Inflation Economics PDF

Inflation INFLATION Macroeconomics The first goal of macroeconomic policy: economic growth (or an increase in the total/aggregate output of an economy) The second goal of macroeconomic policy: full employment (or, getting unemployment to a minimum) The third goal of macroeconomic policy: price sta...

Inflation INFLATION Macroeconomics The first goal of macroeconomic policy: economic growth (or an increase in the total/aggregate output of an economy) The second goal of macroeconomic policy: full employment (or, getting unemployment to a minimum) The third goal of macroeconomic policy: price stability (avoiding excessive inflation or deflation)  An increase in the overall price Inflation level Aggregate Price Level A measure of the overall level of prices in the economy Why might economists say that a little inflation is a good thing? Anticipated and Unanticipated Inflation -Everyone anticipates a certain amount of inflation, and they build this expectation into their decision-making. For example, if workers expect that prices will continue to rise, then they will demand increasing wages. This will allow them to continue to buy the same amount of goods and services. -When inflation is unanticipated, then this can have disparate effects on various people and firms, depending on how they make and spend money. Unanticipated inflation: Who wins, who loses? Winner? Loser? Banks that have lent money out at a fixed interest rate Borrowers at a fixed interest rate People living on fixed incomes People with large cash savings People with real estate Hyperinflation How might you respond to a period of hyperinflation? So what causes inflation? What are some possible explanations for why we are experiencing it right now? In August 2022, the annual rate of inflation in the U.S. was 8.3%. What does this mean? Calculating the rate of Inflation Difference in price levels Rate of inflation = Original price level X 100 (In other words, inflation is the slope of the price level curve, expressed as a percentage) In August 2022, the annual rate of inflation in the U.S. was 8.3%. What does this mean? It means that the aggregate price level has increased by 8.3% from August 2021 to August 2022. Market basket -A hypothetical set of consumer purchases of goods and services -Used to calculate a price index, which is a way of measuring the price level  The cost of purchasing a given market basket in a given year, relative to a base year. A price index is used to measure the Price Index price level. Given-year cost x 100 Base-year cost  Market basket example -Three items in this basket: quesadillas, floppy disks, and Christmas ornaments. Quantity Unit price Spending Unit price Spending Unit price Spending (base year) (base year) (Year 1) (Year 1) (Year 2) (Year 2) What’s the price index in Quesadilla 30 $5.00 $150.00 $7.00 $210.00 $9.00 $270.00 Floppy disks 40 $6.00 $240.00 $5.00 $200.00 $4.00 $160.00 Christmas ornament 60 $1.50 $90.00 $2.00 $120.00 $2.50 $150.00 Year 1 for this basket of Total $480.00 $530.00 $580.00 goods?  Market basket example Quantity Unit price Spending Unit price Spending Unit price Spending (base year) (base year) (Year 1) (Year 1) (Year 2) (Year 2) What’s the price Quesadilla 30 $5.00 $150.00 $7.00 $210.00 $9.00 $270.00 index in Year 1 for this basket of Floppy disks 40 $6.00 $240.00 $5.00 $200.00 $4.00 $160.00 goods? Christmas 60 $1.50 $90.00 $2.00 $120.00 $2.50 $150.00 ornament Year 2? Total $480.00 $530.00 $580.00 CPI The Consumer Price Index is one of the most important single pieces of data produced by the BLS. It’s essentially a very large market basket that aims to quantify the U.S. price level. Inflation Is it a good or bad thing that the average cost of a new car in 1950 was $1,510 but $33,560 in 2016? Inflation Is it a good or bad thing that the average cost of a new car in 1950 was $1,510 but $33,560 in 2016? Nominal price versus real price A question A movie ticket cost $1.75 in 1972. How much would this cost in 2016 dollars? How would one go about answering this? A question A movie ticket cost $1.75 in 1972. How much would this cost in 2016 dollars? How would one go about answering this? We need a price index. Calculating real prices Remember, when we talk about “real prices,” we’re always talking about those prices relative to a base year. So, if we’re trying to determine the real price of a good in terms of another year’s dollar value, we can use price indices to essentially set up a ratio: Real Price = (Nominal Pricez ) x (CPIbase year / CPIz) Base year = your point of reference Calculating real prices So, if we’re trying to determine the real price of a good in terms of another year’s dollar value, we can use price indices to essentially set up a ratio: Real Price = (Nominal Pricez ) x (CPIbase year / CPIz) Base year = your point of reference A movie ticket cost $1.75 in 1972. How much would this be in 2016 dollars?  Another way to think about CPI calculations CPI [base year] Real price [base year$] = Nominal price [given year $] X CPI [given year] Algebraically, you’re using the CPI to set up a ratio that allows you to cancel out the given year units and convert the given year nominal price into the base year real price. See the next slide to see how the given year gets canceled out.  Another way to think about CPI calculations CPI [base year] Real price [base year$] = Nominal price [given year $] X CPI [given year] Another example A Big Mac cost $2.45 in 1982. How much would that cost in 2022 dollars? Another example $250,000 in 2019 would have had what value in 2022? A trickier example A monthly MetroCard cost $63 in 1998. It cost $127 in 2022. Which was more expensive in real terms? Yet another example If you earned $10 an hour in 1994, how much would you have to earn in 1995 for your wage to have the same purchasing power? You can handle this... If you saved $200 in 2004, what annual rate of interest would you have to earn in order for the savings to have the same purchasing power in 2005? Market Basket! Using BLS data, construct a market basket which you’ll use to estimate the rate of inflation from 2016-2017, 2017-2018, and 2018-2019.