Basic Definition of Inflation
the growth of the overall level of prices in an economy. caused by an increase in amount of Money.
What is CPI?
Consumer Price Index, a measure of the price level based on the consumption patterns of a typical consumer.
How is the price index calculated?
(Basket price)/(Basket price in base year) x 100 = Price index
how is inflation rate calculated?
(P2 - P1)/P1 (Base year) x 100
How is CPI used to compare dollar values over time?
Price level today/Price level in earlier time x price in earlier time = price in today's dollars
Concerns of CPI accuracy
Substitution - exaggeration of the effects of the price increase due to lack of inclusion of substituted goods
Changes in Quality - CPI does not account for increase in quality in product and service of good being purchased
New Goods, Services, and Locati
Chained CPI Characteristics
Updated Monthly and accounts for substitution bias, thus decreasing upward bias of regular CPI
Nominal Vs Real Wage
Nominal - how much you're actually getting on your pay check numerically
Real Wage - how much purchasing power we have when accounting for inflation
What problems does inflation bring?
Show-Leather costs: Inflation is essentially a tax on holding money. Therefore shoe leather costs are the costs incurred from people changing behavior to avoid holding money.
Money illusion:
Menu Costs:
Future Price level uncertainty: Long term contracts
Same standard of living equation (how much you need to make in order to keep the same standard of living)
Current Salary * (New CPI/Old) = How much required for same standard of living.
How wealth is redistributed via inflation vs deflation between borrowers and lenders:
When inflation occurs, borrowers gain due to a decrease in the real value of the amount owed.
When deflation occurs, lenders gain due to an increase in the real value of the amount owed.
Equation of Exchange:
M x V = P x Y
Quantity of Money x Velocity = Price level x GPD
Direct relationship between prices and the size of the money supply.
Cause of inflation
Inflation is caused by increases in a nation's money supply relative to quantity of real goods and services in an economy.
Governments often increase the money supply too quickly when they are in debt or when they desire a short-run stimulus for the econo
Definition of Aggregate Demand:
Total demand for final goods and services in an economy.
AD = C + I + G + NX
Any increase shifts graph to right
Any decrease shifts Graph to left
Reasons for negative relationship between quantity of AD and price level.
Wealth Effect: When price level increases, real GDP decreases, therefore making real purchasing power decreased.
Interest Rate effect: When savings decline, this equals a decrease in the quantity of investment, thus leading to a leftward shift in
Shifts is LRAS
Y* changes when a nation's ability to produce output is adjusted. Changes in:
Technology: As it allows firms to produce more with the same amount of resources
resources: An increase in Oil, increases output
institutions: Quality of government regulations,
U=U*
Natural rate of Employment = U*
Adjusted rate of employment, in reference to national output = U
Effects which shift SRAS curve
All LRAS shifts cause SRAS shifts in the same direction.
Changes that directly affect firm's costs of production and form their incentives for supply.
Anything that causes firm costs of production to go up, shifts line to the left.
Changes in input or res
SRAS
Total supply of the market in the short term
Y*
Nations output or GDP