Quiz Two Flashcards
Price level
Measures average prices of goods and services
Inflation rate
Percentage increase in price level from year to year
CPI v. GDP deflator
GDP deflator is broad, includes every good and service . CPI can answer more specific questions about inflation
CPI market basket
211 goods and services purchased by a typical family of 4. Consists of 8 broad categories
Consumer Price Index definition
Ratio of the value of a market basket of goods and services for the typical household in a month as compares to that of the arbitrary base period
CPI formula
(Expenditures in the current year)/(Expenditures in the base year) * 100
Can CPI tell us how high the price level is?
No, only how it’s changed over time
Inflation
Percent increase between CPI values
Inflation rate formula
(Current CPI- Previous year CPI)/(Previous CPI) * 100
Substitution bias
BLS assumes people buy the same amount of each product in the market basket. In fact, consumers want the items that increase the least in price over time. Measure doesn’t account for these changes from year to year
Increase in quality bias
Recorded price increases overstate pure inflation since products improve in quality over time
New product bias
New products aren’t included in market basket updates, and prices of new products decrease in the years immediately after release
Outlet bias
Market basket stats only account for prices at traditional retailers and don’t reflect prices some consumers are paying online or at outlets
Problems with CPI as a measure
Substitution bias, increase in quality bias, new product bias, outlet bias. Can’t say how high price level is, and overstates true inflation
CPI adjusts for the ___ of inflation and lets us ____ dollar amounts from different years
Effects, compare
Ex: we can calculate what $25,000 1993 dollars equals in 2018
Nominal variables
Economic variables calculated in current year prices
Interest rate
Cost of borrowing funds, expressed as a percentage of the amount borrowed
Ex: if you loan someone $1000 at a 4% interest rate, they pay back that 4% with the amount of money borrowed
Nominal interest rate
Stated interest rate on a loan
Real interest rate calculation
Nominal interest rate - inflation rate
How to measure nominal interest rate for the whole economy
Use interest rate on 3 month treasury bills, since they’re an important security in the market
Real v nominal interest rate
Hard to know if nominal is high or low, but it’s always lower than real (save negative interest rates)
Real interest rate is a better measure of true cost of borrowing and return of lending
Deflation
Decline in price level
Core CPI
Measures CPI adjusted for food and energy prices
Core rate of inflation
Measures inflation without food and energy prices, gives a better sense of inflation
Is it possible for the whole economy to see deflation
Yes, especially in recessions
True or false: if prices double overnight, wages and salaries would also double, leaving purchasing power the same
True
Issues with inflation
Incomes don’t always rise with inflation
Those with fixed incomes are particularly hurt by inflation
Menu costs
The costs to firms of changing prices. Can become quite high at high rates of inflation
Uses of CPI
Measures price level for consumers
Tells how price level changes over time
Measures the cost of market basket from year to year
Disinflation
Less inflation
Connection between inflation and CPI
Inflation is the percent change between CPI from year to year
Connection between inflation and interest rates
High interest rates = less inflation, low supply
Low interest rates = high inflation, high demand
Bond
Financial security that represents a promise to repay a fixed amount of funds
Financial security
States any terms under which money changes hands
Stock
Financial security that represents partial ownership of a firm
Beating the market
Earning a return higher than the increase in a stock market average
Why is beating the market hard.
Because stock prices are extremely hard to predict as they’re based on expected future profitability of a firm
Fiscal policy
A change in federal expenditures
How is fiscal policy being used post pandemic
Government uses increase in federal expenditures to stimulate economic growth. Trillions were spent to fight the economic effects of covid
Nominal price
The amount it takes to buy an item
Real price definition
Removes inflation from a nominal price or interest rate
Real price subtraction method
Percent change in nominal price/wage - inflation rate
CPI value
295.3
Real price division method
Price * (current CPI/base CPI)
Federal deficit
Occurs when the govts spending exceeds its revenues
Federal debt
Money owed to someone else, accumulation of years of deficit
