Inflation Understanding Measuring Inflation INFLATION Economic condition of

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Inflation Understanding & Measuring Inflation

Inflation Understanding & Measuring Inflation

INFLATION • Economic condition of Average Prices Rising • Jeans $20 1999 => Jeans

INFLATION • Economic condition of Average Prices Rising • Jeans $20 1999 => Jeans $40 2009 • GDP increases => output remained the SAME • All economic numbers must be adjusted for inflation – Real numbers – adjusted for inflation – Nominal numbers – NOT adjusted for inflation

Consumers notice when their paychecks start to buy less!

Consumers notice when their paychecks start to buy less!

Historical Inflation • Germany: “hyperinflation” after World War I – Currency became worthless •

Historical Inflation • Germany: “hyperinflation” after World War I – Currency became worthless • USA: Late 1970 s—Oil Crisis-- 13% low inflation since 1985 [2. 0 -3. 5%] • USA speed limit: target for inflation is well under 3. 0%

Stagflation Deflation Some factors: Technology & Globalization

Stagflation Deflation Some factors: Technology & Globalization

WHY? Your life has not yet seen significant inflation (in USA) We have enjoyed

WHY? Your life has not yet seen significant inflation (in USA) We have enjoyed low inflation for almost 30 years! Some factors: Technology & Globalization

Notice how inflation Increased in the 1970’s

Notice how inflation Increased in the 1970’s

Calculating % Change • You buy a stock at $8 per share • It

Calculating % Change • You buy a stock at $8 per share • It is now at $10 per share • What % gain did you make? Formula is: [(Ending Price – Beginning Price) / Beginning Price] * 100 (10 -8)/8 * 100 = +25%

What is in the CPI’s Basket? 17% Transportation 15% Food and beverages Education and

What is in the CPI’s Basket? 17% Transportation 15% Food and beverages Education and communication 6% 42% Housing 6% 6% 4% 4% Medical care Recreation Apparel Other goods and services

Use 2005 as the base year Measuring Inflation CPI =100 • Consumer Price Index

Use 2005 as the base year Measuring Inflation CPI =100 • Consumer Price Index (CPI) measures inflation – Pick a base year which = 100 Example: • Uses a market “basket” of goods & services – Government prices it monthly – Compares cost of the new basket to old basket • CPI = Current Price of Basket in Base Year X 100 2005 2007 $10 $12 ($12/$10) X 100 = 120 = CPI Index 120 is the CPI Index for 2007

Worksheet • Creating an Index

Worksheet • Creating an Index

Day 2

Day 2

Problems with CPI • • Substitution Bias New goods Unmeasured quality changes Housing Measurement

Problems with CPI • • Substitution Bias New goods Unmeasured quality changes Housing Measurement Basket must “evolve” with the market

The Most Popular Movies of All Times, (Inflation Adjusted)

The Most Popular Movies of All Times, (Inflation Adjusted)

Adjusting numbers for inflation • Convert Babe Ruth’s wages in 1931 to 2005 dollars:

Adjusting numbers for inflation • Convert Babe Ruth’s wages in 1931 to 2005 dollars: CPI Index (2005) Base Year Index (1931) 1931 Salary = $ 80, 000 195 15. 2 X Old Dollar Value = 2005 dollars CPI = 15. 2 1931 CPI = 195 2005 X $80, 000 = 1, 026, 316 (2005 dollars)

Calculating a CPI Index (video) • http: //www. youtube. com/watch? v=Xxk. Dh. Gl. Mqko

Calculating a CPI Index (video) • http: //www. youtube. com/watch? v=Xxk. Dh. Gl. Mqko

Practice Test

Practice Test

Key Concepts for lecture • • Inflation Defined Historical Inflation Rates Consumer Price Index

Key Concepts for lecture • • Inflation Defined Historical Inflation Rates Consumer Price Index (CPI) Adjusting numbers for inflation