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Unformatted text preview: Inflation & Economic Growth Inflation As prices for goods and services that we consume increase, inflation is the result. The inflation rate is used to measure the rate of change in the overall price level of goods and services that we typically consume. While inflation is a regular annual occurrence in modern economic systems, it only becomes a policy concern when reaching unacceptably high levels. As we shall see, many modern economic policymakers have developed a short fuse for reacting to potential increases in inflation. To the majority of us, small doses of annual inflation seem normal and uneventful. Historically, despite bursts of sustained inflation during the Roman Empire, the Middle Ages and the reign in England of Queen Elizabeth I, prices remained broadly stable over long periods, including periods of falling prices. In fact, the average price level in Britain in the early 1930s was no higher than in the 1660s. Measuring Inflation An inflation rate gives us a consensus or aggregate measure of the price changes occurring for a number of different goods and services. When we look at individual goods, price changes often vary greatly. During the past decades the price of goods such as automobiles, gasoline, movies, health care, and housing have increased significantly. In contrast, the price of calculators and computing power has decreased substantially. There are many different measures of inflation; we will focus on the most common index known as the consumer price index (CPI). There are several steps taken in calculating the current CPI: 1. Measuring the price changes of all goods is complex if not impossible. Instead a market basket of goods is used which represents many of the goods and services that we consume frequently. Items such as housing, food, transportation, communication, etc. are represented by specific goods whose price changes can be accurately recorded over time. 2. The individual items in the market basket are weighted as to their relative importance. The price of gasoline will receive a more significant weighting than that of tomatoes since we spend a greater percentage of our budget on fuel. 3. The prices of individual items and their respective weights are used in calculating the CPI. The inflation rate for 2002 represents the rate of price increases of the weighted basket of goods (the CPI) since 2001. The calculation is: Inflation rate (2002) = CPI (2002) - CPI (2001) x 100 CPI (2001) Nominal GDP Growth vs. Real GDP Growth GDP, or Gross Domestic Product is the value of all the goods and services produced in a country. The Nominal Gross Domestic Product measures the value of all the goods and services produced expressed in current prices. On the other hand, Real Gross Domestic Product measures the value of all the goods and services produced expressed in the prices of some base year. An example: Suppose in the year 2000, the economy of a country produced $100 billion worth of goods and services based on year...
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This note was uploaded on 01/31/2010 for the course ACCOUNTING 30516 taught by Professor Whoever during the Spring '09 term at American Academy of Art.
- Spring '09