Inflation Prices, and the SR Phillips Curve
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Key Points
CPI interpretation, calculation, problems, use GDP Deflator interpretation and use Real and Nominal Interest rates Inflation in the Short-Run Keynesian Demand-pull, cost push Wage- price Spirals Wage Price Guidelines Short-run Phillips Curve Growth rates & Rule of 72/70/69
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Course Issues
Inv game round 2 Clicker points More than half done-start studying for the final exam Wikis EC HW Q&A posted Midterms in other courses? Business School update
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In the News?
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CPI Uses
Used for:
tracking changes in cost of living/ inflation Deflating nominal variables adjust contracts for inflation "COLAs"
Not a true cost of living index Note large role of housing
Medical, etc?
Core CPI w/o energy & food
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How the CPI is Calculated.
Consumer Expenditure Survey (CES) irregular typical consumer's "basket" of goods in base year
30,000 individuals and families, 80,000 items 2001-02
Monthly collection of data on prices of all items in the basket - 200 item categories, 80,000 prices 82-84 base year (2000-01 survey), 87 urban areas CPI all urban CPI-U (and CPI-W wage and clerical)
Each year's expenditures on quantities from BASE year divided by base year expenditures The weight on each price reflects that good's relative importance in the CPI's basket in the BASE YEAR Fixed base year weights
Chained CPI average of current and previous quantities
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Calculating a CPI - Example
2. Using the following price and quantity data, calculate the CPI for years 0-2 year Price A Quant A Price B Quant B Expenditure Index
0 1 2 $1 $2 $5 100 70 20 $1 $1 $0.50 100 100 2000 200 300 550 100 150.0 Exp1/Exp0 275.0 Exp2/Exp0
a. Calculate a consumer price index for each year (hint: remember base year quantity only) see above note it is Pt*Q0 b.What are prices in year 2 in year 0 dollars? What does this mean?
275 the market basket that cost $100 in year 0 now costs $275 i.e., prices have risen more than 2.75 fold c. According to your index, what's been happening to prices on the island? What has really been happening? Index indicates rapid increase in prices, yet only Price of A has increased five-fold, B has actually halved d. In what ways has the index misstated price changes?
By using base year quantities, weighted the increase in A's much prices too heavily and the decline in B's too little
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Drawbacks of the CPI?
o Substitution bias
o fixed weights
o Introduction of new goods o Unmeasured changes in quality o CPI may overstate true increase living by .5%
o Hence understated Q estimates
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Real and Nominal GNP 1929-33
Nominal GNP GNP (bil) Deflator
1929
Pop (mil) 100 77
Real GNP 1929$
Real Per Capita
103 56
121,767 (103/(100/100) 103/(.122) = )=103 844 125,579 (56/(77/100))= 72.7/(.126)= 72.7 577
1933
What happened to total spending during the depression? nominal GNP= P*Q down 45.6% ((103-56)/103) What happened to prices? Down 23% ((100-77)/100) What happened to real output? Down 29.4% ((10372.7)/103) What happened to real per capita output? Down 31.6% ((844-577)/844)
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Applications
CPI news DeLong Inflation DeLong Phillips Curve
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Inflation, Deflation, Hyperinflation
Anticipated Inflation
Index: Use COLA's Shoe Leather/ Menu costs
Unanticipated Inflation
Distorts function of price system
relative and absolute price changes confused Transactions costs- search
Transfers wealth from Lenders to borrowers real interest rate Tax distortions - Taxed on nominal income
Deflation
Japan U.S. depression 33% decline in prices
Hyperinflation
Germany 8/22-11/23 - 322% monthly; quadrupled Hungary 1946 tripled daily Zimbabwe's 231,000,000%
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Inflation in the Short-Run - Keynesian
Demand Pull p,y up Cost Push p up, y down Stagflation Supply Shocks Wage-Price Spiral Self-Limiting Prices rise inflation Stop
Dynamic versus Static
Up v up faster
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Short-Run Phillips Curve
Short-Run Phillips Curve Inflation inversely related to Unemployment Rate of Inflation (%) & Level of Unemployment (%) from Aggregate D & S downward sloping tradeoff between U and inflation controversial
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GDP Deflator
1929 Year GDP 12.62 deflator 27 54 109 119.5 1970 1980 2004 2007
a.What does the value of the GDP deflator in 2006 mean? b. using the rule of 72 (or 70 or 69), calculate the average annual inflation rate between 1970 and 1980; between 1980 and 2004 70-80: 72/x=10 -> x=7.2% per year 80-04: 72/x=24 ->x=3% per year c. calculate the average annual percentage increase in prices (inflation) for 1929-2006 P06=P29*(1+g)77 or P06=P29e77g ln(P06/P29)/77=g -> ln(116.5/12.62)/77=.028865 or 2.9% per year
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Selected HW
Here
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