Lecture 01 - Intro and Review

A price index is weight average of prices an economy

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> A price index is weight-average of prices. An economy has many goods, hence many prices, so a price index gives us a “representative price” to use and compare. Different price indices can represent different things to different people.
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Price Indices ࠵? ࠵? > GDP Deflator – necessary index to deflate nominal GDP into Real GDP. (average price of output) > CPI (Consumer Price Index) – price index that tracks the weight value of a basket of typical consumer goods. (average price of consumption) > PPI (Producer Price Index) – price index that tracks the weight value of a basket of typical producer goods. (average price of production) > Personal Consumption Index (PCE) – price index that is typically used by the FED that strips the CPI of the more volatile energy components.
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> Inflation is given by: ࠵? & = ࠵? & − ࠵? &’( ࠵? &’( ∗ 100 > GDP Deflator ( ࠵? ࠵? ) ࠵? ࠵? = ࠵?࠵?࠵?࠵?࠵?࠵?࠵? ࠵?࠵?࠵? & ࠵?࠵?࠵?࠵? ࠵?࠵?࠵? & = $࠵? & ࠵? & > CPI ( ࠵? ࠵? ) ࠵? ࠵? = ࠵?࠵?࠵?࠵?࠵?࠵? ࠵?࠵?࠵?࠵?࠵? & ࠵?࠵?࠵?࠵?࠵?࠵? ࠵?࠵?࠵?࠵?࠵? OPQR SRPT ∗ 100 Price Indices ࠵? ࠵?
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Price Index and Inflation Source: U.S. Bureauof Labor Statistics
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CPI and the GDP Deflator ࠵? ࠵? used to measure inflation GDP Deflator CPI Reported Quarterly Reported Monthly Bureau of Economic Analysis Bureau of Labor Statistics Exports Only Imports Only All Final Goods/Services Typical Consumer Goods No Basket (all goods) Fixed Basket Can underestimate inflation (infinite substitution) Can overestimate inflation (no substitution)
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> Welfare Impact ࠵?࠵?࠵?࠵? ࠵?࠵?࠵?࠵? = WXYZ[P\ ]P^R _TZ‘R aRbR = ] c _ c if prices rise (inflation) and nominal wages are “sticky” in the short-run (sticky wages), then real wages decrease. > Inefficient Allocations Uncertainty in production (menu cost) Fisher Effect (expected inflation tomorrow can cause interest rates to rise today) Deflations can lead to more problematic effects. (Deflationary Spiral)* ---theory! Why Care About Inflation?
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Okun’s Law Figure 2-5 Changes in the unemployment rate versus output growth in the United States, 1960–2010 KEY POINTS 1. On average, each 1% decrease in output growth (y t ) coincides with a 0.4% increase in the UE rate. 2.To hold changes in UE at 0%, output growth needs to be around +3%. Why?
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1. The y-axis is a change in the rate of change of the price level. So movement upwards is accelerating inflation.
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