week 15 Flashcards
what is consumer price index
measure of the cost of living during a particular period
measures cost of a standard basket of goods and services in a given year
relative to the cost of the same basket of goods and services in the same year
base year changes periodically
what is a price index
measures the average price of a given quantity of goods and services relative to the price of the same goods and services in a base year
what is inflation
measures how fast the average price level is changing overtime
what is rate of inflation
the annual percentage rate of change in the price level
what is deflation
a situation in which most goods or services are falling over time, so that inflation is negtaive
what is a nominal quantity
measured in terms of its current dollar value
what is a real quantity
measured in physical terms
how do you convert a nominal quantity to its real quantity
deflate it
divide a nominal quantity by its price index to express the quantity in real terms
what are real wages
the wage paid to the worker measured in terms of purchasing power
what is indexing
increases nominal quantity each period by the percentage increase in a specified price index
automatically adjusts certain values such as social security payments by the amount of inflation
what is minimum wage
national minimum wage set by gov
increasing minimum wage can contribute to inflation
companies pass on increased labour costs to consumers in the form of higher prices
what is a tight labour markets
a stituation where there is a low level of unemployment and a high level of job vacancies, few workers to fill jobs
causes employers to compete for workers, pushes up wages
increases cost of goods for customers
also causes increased consumer spending as people have more money to spend
sign of a strong economu
what is a tight labour markets
a situation where there is a low level of unemployment and a high level of job vacancies, few workers to fill jobs
causes employers to compete for workers, pushes up wages
increases cost of goods for customers
also causes increased consumer spending as people have more money to spend
sign of a strong economy
how can inflation be overstated
CPI can influence policy decisions
unnecessary increases in gov spending
CPI may overstate cost of living as it is based on a fixed basket of goods
CPI doesn’t account for changes in quality
what are CPI bias changes
CPI measures price changes not quality changes
adjusting for quality is difficult - large numbers of goods and subjective differences
incorporating new goods is difficult, no base price for this years new goods
what are CPI biases
CPI uses a fixed basket of goods
when price of a good increases, consumers buy less and substitute other goods
failing to account for substitution overstates inflation and CPI
what is a GDP price deflator
measures changes in prices for all goods and services
helps compare real economic activity year on year
helps identify how much prices have inflated over a specific time period
what is the formula for the GDP price deflator
nominal GDP / real GDP x 100
what is the difference between GDP price deflator and CPI index
CPI based on fixed basket of goods, misses changes in prices of goods outside basket
GDP isn’t based on fixed basket of goods
changes in consumption patterns or introduction of new goods and services are automatically reflected in deflator
what is price level
a measure of the overall level of prices at a particular point in time as measured by a price index such as CPI
what is relative price
the price of a specific good or service in comparison to prices of other goods and services
increasing relative price encourages consumers to save money on expensive products and search for their substitutes while companies try to bring more products to the market to gain profit
what are the observations about cost of inflation
changes in price do not imply significant inflation
inflation can be high without effecting prices
to counteract price changes, gov policy would have to affect the market for specific goods
to counteract inflation, gov uses monetary and fiscal policy
how do taxes cause distortions
is they are not indexed the distort incentives for people to work, save and invest
lower savings and investment means lower economic growth
income tax treats nominal interest earned on savings as income
after-tax real interest rate falls, making saving less attractive
how does inflation increase the cost of cash
without inflation, cash holds value overtime
when inflation is high, cash loses value
people withdraw cash more frequently, increases processing costs for banks, real cost of inflation
