question
Real income
answer
The ability to afford things with our income
question
Real Income Formula
answer
Nominal Income for given year X (Price Level Adjustment)
-which is -
(Price Index Desired Year/Price Index in GivenYear)
-which is -
(Price Index Desired Year/Price Index in GivenYear)
question
Inflation Rate
answer
% difference in price index from one year to the next
question
What are the two Price Indices?
answer
GDP Deflator or CPI
question
What is the most commonly used Price Index?
answer
CPI
question
GDP Deflator Formula
answer
(Nominal GDP/Real GDP) x 100
question
Growth Rate or Percent Change Formula
answer
(Current-Previous) / Previous
question
Formula for Percent Change for GDP per person
answer
% Change Real GDP - % Change in Population
question
What is Real GDP in the base year?
answer
100
question
What does CPI stand for?
answer
Consumer Price Index
question
CPI
answer
Measures the average of the prices paid by urban consumers for a "fixed" basket of consumer g&s
-ratio, or weights, in basket stay the same, quantity frozen, just compare prices and total cost of basket
-ratio, or weights, in basket stay the same, quantity frozen, just compare prices and total cost of basket
question
Current Reference Base Year for CPI
answer
1982-84, CPI=100
question
CPI basket
answer
Average cost of g&s X % of income spent on that g&s, do this for every g&s in basket then add all together
Adds together g&s average household spends on, weights them according to radio of budget
Adds together g&s average household spends on, weights them according to radio of budget
question
What is today's CPI basket based on?
answer
2012-13 consumption expenditure survey
question
Who creates the CPI basket and how?
answer
Bureau of Labor Statistics (BLS) in a monthly price survey of 80,000 g&s in 30 metropolitan areas
They try to analyze changes in quality or packaging to isolate price changer
They try to analyze changes in quality or packaging to isolate price changer
question
CPI Formula
answer
(Cost of basket at current prices/Cost of basket at base prices) X 100
question
How do we compare separate items that make up the GDP?
answer
Real Income
question
How do we get real income
answer
-measure price level
1. Use either GDP deflator or CPI
2. Adjust nominal variable for price level
1. Use either GDP deflator or CPI
2. Adjust nominal variable for price level
question
What are the 4 reasons CPI might overstate true inflation
answer
New Goods Bias
Quality Change Bias
Commodity Substitution Bias
Outlet Substitution Bias
Quality Change Bias
Commodity Substitution Bias
Outlet Substitution Bias
question
New Goods Bias
answer
New goods not available in the base year appear, if more expensive than goods replaced, put an upward bias into CPI
question
Quality Change Bias
answer
Part of price rise is for improved quality and not inflation, CPI accounts all price rise as inflation
question
Commodity Substitution Bias
answer
Market basket of goods ratio is set, consumers preferences can substitute away from goods whose relative prices increase
question
Outlet Substitution Bias
answer
People can switch to buying from cheaper sources
question
Differences in CPI and GDP Deflator
answer
GDP Deflator-
Includes everything bought by gov. & businesses, things not purchased by households
In computing for it-
Q changes and Prices Frozen
Annual average calculates 2% inflation since 2000
CPI-
Includes imports in goods in basket
Housing-related Expenditures have larger weight
In computing for it-
Q frozen and Prices
Change
On average calculates 2.4% inflation a year since 2000
Includes everything bought by gov. & businesses, things not purchased by households
In computing for it-
Q changes and Prices Frozen
Annual average calculates 2% inflation since 2000
CPI-
Includes imports in goods in basket
Housing-related Expenditures have larger weight
In computing for it-
Q frozen and Prices
Change
On average calculates 2.4% inflation a year since 2000
question
Inflation Rate Formula
answer
((Price Index in 2014 - Price Index in 2013) / Price Index in 2013) X 100
question
How much is CPI annually overestimated at?
answer
1.1%
question
Price level
answer
Average level of prices and value of money, Price Index will measure
question
Inflation
answer
Persistently rising price level
question
Deflation
answer
Persistently falling price level
question
Price Level and Inflation Rate Relations
answer
Inflation Rate-
High~ price level rapidly rising
Low~ price level rising slowly
Negative~ price level falling
High~ price level rapidly rising
Low~ price level rising slowly
Negative~ price level falling
question
Hyperinflation
answer
Monthly inflation rate greater than or equal to 50%
question
What are 4 reasons unexpected bursts of inflation or deflation are bad?
answer
-Redistribution of Income
-Redistribution of Wealth
-Lowers Real GDP and Employment
-Diverts Resources from Production
-Redistribution of Wealth
-Lowers Real GDP and Employment
-Diverts Resources from Production
question
Redistribution of Income (context of 4 reasons)
answer
Wages set
Inflation- employees profit & workers struggle
Deflation- employees struggle & workers profit
Inflation- employees profit & workers struggle
Deflation- employees struggle & workers profit
question
Redistribution of Wealth (context of 4 reasons)
answer
Loan contracts: interest rate agreed as % of money borrowed and lent
Inflation- $ borrower pays worth less than before, borrower wins
Deflation- $ borrower pays worth more than before, loaner wins
Inflation- $ borrower pays worth less than before, borrower wins
Deflation- $ borrower pays worth more than before, loaner wins
question
Lowers Real GDP & Employment
answer
Inflation- raises firms profits - rise in investment, boom in production and employment, real GDP>potential GDP, unemployment rate falls below natural rate
Always comes back down, causing swings
Deflation- cut in spending brings recession & larger unemployment
Always comes back down, causing swings
Deflation- cut in spending brings recession & larger unemployment
question
Price variable
answer
Nominal quantity/price level
question
High Inflation vs. High Price Level
answer
Price Level is always compared to base year, so even if inflation rate last year was low it can technically still be high if at one point since base year there was high inflation, inflation is always comparing the price level change from year to year
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