Chapter 7 Inflation

Definitions: - Inflation, Disinflation, Deflation,

Hyperinflation, and Core Inflation
Inflation is a problem since it reduces consumers
purchasing power.

As an example of hyperinflation, one U.S. dollar was

equal to one million German marks in 1923, compared
to 8.9 marks in 1919.

Brazil experienced 1,000% inflation between 1989 and

1994, which means that prices rose by 10 times in a
year.

CPI allows us to track the changes in the average price

level from an established base year. (1982-84)

CPI is published every month by the BLS.

Definition of a Market Basket

Whats included Market Basket?

CPI = CYP / BYP * 100

CPI versus GDP Chain Index

ARI = (CYCPI PYCPI) / PYCPI * 100

Effects of inflation

Inflation helps borrowers, and those with financial

wealth
Inflation hurts lenders, savers, those on fixed income

Unaffected by inflation are those whose income is

flexible and or have COLAs.
Definition of Nominal Income
Definition of Real Income
RI = NI / CPI * 100
RI = NI / CPI (in hundredths or decimal)
% in real income =
% in nominal income - %

in CPI (inflation)

Calculation of real income

The formula for a real value is Real money amount =

Nominal money amount (CPI for the base year
CPI for the current year).

In the base year, real and nominal values will be equal.

Criticisms of CPI
Because the market basket may be
unrepresentative, it can overstate or understate
inflation for certain groups.
It does not measure quality therefore it overstates
inflation

 Substitutes (the law of demand) are ignored

therefore it overstates inflation

Definition of Nominal Interest rates

Definition of Real Interest rates
Types of inflation
Definition of Demand Pull inflation and when it occurs
Definition of Cost Push inflation and when it occurs
Stagflation, Wage Spiral
Expectations and inflation can cause inflation