Chapter 24 Flashcards
(24 cards)
Inflation
when overall price level rises
inflation rate
percentage change in the price level
consumer price index
CPI: measure of the overall cost of the goods and services bought by a typical consumer
used: to monitor changes in the cost of living over time
ONS
office of national statistics (reports CPI each month)
CPI rises
typical consumer has to spend more to maintain the same standard of living
How is the CPI calculated?
- Fix the basket
- Find the prices of each good
- Compute prices of the basket
- choose base year and compute index
- compute the inflation rate
compute prices of the basket (CPI)
quantity stays fixed while dollar amount changes
compute index (CPI)
chosen year/base year x 100 = CPI
compute inflation rate
CPI(1) - CPI(2) / CPI(2) x 100 = (1)%
What are the 3 main problems in measuring the cost of living?
- Substitution bias
- Introduction of new goods
- Unmeasured quality changes
Substitution bias
because CPI locks quantity and prices are flexible when prices change it ignores it
- index overstates the increase in cost of living
Introduction of New Goods
- more variety (may not include new goods)
- makes each euro more valuable
- consumers need less money to maintain any given standard of living
unmeasured quality changes
- quality goes down -> value of euro falls
- quality increases -> value increases
producer price index
the cost of a basket of goods and services bought by firms rather than consumers
difference btw GDP deflator and CPI (1)
GDP deflator -> produced domestically
CPI -> bought by typical consumer
difference btw GDP deflator and CPI (2)
GDP deflator: compares currently produced goods and services with the price of the same goods in the base year
CPI -> compares the price of a fixed basket of goods and services with price of basket in base year
indexation
used to correct for the effects of inflation
purchasing power
the goods or services that one unit of money can buy
interest
a payment in the future for a transfer of money in the past
how to calculate money figures from different times
value in year 1 = $(year 2) x CPI (year 1) / CPI (year 2)
nominal interest rate
without correction for inflation (what banks use)
real interest rate
corrected for inflation
formula for real interest rate
real interest rate = nominal interest rate - inflation rate
how to calculate GDP deflator
= nominal GDP/Real GDP x 100
