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Chapter 23246
Chapter 23246
Living
Chapter 23
Copyright 2001 by Harcourt, Inc.
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InflationRatein Year2
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Year
Price of
Hot dogs
Price of
Hamburgers
2001
$1
$2
2002
$2
$3
2003
$3
$4
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($1 per hot dog x 4 hot dogs) + ($2 per hamburger x 2 hamburgers) = $8
2002
($2 per hot dog x 4 hot dogs) + ($3 per hamburger x 2 hamburgers) = $14
2003
($3 per hot dog x 4 hot dogs) + ($4 per hamburger x 2 hamburgers) = $20
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2002
2003
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2003
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GDP Deflator
The GDP deflator is calculated as follows:
NominalGDP
GDPdeflator=
100
RealGDP
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6% 5% 5%
Housing
Food/Beverages
Transportation
40%
17%
16%
Medical Care
Apparel
Recreation
Other
Education and
communication
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Substitution Bias
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CPI
10
GDP deflator
0
1965
1970
1975
1980
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1985
1990
1995
2000
Dollar Figures
from Different Times
Price indexes are used to correct
for the effects of inflation when
comparing dollar figures from
different times.
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Dollar Figures
from Different Times
Salary1999 = Salary1931
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Pricelevelin1999
Pricelevelin1931
Pricelevelin1999
Salary1999 = Salary1931
Pricelevelin 1931
166
= $80,000
15.2
= $873,684
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1939
$920
2. Star Wars
1977
798
1965
638
4. Titanic
1997
601
1982
601
1956
587
7. J aws
1975
574
8. Doctor Zhivago
1965
543
1967
485
1937
476
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Indexation
When some dollar amount is
automatically corrected for inflation
by law or contract the amount is said
to be indexed for inflation.
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= 15% - 10% = 5%
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Nominal
interest rate
10
0
Real interest rate
-5
1965
1970
1975
1980
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1985
1990
1995 1998
Summary
The consumer price index shows the cost
of a basket of goods and services relative
to the cost of the same basket in the base
year.
The index is used to measure the overall
level of prices in the economy.
The percentage change in the CPI
measures the inflation rate.
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Summary
The consumer price index is an imperfect
measure of the cost of living for the
following three reasons: substitution
bias, the introduction of new goods, and
unmeasured changes in quality.
Because of measurement problems, the
CPI overstates annual inflation by about
1 percentage point.
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Summary
The GDP deflator differs from the CPI
because it includes goods and services
produced rather than goods and services
consumed.
In addition, the CPI uses a fixed basket
of goods, while the GDP deflator
automatically changes the group of
goods and services over time as the
composition of GDP changes.
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Summary
Dollar figures from different points in
time do not represent a valid
comparison of purchasing power.
Various laws and private contracts use
price indexes to correct for the effects
of inflation.
The real interest rate equals the
nominal interest rate minus the rate of
inflation.
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Graphical
Review
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6% 5% 5%
Housing
Food/Beverages
Transportation
40%
17%
16%
Medical Care
Apparel
Recreation
Other
Education and
communication
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CPI
10
GDP deflator
0
1965
1970
1975
1980
Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.
1985
1990
1995
2000
Nominal
interest rate
10
0
Real interest rate
-5
1965
1970
1975
1980
Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.
1985
1990
1995 1998