Inflation Ch.8 - Professor Daniel Forsberg PDF

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Professor Daniel Forsberg...

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HInflation- an overall increase in the level of prices prevalent in an economy over time HInflation rate- the rate at which the overall price level increases on an annual basis HConsumer price index H a price index providing: H“A measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services” HThe basket is determined by using consumer information provided by expenditure surveys. HCPI is calculated by the price changes that are weighted by the importance of the goods HCalculating the cost of the weighted basket in the base year: HBasket cost (base) = (P(b) good 1 x Q(b) good 1) + (P(b) good 2 x P(b) good 2) + … HCalculating the cost of the weighted basket in the current year: HBasket cost(t) = (P(t) good 1 x Q(t) good 1) + (P(t) good 2 x Q(t) good 2) +... HCalculating the value of CPI in the current year: HCPI = Basket cost (t) / Basket cost (base) x 100 HCalculating the inflation rate: HInflation rate = CPI(new) - CPI(old) / CPI(old) x 100 HCPI Limitations: HChanges to the market basket are infrequent and may overstate changes overall price level HCPI level does not account for changes in quality HCPI only includes “out of pocket” healthcare expenditures and not the total cost of healthcare HProducer price index (PPI)- measures the average change over time in the selling prices received by domestic producers for their output HImplicit GDP deflator- the ratio of the current dollar value of GDP to its corresponding chained-dollar value, multiplied by 100. HConverting nominal values to real values: HReal value = nominal value/price index x 100 HCost of inflation: HShoe leather HMenu costs HDiscourages saving & lending HSources of inflation: HNegative supply shocks (short-run) HPositive demand shocks (short-run) HPrinting money (long-run) HDemand-pull inflation- if too much money chasing too few goods; prices rice as output rises and unemployment falls HCost-push inflation- a supply shock resulting from a rise in the cost of the inputs of production; price rises as output fall HIn recent years, most stable developed economies typically have inflation rates between

0% to 4%. HMoney- an asset that is socially and legally accepted as payment for goods/services HFunctions of money: HMedium of exchange HStore of value HUnit of measure HFiat money and commodity money: HFiat money has no intrinsic value, while commodity money is based on a good (the price of dollars were tied to the value of gold using a fixed rate) HTransaction costs- the costs that must be incurred in order to participate in a market (search costs, informational costs, bargaining costs, exchange fees, and transportation costs) HGold standard- where a country fixes the value of its currency in terms of a specific amount of gold. HDeflation- a general decrease in the price level HDisinflation- a reduction in the rate of inflation HHyperinflation- an extremely high rate of inflation, generally above 100% per year. HRelative price- the price of a good expressed in terms of some other good HExample: if the price of a candy bar = $0.50 and the price of a burger = $1.00, then the relative price of a burger is two candy bars. HQuantity Theory of Money: HM x V = GDP = P x Q HM = money supply HV = velocity of money HP = average price level HQ = quantity of output HThe federal reserve system- the central bank of the united states. The FED has the power to enact monetary policy. HThe FED’s Monetary Policy Tools: HOpen Market OperationsHThe buying and selling of U.S. Treasury debt securities HReserve Requirements HSetting the minimum amount of required bank reserves HThe Discount Rate HThe interest rate the FED charges banks for overnight loans HThe loanable funds market: HConceptual graphical representation of all loan markets in which borrowers (demand) and lenders (supply) interact together. HExpansionary Monetary Policy: HBuying U.S. Treasury HLowering the Reserve Requirement HLowering the Discount Rate HContractionary Monetary Policy: HSelling U.S. Treasury Securities HRaising the Reserve Requirement

HRaising the Discount Rate HMonetary Policy: HParts of the aim of monetary policy (like fiscal policy) are to smooth the business cycle. HThe main goal of the FED is to maintain stable prices and thereby support conditions for long-term economic growth and maximum employment....