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Inflation and Deflation 6-4 Correcting for prices • There is a need to correct for prices changing • This an important idea and you will see it over and over again in this course. • Pay attention to the next slide! The vocabulary • A nominal measure is a measure that has not been adjusted for changes in prices over time. • A real measure is a measure that has been adjusted for changes in prices over time. • The aggregate price level is the overall level of prices in the economy. Real Wages • Economist typically express wages in real terms • Real wages is a better indicator of the actual change in the workers’ purchasing power over time Consumer price index from 1913 to 2004 Aggregate Prices • Aggregate Price Level is the overall price level for final goods and services in the economy. Inflation and Deflation A rising aggregate price level is inflation. A falling aggregate price level is deflation. The inflation rate is the annual percent change in the aggregate price level. Indexes and Deflator • The two most widely used measures: 1. The CPI 2. The GDP Deflator • There are other indexes in chapter 7 we will cover all of these in more detail. Price Stability • Both inflation and deflation can pose problems for the economy • Policy makers hope to achieve price stability. • The economy has price stability when the aggregate price level is changing only slowly. Inflation and deflation since 1929 NO Hamburgers are Cheaper today! ▪ No ─ in fact, a burger is, compared with other consumer goods, a better bargain than it was in 1954. Burger prices have risen about 400%, from $0.15 to about $0.75, over the last half century. But the overall consumer price index has increased more than 600%. ▪ If McDonald’s had matched the overall price level increase, a hamburger would now cost between 90 cents and $1.00.