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Inflation and Unemployment. By: Lauren, Raunak, Paul, Hussein, and Thomas. Inflation. Inflation - A general increase in the price of goods and services in an entire economy over time.

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inflation and unemployment

Inflation andUnemployment

By: Lauren, Raunak, Paul, Hussein, and Thomas

  • Inflation - A general increase in the price of goods and services in an entire economy over time.
  • Ex. Canada has an annual inflation rate of 3% this year, some prices falling, rising, and remaining constant
  • Deflation – A general decrease in the level of prices.
  • To explain why Canadian government stress the goal of price stability, let’s examine Inflation in detail, how it is measured, and its implications for the economy.
  • The Consumer Price Index.
  • Limitations of CPI (Consumer Price Index.)
  • The GDP Deflator.
  • Inflation’s Effects.
consumer price index
Consumer Price Index
  • It is a measure of price changes for a typical basket of consumer products. (see chart)
  • Item weights – The proportions of each good in the total cost of the basket of consumer good in total cost of the basket of consumer goods used to calculate CPI.
  • Base year – The survey year used as a point of comparison in subsequent years.
  • A typical price index includes many more items. Modal distribution of other basic needs in Fig 11.2
nominal vs real income
Nominal vs. Real Income.
  • Nominal Income – Income expressed in current dollar.
  • Real Income – Income expressed in constant base – year dollars. Measures the purchasing power of the household over time.
  • Real Income = nominal income


  • Cost of Living – The amount consumers must spend on the entire range of goods and services they buy.
  • E.g.  a consumer’s monthly income increases from $1000 to $1050 in a year when CPI rises from 1.0 to 1.10. If the consumer’s own monthly purchases roughly correspond to those in the representative “Shopping Basket,” he can evaluate the personal impact of inflation.
limitation of the cpi
Limitation of the CPI.
  • Consumer Differences:

CPI may not apply to consumer’s individual

cost of living because individual consumption

patterns not always match with those of the

typical urban households.

limitations of the cpi
Limitations of the CPI.

Changes in Spending Patterns.

  • Changes in consumption patterns are ongoing and gradual.
  • E.g.  More cell phones and CD players were steadily bought in the 1990s. As prices rise consumers tend to buy fewer items. These products have too high a weight in the CPI basket, meaning that the index overstates the rate of inflation.

Product Quality.

A product’s tremendous improvement in quality may change an

individual’s standard of living but it will not be reflected in the CPI.

(E.g. – Medicines or stereos).

the gdp deflator
The GDP Deflator
  • An indicator of price changes for all goods and services produced in the economy, and weights them in terms of the economy’s total output.
  • GDP deflator receives less publicity than then CPI. The results of the two indicators (GDP deflator and CPI) give similar but not identical estimates of inflation.
nominal vs real gdp
Nominal vs. Real GDP.
  • Nominal GDP – Gross Domestic Product expressed in current year.
  • Real GDP – Gives an indication of the purchasing power of an entire economy.
  • Real GDP = Nominal GDP / GDP Deflator
inflation s effects
  • If household ↑ but Inflation ↑ at a higher rate, then household’s purchasing power ↓.
  • If household ↑ and inflation rate ↑ proportionally, then household maintains purchasing power.
  • Cost – of – living adjustment clauses (COLA)  Provisions for income adjustment to accommodate changes in price level, which are included in wage contracts.
effect s cont
  • Fully Indexed Incomes  Nominal incomes that automatically increases by the rate of inflation.
  • Partially Indexed Incomes  Nominal incomes that increases by less than the rate if inflation.
  • Fixed Incomes Nominal incomes that remain fixed at some dollar amount regardless of the rate of inflation.
effect s cont1
  • Nominal Interest rate: The interest rate expressed in money terms.
  • Real interest rate: The nominal interest rate minus the rate if inflation.
  • Real interest rate = Nominal interest rate – inflation rate.
  • Nominal interest rate = desired real interest rate + inflation premium.