Module 2b Inflation Why do we care about prices? - - What happens when prices rise? What are some things to consider? o Cost of living o Purchasing power o Is one group of people affected by inflation more than another group? Should policy makers care about rising prices? Price index: a number whose movement reflects movement in the average price level Inflation: increase in the price level (%) from one year to the next Deflation: falling price level; negative inflation rate Measuring inflation – the CPI - Consumer price index: measure of the average prices paid by urban consumers for a fixed market basket of consumption goods and services Calculated as the current cost of a fixed basket of consumer goods divided by the cost of the basket in the base period (multiplied by 100) Base year CPI = 100 Market basket - The CPI measures how much more (or less) it costs to buy a given market basket from one month. Quarter, or year to the next A market basket is the combination of goods and services that the typical consumer purchases during the period in question 4 steps to calculate the CPI 1. 2. 3. 4. Survey consumers Survey retailers Determine the costs of the market basket Compare costs of the market basket across time periods a. The base year serves as the basis for comparison with prices in another year Interpreting our CPI - CPI of 156% means prices increased by 56% from 2010 to 2020 Inflation rate was 56% from 2010 to 2020 Real value: a value expressed in units of constant purchasing power or of a reference base year Nominal value: a value expressed in dollars of the current period - RealEarn = cpi a / CPI b Nominal GDP and real GDP Nominal GDP: value of final goods and services The GDP deflator: average of the current prices of all the goods and services included in GDP expressed as a percentage of base-year prices - GDP deflator = (Nominal GDP/real GDP) * 100 GDP deflator - Since nominal and real GDP are calculated using prices from different years, they can be used to measure general price changes in the economy Unlike the CPI, the GDP deflator includes the prices of all goods and services produced in the US