• Inflation - An increase in the general price level of goods and services in an economy.

• Deflation - A decrease in the general price level of goods and services in an economy.

• Be careful not to confuse increases in the price of an individual good with inflation, which measures the general increase in price of all goods.

Current measures of inflation examine a basket of goods or index of goods that are consumed or produced.

• Consumer Price Index (CPI) - An index that measures changes in the average prices of consumer goods and services

  • Food, Energy, Vehicles, Medical Care

• Producer Price Index (PPI) - An index that measures changes in the average prices of selling prices of goods and services

• Cost of Living Index

Base Year - Choose a year to serve as a baseline and normalize the index value to 100 for that year. CPI 1982-1984 serves as the base year.

• Measure changes in prices for a similar basket of goods over time to create a relative index.

CPI Price Level in 2020 = 258.844

CPI Price Level in 2019 = 255.653

CPI Price Level in 2015 = 237.002

Inflation Rate 2019-2020 = \(\frac{258.844-255.653}{255.653}X100\) = 1.25%

Inflation Rate 2015-2020 = \(\frac{258.844-237.002}{237.002}X100\) = 9.22%

• Changes in the CPI are based on a typical market basket of products that does not match the actual market basket purchased by many consumers.

• The BLS has difficulty adjusting the CPI for changes in quality.

• The use of a single base-year market basket ignores the law of demand.

• Inflation Shrinks Income

Suppose you’re making $60,000 per year and you receive a 2% raise. The inflation rate over that period is 3%.

Pct Chg in Real Income = Pct Chg in Nominal Income - Inflation Rate

Pct Chg in Real Income = -1%

• Increase in the supply of Money (Governments Print too much money)

• Low interest rates

• Supply Shocks (energy prices) or Excess Demand

• Expectation of Inflation

• Wealth - The accumulation of a stock of assets like houses, stocks, bonds, etc…

Real Interest Rate = Nominal Interest Rate - Inflation Rate

Inflation tends to be good for borrowers as you pay back money over time.

Inflation tends to hurt lenders who are locked in to low interest rates.

• Demand-Pull- A rise in the general price level resulting from excess of total spending (Too many dollars chasing too few goods)

• Cost-Push - An increase in the general price level resulting from an increase in the cost of production

• Hyperinflation - An extremely rapid rise in the general price level

• Wage-Price Spiral - A situation that occurs when increases in nominal wage rates are passed on in higher prices, which in turn, result in even higher nominal wage rates and prices.

• Stagflation - a period characterized by high inflation and high unemployment.

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