inflation Flashcards

1
Q

what is economics?

A

economics is the study of the optimal use of limited resources in production and consumption

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2
Q

what is inflation?

A

inflation is a generalized rise in the overall level of prices

also the decline in the purchasing power of money

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3
Q

what is CPI?

A

the consumer price index (CPI) is an index that tracks the average price consumers pay over time for a representative basket of goods and services

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4
Q

what is the formula for inflation rate?

A

inflation rate = ( (price this year - price last year)/ price last year ) x 100

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5
Q

how is CPI constructed?

A

step one: find out what people typically buy

step two: collect prices from the stores where people do their shopping

step three: tally up the price of the basket of goods and services

step four: calculate the inflation rate based off the weighting

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6
Q

what are some challenges with measurement of CPI?

A
  • basket doesn’t apply to everyone
  • government may not accurately collect price data
  • quality improvements can hide price decreases (better products last longer)
  • new products can make you better off, reducing your cost of living ( CPI only tracks the changing prices of existing goods - doesn’t account for the reduction in the cost of living due to the introduction of new products )
  • you can save yourself money without sacrificing much (substitution bias)
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7
Q

what is substitution bias?

A

the overstating of inflation occurs because people substitute towards goods whose prices rise by less

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8
Q

what are the inflation measures (consumer) ?

A

1) CPI
2) personal consumption expenditure deflator
3) core inflation

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9
Q

what is CPI used to measure?

A

measure the change in the cost of living

automatically adjusting wages, benefits, tax brackets, and the like to compensate for inflation is called indexation

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10
Q

what is the personal consumption expenditure deflator used for?

A

used for monetary policy

the federal reserve sets its inflation target using the personal consumption expenditure (PCE) deflator

uses a slightly different basket of goods and services compared to the CPI

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11
Q

what core inflation used for?

A

for forecasters who look for underlying trends in inflation

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12
Q

what is core CPI?

A

everything except food and energy

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13
Q

what is the formula for calculating CPI?

A

CPI (t) = (ptq0)/ (p0q0) x 100

quantity always stays the same

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14
Q

what is the CPI for a base year?

A

always equal to 100

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15
Q

what are the inflation measures for businesses?

A

1) Producer price index (PPI): a price index that tracks the price of inputs into the production process
2) GDP deflator: a price index that tracks the price of all goods and services produced domestically

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16
Q

what is the formula for GDP deflator?

A

GDP deflator = nominal GDP/ real GDP x 100

17
Q

what is the inflation adjustment formula?

A

another time’s nominal dollars x (price level today / price level over time)

18
Q

what is a nominal variable?

A

a variable measured in dollars

19
Q

what is a real variable?

A

a variable that has been adjusted to account for inflation

20
Q

what is the nominal interest rate?

A

the stated interest rate without a correction for the effects of inflation

21
Q

what is the real interest rate?

A

the interest rate in terms of changes in your purchasing power

22
Q

how do you calculate real interest rate?

A

real rate = nominal rate - inflation rate

23
Q

what is money illusion?

A

the (mistaken) tendency to focus on nominal dollar amounts instead of inflation-adjusted amounts

24
Q

what are some issues that arise from money illusion?

A

1) distorting prices
2) leads to mispricing
3) creates nominal wage rigidity

25
Q

what is nominal wage rigidity?

A

the reluctance to cut nominal wages

26
Q

what is money?

A

any asset regularly used in transactions

27
Q

what are the three functions of money?

A

1) medium of exchange
2) unit of account
3) store of value

28
Q

what is hyperinflation?

A

hyperinflation is an extremely high rate of inflation

makes most aspects of life harder and erodes all the functions and value of money

29
Q

what are the costs of expected inflation?

A

1) Menu costs: (businesses have to change prices regularly, which is costly)
2) shoe leather costs: the costs incurred trying to avoid holding cash.
Arise because inflation undermines money’s function as a store of value

30
Q

what are costs of unexpected inflation?

A

1) confusing signals that the prices send
2) redistributing income - refers to loans

31
Q

what is the inflation fallacy?

A

the mistaken belief that inflation destroys purchasing power

The purchasing power stays the same because the wage also increases. Therefore, the opportunity cost of buying each item doesn’t change.

There is no change in the real variables