Inflation
When we measure changes in the
macroeconomy, we usually care not about the
number of dollars we are counting, but the
purchasing power those dollars represent. We
translate nominal values into real values.
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Measuring the Price
Level and Inflation
GDP Price Index
An index of the price level for all final goods
and services included in GDP.
© 2001 South-Western, a division of Thomson Learning
Measuring the Price
Level and Inflation
The GDP price index measures the prices of all
goods and services that are included in U.S. GDP,
while the CPI measures the prices of all goods and
services bought by U.S. households.
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The Costs of Inflation
•The Inflation Myth
•The Redistributive Cost of Inflation
•The Resource Cost of Inflation
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The Costs of Inflation
Inflation can redistribute purchasing power
from one group to another, but it cannot--by
itself--decrease the average real income in the
economy.
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The Costs of Inflation
Inflation can shift purchasing power away
from those who are awaiting future payments
specified in dollars and toward those who are
obligated to make such payments.
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The Costs of Inflation
Over any period, the percentage change in a
real value is approximately equal to the
percentage change in the associated nominal
value minus the rate of inflation.
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The Costs of Inflation
If inflation is fully anticipated, and if both
parties take it into account, then inflation will
not redistribute purchasing power.
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The Costs of Inflation
Nominal Interest Rate
The annual percent increase in a lender’s dollars
from making a loan.
Real Interest Rate
The annual percentage increase in a lender’s
purchasing power from making a loan.
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The Costs of Inflation
When inflationary expectations are inaccurate, purchasing
power is shifted between those obliged to make future
payments and those waiting to be paid. An inflation rate
higher than expected harms those awaiting payment and
benefits the payers; an inflation rate lower than expected
harms the payers and benefits those awaiting payment.
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The Costs of Inflation
When people must spend time and other resources
coping with inflation, they pay an opportunity cost-they sacrifice the goods and services those
resources could have produced instead.
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