Ch006 - Chapter 6 Measuring the Price Level and Inflation...

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Chapter 6 Measuring the Price Level and Inflation Overview This chapter looks at the measurement third of the major macroeconomic variables: the rate of inflation. In particular, it points out how to avoid the confusion in comparing economic conditions over time created by price changes. The chapter looks at how prices and inflation are measured and how to adjust data to eliminate the effects of price changes. It looks at why high inflation can significantly impair an economy's performance to the extent that economic policymakers claim a low a stable rate of inflation as one of their chief objectives. Core Principles Cost-benefit Principle – the principle is applied to a consumer deciding how much cash to hold during a time of inflation. The example also illustrates the shoe-leather costs of inflation. Equilibrium Principle – the text takes a macro view of price changes in individual markets, noting “Multiply this example a million times, and you will gain a sense of how the price system achieves a truly remarkable degree of economic coordination.” Important Concepts Covered Consumer price index Rate of inflation/deflation Nominal versus real Fisher Effect Teaching Objectives After completing this chapter, you want your students to be able to: Define inflation, deflation and the consumer price index Explain how the CPI is measured Calculate the price index and the rate of inflation Convert from real to nominal values Explain the causes and effects of the CPI overestimating true inflation Discuss the five costs of inflation Define hyperinflation and its effects 59
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Define and calculate the nominal and real rate of interest Discuss the relationship between the inflation rate and interest rates Answers to Text Questions and Problems Answers to Review Questions 1. The official cost-of-living index, the CPI, measures the cost of buying a particular “basket” of goods and services, relative to a specified base year. The official basket of goods and services is intended to correspond to the buying patterns of the typical family. However, a family whose buying patterns differ from the average may find that changes in its cost of living are not well captured by the official CPI. For example, if the price of peanut butter rises sharply, the cost of living of a family that buys much more peanut butter than the typical family will increase more than the CPI, all else being equal. 2. The price level measures the cost of a basket of goods and services, relative to a base year. The CPI is one standard measure of the price level. In contrast, the rate of inflation is the annual percentage change in the price level. For example, suppose that the basket of goods and services on which the CPI is based
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This note was uploaded on 04/15/2008 for the course ECO 181 taught by Professor Cherry during the Spring '07 term at SUNY Buffalo.

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Ch006 - Chapter 6 Measuring the Price Level and Inflation...

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