Transcript Gross Domestic Product

Inflation
Define Inflation / Deflation
 Inflation – a general increase in the price level
 Deflation – a general decrease in the price level
 Hyperinflation – extraordinarily high inflation
 (Germany 1923 – prices doubled roughly every 2 days)
Measuring Inflation
 Question: How do we measure inflation?
 Answer:
With a price index!
Measuring Inflation
 Common Price Indexes
 CPI (Consumer Price Index)
 PPI (Producer Price Index)
 GDP Deflator
 Each focuses on a different part of the economy
 CPI uses a market basket typically faced by the household
sector.
 PPI uses a market basket typically faced by the private sector
(the Firms).
 CPI and PPI is tracked by the Bureau of Labor
Statistics
Measuring Inflation
Broad Categories of the CPI
4%
3%
3% 4%
6%
42%
6%
15%
17%
Housing
Transportation
Food & Beverages
Medical Care
Recreation
Clothing
Education
Communication
Other
Calculating Inflation
Charlotte, NC produces two goods: Panther’s footballs and Hornet’s basketballs.
Assume a market basket of 3 footballs and 4 basketballs:
1.
2.
3.
4.
Year
Price of
Footballs
Price of
Basketballs
Year 1
$10
$12
Year 2
$12
$15
Year 3
$14
$18
Calculate Cost of the Basket for each year.
Calculate the CPI for each year (using Year 1 as the base year)
Calculate the Inflation Rate from Year 1 to Year 2.
Calculate the Inflation Rate from Year 2 to Year 3.
Calculating Inflation
Charlotte, NC produces two goods: Panther’s footballs and Bobcat’s basketballs.
Assume a market basket of 3 footballs and 4 basketballs:
Year
Price of
Footballs
Price of
Basketballs
Year 1
$10
$12
Year 2
$12
$15
Year 3
$14
$18
1. Compute the Cost of the Basket:
Cost in Year 1 = (3 × $10) + (4 × $12) = $78
Cost in Year 2 = (3 × $12) + (4 × $15) = $96
Cost in Year 3 = (3 × $14) + (4 × $18) = $114
Calculating Inflation
Charlotte, NC produces two goods: Panther’s footballs and Bobcat’s basketballs.
Assume a market basket of 3 footballs and 4 basketballs:
Year
Price of
Footballs
Price of
Basketballs
Year 1
$10
$12
Year 2
$12
$15
Year 3
$14
$18
2. Calculate the CPI for each year (using Year 1 as the base year):
CPI in Year 1 = ($78/$78) × 100 = 1 × 100 = 100
CPI in Year 2 = ($96/$78) × 100 = 1.2308 × 100 = 123.08
CPI in Year 3 = ($114/$78) × 100 = 1.4615 × 100 = 146.15
Calculating Inflation
Charlotte, NC produces two goods: Panther’s footballs and Bobcat’s basketballs.
Assume a market basket of 3 footballs and 4 basketballs:
Year
Price of
Footballs
Price of
Basketballs
Year 1
$10
$12
Year 2
$12
$15
Year 3
$14
$18
3. Calculate the Inflation Rate from Year 1 to Year 2.
4. Calculate the Inflation Rate from Year 2 to Year 3.
Inflation rate for Year 2 = [(123.08 – 100)/100] × 100% = 23.08%
Inflation rate for Year 3 = [(146.15 – 123.08)/123.08] × 100% = 18.74%
CPI, PPI & GDP Deflator History
Comparisons
 CPI vs. GDP Deflator
 CPI measures the prices of only the goods and services bought
by the households
 GDP Deflator measures the prices of all goods and services
produced



Thus an increase in the price of goods bought by firms or the
government would not show up in the CPI, but would increase the
GDP Deflator
GDP Deflator does only includes domestic goods
GDP Deflator allows the market basket of goods to change over
time
Comparisons
 The difference in each price index is usually not
large.
 CPI usually overstates inflation

Estimated to overstate inflation between 0.8 and 1.6 %... with
1.1% being a “best estimate”
 GDP Deflator tends to understate inflation
Biases in the CPI
 Substitution Bias
 Prices go up, households substitute away from the higher
priced goods
 Introduction of New Goods
 Effectively increases the purchasing power of the dollar. CPI
does not account for this.
 Unmeasured Changes in Quality
 Not all price increases are due to cost of living increases
Nominal & Real Interest Rates
 We see inflation in interest rates as well.
Real Interest Rate = Nominal Interest Rate – Inflation Rate
 What matters is the purchasing power of money.
Nominal & Real Interest Rates
Real Interest Rate = Nominal Interest Rate – Inflation Rate
 Example: Sally deposits $1,000 into a bank account that pays an
annual interest rate of 10%. A year later, she withdraws $1,100.
(remember to focus on the purchasing power of the money)
 If there is zero inflation, her purchasing power has risen by 10%.
 If there is 10% inflation, her purchasing power has remained the
same.
 If there is 12% inflation, her purchasing power has declined by
about 2%.
Inflation Winners & Losers
 Borrowers vs. Lenders
 Expected Inflation vs. Unexpected Inflation
 Unexpected Inflation can transfer wealth from lenders to
borrowers
 The payments on a 30 year fixed mortgage remain constant,
but the value of the dollar decreases with inflation. The
lenders in these cases receive less “real money.”
Biggest Movie Ever?
 What is the biggest movie ever?
 Avatar’s Box Office Receipts were roughly $760
million domestically and just under $3 Billion world
wide.
 What if we adjust
other movies for
inflation?
 Nominal Records – Real Records