This slide is inserted for humor. John Kerry did not release his transcript. Some say he (Kerry) had about the same grades.
Ap macro inflation_teacher
What is Inflation?• The general upward movement in the average level of prices of the goods and services in an economy
What is Deflation? • The general decrease in the average level of prices of the goods and services in an economyWhat the state of Inflation/Deflationaround the world? www.nationmaster.comeco_inf_200&int=-1
Consumer Price Index (CPI) [CPI measures cost of living relative to a base year The CPI is a market basket of 364 items at 21,000establishments in 91 cities that the typicalhouseholder buys. It does not include exportsbecause we do not buy exports but does includeimports. About 55% of the CPI is services.services
What is actually measured in this market basket?http://www.bls.gov/news.release/cpi.t02.htm
How is the CPI calculated? Value of the market basket in the current periodCPI = x 100 = PRICE INDEX Value of the market basket in the base period (See Handout) http://inflationdata.com/Inflation/Consumer_Price_Index/CurrentCPI.asp
Consumers in this economy buy only two goods–hot dogs & hamburgers.Step 1. Fix the basket. What percent of income is spent on each. Consumers in this economy buy a basket of: 4 hot dogs and 2 hamburgersStep 2. Find the prices of each good in each year. Year Price of Hot Dogs Price of Hamburgers 2001 $1 $2 2002 $2 $3Step 3. Compute the basket cost for each year. 2001 ($1 per hot dog x 4 = $4) + ($2 per hamburger x 2 = $4), so $8 2002 ($2 per hot dog x 4 = $8) + ($3 per hamburger x 2 = $6), so $14Step 4. Choose one year as a base year (2001) and compute the CPI 2001 ($8/$8) x 100 = 100 2002 (14/$8) x 100 = 175Step 5. Use the CPI to compute the inflation rate from previous year 2002 (175/100 x 100 = 175%) or to get actual % (175-100)/100 x 100 =75%
(42%) 18. Suppose that a typical consumer buys the following quantities of these three commodities in 2000 and 2001. 2001Commodity Quantity 2000 per Unit Price 2001 per Unit PriceFood 5 units $6.00 $5.00Clothing 2 units $7.00 $9.00Shelter 3 units $12.00 $19.00 Which of the following can be concluded about the CPI for this individual from 2000 to 2001? 2001 a. It remained unchanged. c. it decreased by 20% b. It decreased by 25%. d. It increased by 20% e. It increased by 25%.(Answer)Year 1 : [5 food x $6 = $30; 2 clothing x $7 = $14; 3 shelters x $12 = $36,for dollar value of $80. CPI = 100 ($80/$80 x 100 = 100 for 2000)]Year 2 : [5 food x $5 = $25; 2 clothing x $9 = $18; 3 shelters x $19 = $57,for value of $100. CPI =125 ($100/$80 x 100 = 125% for 2001)]So, the CPI increased by 25%.
If the value of the CPI equals 120, what does this mean?• The fixed market basket of goods costs 20% more than in the base period of time
1962 Prices v. 2006 Prices• Tuition at MIT - $1,500 • Tuition at MIT - $32,300• Starting salary - $6,000 • Starting salary - $44,000 [college [college graduate] [college graduate]• FICA of 3.125 of $4,800 • FICA of 7.65 of $94,600 [$150 maximum] [$7,237 maximum]• Top marginal tax rate of 91% of • Top marginal tax rate of 35% of incomes over $200,000. incomes over $326,450• New house for $10-15,000 [2.5 • New median house price is times the income of a new $218,000 [5 times the income of college graduate] today’s college grads]• Coke - 10 cents • Coke - 60 cents• Movies - .50 • Movies - $7• 1962 Chevy - $1,500 • 2006 Chevy - $23,000 2006 Corvette $58,000 62 Corvette $2,995
Dollar Figures From Different TimesBabe Ruth made $80,000 in 1931. That would 1931be equivalent to $1 million today. [Barry Bonds todaygets $18 million a year] President Herbert Hoover’s salary in 1931 was $75,000. That would be equivalent to 75,000 $900,000 today. George Bush is being paid $400,000 a year. President Kennedy was paid $100,000 in 62 [$650,000 today] $80,000=$1 M Who is the Richest American Ever? John D. Rockefeller’s [1839-1937] wealth would be worth $200 billion in today’s money, or 4 times that of Bill Gates.Although Rockefeller was worth $200 billion, he could notwatch TV, play video games, surf the internet, or send emailto his grandkids. For most of his life, he could not use AC,travel by car or plane, use a telephone to call friends, or takeadvantage of antibiotics to prolong & enhance life.Perhaps the average American today is richer thanthe richest American a century ago.
GDP Deflator – more broadGDP Deflator includes pricesfor all goods that we produce: produce• What householders are buying• What businesses are buying• What the government is buying• What foreigners are buying [does not include imports because we don’t produce imports]
GDP Deflator Compared to the CPI [CPI is normally higher.]
What are the effects of unexpected inflation?• Inflation redistributes income – some people win – the ones getting the higher prices (think oil/gas companies) – Some people lose – the ones paying the higher prices (think YOU!)
Who wins and who loses from inflation?• Debtors win – Borrowers pay back loans with inflated dollars (dollars that are worth less)• Creditors lose – Lenders are paid back with inflated dollars (dollars that are worth less)
More winners and losers of inflation • Those on fixed incomes lose – Income does not keep up with prices - standard of living goes down. – Exception – if fixed income is INDEXED to inflation (CPI) • Savers often lose – If prices rise faster than the rate of interest they are getting from their savings (investment) then they lose purchasing power • Government sometimes wins – Government wins – Biggest debtor in the World (Debtors WIN!) – Government loses – surplus in savings, increase in salaries and other prices paid • Menu costs of inflation – Individuals and business must allocate resources to keep up with changing prices – increases transaction costs • Inflation and uncertainty – Do I spend today, or save? Prices going up or not? What is happening to my purchasing power? ARRRGGHH!
President Bush’s College Transcript“So - - If you are having a hard time in economics,don’t worry about it. You can always be Presidentof the United States.”
The Inflation-GDP-Unemployment Connection• GDP is calculated by taking the price of a good or service and multiplying it by the quantity of the good or service produced. – Example (assume a one product economy) • Dry Erase Marker (sold this year) – $1.00 (Price of one) X 1,000 produced this year »GDP = $1,000
The Inflation-GDP-Unemployment Connection• Let’s assume next year the price of Dry• Erase Markers is $2.00 each and the economy still produces 1,000 markers. $2.00 X 1,000 GDP = $2,000 Has our GDP grown? What caused GDP to rise? Is this good? What should be our main concern?
The Inflation-GDP-Unemployment Connection• Our main concern should be the growth of the production of goods and services (G/S). The implication is that with the growth of production of G/S more workers will be needed to produce the G/S, thereby putting people to work and getting closer to the Economic Goal of Full- employment.
The Inflation-GDP-Unemployment Connection• Our example tells us that we only experienced a rise in price, not a rise in the quantity of the good produced. – We had inflation. To see how we are doing from year to year in the production of G/S we need to factor out Inflation
The Inflation-GDP-Unemployment Connection• Terms we need to know and understand: – Nominal GDP – the GDP calculated in any given year using that particular years prices or price level. – Real GDP – the GDP calculated for a given year with the change in price level (Inflation) factored out. Measures the production of G/S in terms of a base year price level – GDP Deflator- calculates the change in price level for a particular year compared to an established base year price level.
Year Price of Quantity Nominal GDP Real GDP Goods of Goods GDP (adjusted for Deflator (unadjusted Price and and for Price Change) Services Services Change) Produced Produced1999 .50 1,0002000 .75 1,0002001 .75 1,2002002 1.00 1,1002003 1.50 1,150 Nominal GDP = Price of G&S x Quantity of G &S GDP Deflator = Current Price/Base Year Price Real GDP = Nominal GDP/GDP Deflator X 100
What does all this mean??? Unemployment Inflation GDP Real Growth RateGood 6% or less 1% to 4% 2.5% to 5%Worry 6.5% to 8% 5% to 8% 1% to 2%Bad 8.5% or more 9% or more .5% or lessUnemployment Rate 9.7 % Inflation Rate -2.10% Real GDP -6.0%
IT IS A MUST TO REMEMBER THIS FORMULA:• Real = Nominal - Inflation GDP GDP Interest Interest rate rate