1 / 54

Introduction

Introduction. What Do You Think?Who had the highest real income?Babe Ruth earning $80,000 in 1930Barry Bonds earning $10.3 million in 2001. The Consumer Price Index: Measuring the Price Level. Consumer Price Index (CPI)For any period, measures the cost in that period of a standard basket of goods and services relative to the cost of the same basket of goods and services in a fixed year, called the base year.

Mia_John
Download Presentation

Introduction

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

    2. Introduction What Do You Think? Who had the highest real income? Babe Ruth earning $80,000 in 1930 Barry Bonds earning $10.3 million in 2001

    3. The Consumer Price Index: Measuring the Price Level Consumer Price Index (CPI) For any period, measures the cost in that period of a standard basket of goods and services relative to the cost of the same basket of goods and services in a fixed year, called the base year

    4. Monthly Household Budget of the Typical Family in 2000 (Base Year)

    5. Cost of Reproducing the 2000 (Base-Year) Basket of Goods and Services in Year 2005

    6. The Consumer Price Index: Measuring the Price Level Constructing the CPI Bureau of Labor Statistics (BLS) Pick a base year Conduct the consumer expenditure survey to determine the base-year basket of goods and services Measure the current prices of the base-year basket

    7. Cost of Reproducing the 2000 (Base-Year) Basket of Goods and Services in Year 2005

    8. The Consumer Price Index: Measuring the Price Level Constructing the CPI The CPI for a given period measures the cost of living for that period relative to the base year

    9. The Consumer Price Index: Measuring the Price Level Constructing the CPI The CPI is a price index. Price Index A measure of the average price of a given class of goods or services relative to the price of the same goods and services in a base year

    10. Inflation CPI Measures the average level of prices relative to prices in the base year Rate of Inflation The annual percentage rate of change in the price level, as measured, for example, by the CPI

    11. Inflation Rate of Inflation The annual percentage rate of change in the price level

    12. Calculating Inflation Rates: 2000 - 2004

    13. Calculating Inflation Rates: 1929 - 1933

    14. Inflation Deflation A situation in which the prices of most goods and services are falling over time so that inflation is negative

    15. Adjusting for Inflation Deflating a Nominal Quantity Nominal Quantity A quantity that is measured in terms of its current dollar value Real Quantity A quantity that is measured in physical terms -- for example, in terms of quantities of goods and services

    16. Adjusting for Inflation Deflating a Nominal Quantity A process of dividing a nominal quantity by a price index (such as the CPI) to express the quantity in real terms

    17. Comparing the Real Values of a Familys Income in 2000 and 2005

    18. Adjusting for Inflation Example Home run hitters drive Cadillacs 1930 Babe Ruths salary was $80,000 2001 Barry Bonds salary was $10.3 million CPI (1982 - 84 = 1) 1930 = 0.167 2001 = 1.78 Babe Ruths real salary = $80,000/0.167 = $479,000 Barry Bonds real salary = $10.3/1.78 = $5.79 million

    19. Adjusting for Inflation Real Wage The wage paid to workers measured in terms of purchasing power The real wage for any given period is calculated by dividing the nominal (dollar) wage by the CPI for that period

    20. Adjusting for Inflation Real Wages of U.S. Production Workers An example:

    21. Nominal and Real Wages for Production Workers 1960 - 2004

    22. Adjusting for Inflation Indexing The practice of increasing a nominal quantity each period by an amount equal to the percentage increase in a specified price index Indexing prevents the purchasing power of the nominal quantity from being eroded by inflation

    23. Adjusting for Inflation Indexing to Maintain Buying Power An example:

    24. Adjusting for Inflation Example An indexed labor contract Contract specifics 1st year wage = $12/hr Real wage will rise 2 percent in the 2nd and 3rd year CPI: Year 1 = 1.00; Year 2 = 1.05; Year 3 = 1.10 Year 2 wage = W2/1.05 = $12 x 1.02 = $12.24 W2 = $12.24 X 1.05 = $12.85 Year 3 wage = W3/1.10 = 12.24 x 1.02 = $12.48 W3 = $12.48 X 1.10 = $13.73

    25. Does the CPI Measure True Inflation? 1996 report by the Boskin Commission estimated that the CPI overstates inflation by as much as 1 to 2 percentage points a year. Overstating Inflation Would unnecessarily increase government spending Would underestimate the improvements in the standard of living

    26. Does the CPI Measure True Inflation? Two Causes of the CPI Overestimation of Inflation Quality adjustment bias Substitution bias

    27. Does the CPI Measure True Inflation? Substitution Bias -- An Example Assume 2000 CPI basket Inflation: 2000 - 2005 = $300/$200 = 1.50 or 50%

    28. Does the CPI Measure True Inflation? Substitution Bias -- An Example Assume 2000 CPI basket Inflation: 2000 - 2005 w/substitution = $250/$200 = 25%

    29. Does the CPI Measure True Inflation? Economic Naturalist Why is inflation in the health care sector apparently high?

    30. The Costs of Inflation: Not What You Think Price Level A measure of the overall level of prices at a particular point in time as measured by a price index such as the CPI Relative Price The price of a specific good or service in comparison to the prices of other goods and services

    31. The Costs of Inflation: Not What You Think Observations Changes in relative price do not necessarily imply a significant amount of inflation. Inflation can be high without affecting relative prices.

    32. The Costs of Inflation: Not What You Think Observations To counteract relative price changes, government policy would have to affect the market for specific goods. To counteract inflation, the government must use monetary and fiscal policy.

    33. The Costs of Inflation: Not What You Think The Price Level, Relative Prices, and Inflation

    34. The True Costs of Inflation Noise in the Price System Inflation obscures the information transmitted by prices and reduces the efficiency of the market system

    35. The True Costs of Inflation Distortions of the Tax System Inflation, Indexation, and --- Bracket creep Capital depreciation allowance

    36. The True Costs of Inflation Observation Inflation may distort the incentives provided by the tax system for people to work, save, and invest and reduce economic growth.

    37. The True Costs of Inflation Shoe-Leather Costs The use of resources to economize on holding cash during periods of high inflation

    38. The True Costs of Inflation Shoe-Leather Costs at Woodrows Hardware Need $5,000 cash/day May withdraw $25,000 on Monday or $5,000/day Cost of a withdraw = $4/trip

    39. The True Costs of Inflation Shoe-Leather Costs at Woodrows Hardware Zero inflation Withdraw $25,000 Shoe-leather cost = $4/week

    40. The True Costs of Inflation Shoe-Leather Costs at Woodrows Hardware 10% inflation Withdraws $25,000 Average cash holding/day = $15,000 Cost of holding cash = $15,000 x 10% = $1,500

    41. The True Costs of Inflation Shoe-Leather Costs at Woodrows Hardware 10% inflation Withdraws $5,000 daily Average cash holding/day = $5,000 Cost of holding cash = $5,000 x 10% = $500 Shoe-leather cost = $4/trip x 200 trips (50 wks) = $800 Benefit of $1,000 > cost of $800

    42. The True Costs of Inflation Unexpected Redistribution of Wealth From workers to employers if wages are not indexed to inflation From lenders to borrowers

    43. The True Costs of Inflation Interference with Long-Run Planning Retirement planning Investment and business strategies

    44. Hyperinflation Economic Naturalist How costly is high inflation?

    45. Hyperinflation Economic Naturalist Fischer, Sahay, and Vegh examined 133 market economies 1960 - 96 45 episodes of high inflation (100% +) in 25 countries Real GDP/person fell by an average of 1.6%/yr Real consumption/ person fell by an average of 1.3%/yr Real investment/person fell by an average of 3.3%/yr

    46. Inflation and Interest Rates Nominal Interest Rate (market interest rate) The annual percentage increase in the nominal value of a financial asset

    47. Inflation and Interest Rates Real Interest Rate The annual percentage increase in the purchasing power of a financial asset The real interest rate on any asset equals the nominal interest rate on that asset minus the inflation rate

    48. Inflation and Interest Rates Inflation and the Real Interest Rate

    49. Inflation and Interest Rates

    50. The Real Interest Rate in the United States, 1960 - 2004

    51. Inflation and Interest Rates Observations Unexpected inflation will benefit borrowers and hurt lenders Expected inflation may not hurt lenders if they can adjust the nominal interest rates

    52. Inflation and Interest Rates Fisher-Effect The tendency for nominal interest rates to be high when inflation is high and low when inflation is low

    53. Inflation and Interest Rates in the United States, 1960 - 2004

More Related