Chapter7Summary - 1 Chapter 7 Summary Tucker Macroeconomics...

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Chapter 7 Summary Tucker , Macroeconomics for Today , 5th Edn 1. Inflation is an increase in the average price level. Deflation is a decline in the average price level. During the course of inflation, some prices may go up and other prices may go down. Further, even among the products or services whose prices rise it is the case that the percentage changes in prices would not all be the same. Inflation is easy to measure in a one- product economy—you simply measure the annual percentage change in the price of X (the single product being produced). In a multi-product economy one has to determine how the construct an average of the percentage change in individual prices. We demonstrated in class that in a multi-product world, the best way to calculate the average of the percentage changes in prices is to “weight” the percentage changes by the relative importance of each item in the consumer’s budget. Calculated in this way, price increases for products that most consumers do not buy would not have much of an effect on the calculated changes in the cost of living (which is what a price index is designed to measure). 2. I presented two ways to measure inflation in class: (a) to compare the cost of buying a fixed quantity of goods in two different years, and then calculate the percentage increase in this total cost as the measure of inflation; and (b) to calculate the weighted average of the percentage changes in prices. (where the weights are the relative importance of the item in the consumer’s budget). Both procedures yield the same result. The reason that I emphasize the second in class is because it is the method used by the Bureau of Labor Statistics in calculating the consumer price index. 3. Consider the following two product example. I will work out both methods (a) and (b) above to show that they are comparable. Year P(x) Q(x) P(y) Q(y) Total Expenditures on X and Y 2000 $10 40 $20 30 $1000 2001 $12 40 $22 30 $1140 The ratio of $1140/$1000 = 1.14 = 114% which yields a price index value (2000 = 100, the base year) of 114. This tells us that the weight average the prices of the products purchased in 2000 has increased by 14% from 2000 to 2001. (Note: This calculation assumes that consumers buy the same amount of X (40) and Y (30) even though the prices of X and Y change from year to year. This is a problem in the construction of “fixed
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This note was uploaded on 04/02/2008 for the course ECN 211 taught by Professor Kingston during the Spring '08 term at ASU.

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Chapter7Summary - 1 Chapter 7 Summary Tucker Macroeconomics...

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