B252 Mod 2 study

1. Dr. Justin Barnette
Module 2 - Main Macroeconomic
Variables: Inflation
Econ B252: Fundamentals of Economics for Business II 1

2. Dr. Justin Barnette
• Announcements in Canvas
• See due dates in syllabus.
• The textbook chapter is full of helpful details!
Announcements
Econ B252: Fundamentals of Economics for Business II 2

3. Dr. Justin Barnette
Learning Objectives
1.Define and determine the cost of inflation and
deflation.
2.Calculate price indexes and inflation; examine their
potential bias and the types of price indexes using
real-world data.
3.Differentiate between nominal and real values.
4.Examine how to protect against inflation.
Econ B252: Fundamentals of Economics for Business II

4. Dr. Justin Barnette
Learning Objective #1
Define and determine the
cost of inflation and
deflation.
Econ B252: Fundamentals of Economics for Business II

5. Dr. Justin Barnette
• Inflation
o An upward movement in the average level of prices
• Deflation
o A downward movement in the average level of prices
Inflation and Deflation
Econ B252: Fundamentals of Economics for Business II

6. Dr. Justin Barnette
• Question
o What is the cost of inflation?
• Purchasing Power
o value of money for buying goods and services
o varies with prices and income
• Confusion
o Prices are supposed to provide a lot of information.
o Money Illusion
 A raise to keep up with inflation is not a raise.
Inflation & Deflation: The Cost
Econ B252: Fundamentals of Economics for Business II

7. Dr. Justin Barnette
Learning Objective #2
Calculate price indexes and
inflation; examine their
potential bias and the types
of price indexes using real-
world data.
Econ B252: Fundamentals of Economics for Business II

8. Dr. Justin Barnette
• Measuring Inflation
o A ratio of costs for a given basket of goods and services
multiplied by 100 for convenience.
 Not a Percentage
Price Index
Econ B252: Fundamentals of Economics for Business II
Price Index =
in Time T
x 100
Basket Cost in Time T
Basket Cost in Base Year

9. Dr. Justin Barnette
2010 Cost of 2011 Cost of
Market Price Market Price Market
Basket per Basket per Basket at
Commodity Quantity Unit in 2010 Unit 2011 Prices
Gasoline (Gallons) 1000 $2.80 $2,800 $3.80 $3,800
Laptops (1 GB) 2 $850 $1,700 $400 $800
Price Index
Totals $4,500 $4,600
Econ B252: Fundamentals of Economics for Business II

10. Dr. Justin Barnette
• Inflation Rate
o The rate of change in the price index between
two time periods
o Practice in Top Hat
Measuring Inflation
Inflation Rate = x 100
Price Index2 - Price Index1
Price Index1
= x 100 = 2.22%
102.22 -100
100
Econ B252: Fundamentals of Economics for Business II

11. Dr. Justin Barnette
o Year - CPI
o 2015 - 100
o 2016 - 107
o 2017 - 113
o 2018 - 121
o 2019 - 129
Measuring Inflation in Top Hat
Econ B252: Fundamentals of Economics for Business II

12. Dr. Justin Barnette
Types of Price Indexes
• Consumer Price Index (CPI) – BLS Link
o The average price of goods bought by a typical American
consumer.
o Covers 80,000 goods.
o Weighted so that major items (housing) count more.
• Personal Consumption Expenditure (PCE) – Fed Link
o Federal Reserve Bank’s Preferred Measure
• Differences?
o Technical Formulas
o Weights
o Scope – PCE Allows Substitution
Econ B252: Fundamentals of Economics for Business II

13. Dr. Justin Barnette
Types of Price Indexes
• Real-world price indexes: Relative Importance of
Components in the Consumer Price Indexes
o FYI - You don’t need to memorize these values.
Econ B252: Fundamentals of Economics for Business II
Items Weight
Food and beverages 14%
Housing 42%
Apparel 2%
Transportation 18%
Medical care 8%
Recreation 5%
Education and communication 6%
Other goods and services 3%

14. Dr. Justin Barnette
Rent Inflation
Econ B252: Fundamentals of Economics for Business II 14
Krugman at NYTimes

15. Dr. Justin Barnette
• From Krugman NY Times
• Core C.P.I., past 12 months: 3.9%
o Core Excludes Food and Energy
o Core C.P.I., past six months (annualized): 3.2%
• Core H.I.C.P., past 12 months: 1.9%
o Harmonized Index of Consumer Prices (HICP)
o Does Not Include Housing
 Europe calculates their inflation like this.
• Market Expectations for 2024 Inflation: 2.2%
Different Price Index Components
Econ B252: Fundamentals of Economics for Business II 15

16. Dr. Justin Barnette
Types of Price Indexes
• Producer Price Index (PPI) – BLS Link
o The average price received by producers.
o Includes intermediate goods as well as final goods.
o PPI’s exist for different industries.
• GDP Deflator
o Measures the average price of all final goods and services.
Econ B252: Fundamentals of Economics for Business II

17. Dr. Justin Barnette
Types of Price Indexes
Econ B252: Fundamentals of Economics for Business II
Link for updated data.

18. Econ B252: Fundamentals of Economics for
Business II
18

19. Dr. Justin Barnette
Learning Objective #3
Differentiate between
nominal and real values.
Econ B252: Fundamentals of Economics for Business II

20. Dr. Justin Barnette
• Nominal value
o Price expressed in today’s dollars
• Real value
o Value expressed in purchasing power
 Most Important
Nominal & Real Values
Econ B252: Fundamentals of Economics for Business II

21. Dr. Justin Barnette
• Anticipated versus Unanticipated Inflation
o The effects of inflation on individuals depend upon
which type of inflation exists.
Nominal & Real Values: Expectations
Econ B252: Fundamentals of Economics for Business II

22. Dr. Justin Barnette
• Inflation and interest rates
o Nominal Rate of Interest
 The market rate of interest expressed in today’s dollars
o Real Rate of Interest
 The nominal rate of interest minus the anticipated rate of
inflation
Nominal & Real Values: Interest Rates
Econ B252: Fundamentals of Economics for Business II

23. Dr. Justin Barnette
• Real Interest Rate (i) = Nominal (i) - Expected Inflation
o Nominal Interest Rate = 11%
o Expected Inflation Rate = 5%
o Real Rate = 10% - 5% = 6%
• Demonstrates how nominal interest rates are set.
o Nominal Interest Rates = Real Rate + Expected Inflation
Nominal & Real Values: Interest Rates
Econ B252: Fundamentals of Economics for Business II

24. Sept. 14, 2021 Recent Data in BLS
Consumer prices rose 5.3% in August from a year earlier,
…the lowest-earning tier of workers, “real” wages—pay adjusted for inflation—fell 0.5%
in August from a year earlier, according to data from the Atlanta Fed and the Labor
Department.
Annual wage growth for the 25% lowest-earning workers was running at 4.8% in August,
according to the Federal Reserve Bank of Atlanta.
4.8% - 5.3% = -0.5%

25. Dr. Justin Barnette
Learning Objective #4
Examine how to protect
against inflation.
Econ B252: Fundamentals of Economics for Business II

26. Dr. Justin Barnette
• Does inflation necessarily hurt everyone?
o Yes and No
• Inflation is an implicit tax.
o It transfers wealth to the government.
o Even tax cheats can’t avoid this tax!
o Governments that print money to pay their bills are
using this type of tax.
• Inflation affects people differently
o Unanticipated Positive Inflation
 Lenders Lose
 Borrowers Benefit
– Wages usually rise with inflation.
Inflationary Protection: Winners & Losers
Econ B252: Fundamentals of Economics for Business II

27. Dr. Justin Barnette
Inflationary Protection: Winners & Losers
Econ B252: Fundamentals of Economics for Business II
Link for updated data.

28. Econ B252: Fundamentals of Econ Business II
Year Predicted inflation rate Actual inflation rate
2000 3% 3%
2001 3% 2%
2002 7% 9%
2003 5% 4%
2004 4% 7%
Using the inflation data in the table above, assume that all loan
contracts matured after one year, and that they all had fixed nominal
interest rates of 10%. In which of the years given did lenders gain
relative to borrowers?

29. Econ B252: Fundamentals of Econ Business II
Year Predicted inflation rate Actual inflation rate
2003 5% 4% Lender Benefits
2004 4% 7% Lender Loses
• Lenders set interest rates to earn a profit.
• Suppose they set the interest rate to 13% for a 2004 loan.
• They were hoping to get a profit of 9% from 13% – 4% in 2004.
• In 2004, they received a profit of 6% from 13% - 7%.
• Most of their costs increased by 7% but they were expecting a 4% increase in costs.
• Borrowers on average benefit here because their wages probably increased by 7%
and now their loan payments make up a smaller portion of their paycheck.

30. Dr. Justin Barnette
• Protecting against inflation
o Cost-of-living adjustments (COLAs)
 Clauses in contracts that allow for increases in specified
nominal values to account of changes in the cost of living
 Your Annual “Raise”
 Expected Inflation
 Local Inflation Rates
– Inflation by Region
Inflationary Protection: COLAs
Econ B252: Fundamentals of Economics for Business II

31. Dr. Justin Barnette
Defining and Measuring Inflation
• Inflation in the U.S. and Around the World
• Using the CPI to calculate real prices
– Real price is the price of a good that has been
corrected for inflation.
• Example:
– 1982 price of gasoline was $1.25/gal.
– 2006 it was double that at $2.50/gal.
– CPI was about 100 in 1982 and about 200 in 2006
– 252 August 2018
– Conclusion: The real price of gasoline was about the same
in 2006 as it was in 1982.

32. Dr. Justin Barnette
Real Value Calculation
• Real Value in Year y
 RVy
o Nominal Price in Year x
 NPx
o Consumer Price Index in Year x or y
 CPIx
• Deflator for Year x = (CPIy /CPIx)
• RVy = (NPx/CPIx)*CPIy
• RVy = NPx * Deflator

33. Dr. Justin Barnette
Real Value Calculation
• RVy = (NPx/CPIx)*CPIy
• The median price of a house in 1975 was $39,000
and CPI was 52.3. What is that worth in 2023 terms
after adjusting for inflation?
o 2023 CPI 303
o 39000*(303/52.3) = 225,946

34. Dr. Justin Barnette
Minimum Wage Revisited
• Top Hat
• Historical Graph: Minimum Wage Revisited
• The minimum wage was $1.60 in 1968. The CPI in
December of 1968 was 35.6 and the CPI in
December of 2018 was 252.72. What was the value
of the minimum wage in 1968 with December 2018
as the base?