Macro Goals Flashcards
(30 cards)
Possible problems of a market economy
Inefficiency, Inhumanity, Instability
Inefficiency
- Monopolies
- Externalities
- Public Goods
Solved with: Allocation policy
Inhumanity
• Inequality
• Working
conditions
• Poverty
Solved with: Distribution policy
Instability
- Unemployment
- Inflation
- Business Cycles
Solved with: Stabilization policy
The „Magic Square“ of macroeconomic goals
- Price Stability
- Steady and Adequate Economic Growth
- External balance
- High Level of employment
Inflation
Rise in the general level of prices
Inflation Rate
Rate Year© =
Price level Year© - Price level Year©-1
——————————————————–* 100
Price level Year©-1
Why is high inflation an economic problem?
- Shoeleather Cost
- Menu Cost
- Distortion of Relative Prices
- Redistribution of wealth
- Slowdown in growth
- Shoeleather Cost
Shoe leather cost refers to the cost of time and effort that people spend trying to counter-act the effects of inflation, such as holding less cash and having to make additional trips to the bank.
- Menu Cost
Menu cost is the cost to a firm resulting from changing its prices. With high inflation, firms must change their prices often.
- Distortion of Relative Prices
this problem is related to menu costs. As firms continuously need to adjust prices (and as consumers continuously need to learn new prices), the adjustments inevitably lead to changes in relative prices that could lead to misallocation of resources
- Redistribution of wealth
Prices change faster than salaries which leads to redistribution of wealth.
- Slowdown in growth
Consumption goes down, export goes down, demand goes down
Inflation is positive or negative for Lender’s
The simplest example is the distribution Negative. between lenders and borrowers . In the case of a fixed-rate loan the borrower benefits (and the lender suffers) from an unexpected increase in inflation because the repayment has a lower value than expected.
Inflation is positive or negative for Taxpayers
Negative. In a progressive tax system, failure to index the brackets to inflation will eventually result in effective tax increases. People will be classified as having high salaries and having to pay more taxes, although their real wage would not increase.
Inflation is positive or negative for Holder of Currency
Negative.
Inflation is positive or negative for Employees
Negative. Salaries are raised slower than prices.
Deflation
Rate at which the general price level
decreases (negative rate of inflation)
Calculating the CPI
CPI Y 19 =
3A * (A Y 19 Price ) + 4B * (B Y 19 Price)
——————————————————–* 100 3A * (A Ybase Price) + 4B * (B Ybase Price)
Problems in Measuring the Cost of Living
Substitution bias
Introduction of new goods
Unmeasured quality changes
Substitution bias
Some prices rise faster than others.
Consumers substitute toward goods that
become relatively cheaper
Introduction of new goods
New goods allow consumers to find
products that more closely meet their needs. Thus each euro become more valuable.
Unmeasured quality changes
Improvements in the quality of goods in the basket increase the value of each euro. Quality is hard to measure.
GDP Deflator
• Price index that informs about the rate of
change of the average price of the goods and services produced and bought.
• It is calculated as the ratio of
real GDP
