©2004 prentice hall publishing ayers/collinge, 1/e 1 chapter 7 “inflation”

1 ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e

CHAPTER 7CHAPTER 7“Inflation”“Inflation”

CHAPTER 7CHAPTER 7“Inflation”“Inflation”

MACROECONOMICS: MACROECONOMICS: EXPLORE & APPLYEXPLORE & APPLYby Ayers and Collingeby Ayers and Collinge

MACROECONOMICS: MACROECONOMICS: EXPLORE & APPLYEXPLORE & APPLYby Ayers and Collingeby Ayers and Collinge


Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

1.1. Describe inflation rates in the U.S. and Describe inflation rates in the U.S. and other countries.other countries.

2.2. Discuss the cost of inflation that cause Discuss the cost of inflation that cause low inflation to be a macroeconomic low inflation to be a macroeconomic goal.goal.

3.3. Compute, interpret, and use a price Compute, interpret, and use a price index to compute a real value.index to compute a real value.

1.1. Describe inflation rates in the U.S. and Describe inflation rates in the U.S. and other countries.other countries.

2.2. Discuss the cost of inflation that cause Discuss the cost of inflation that cause low inflation to be a macroeconomic low inflation to be a macroeconomic goal.goal.

3.3. Compute, interpret, and use a price Compute, interpret, and use a price index to compute a real value.index to compute a real value.


Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

4.4. Identify problems with price indexes and Identify problems with price indexes and efforts to improve them.efforts to improve them.

5.5. (E&A) Explain how people respond to (E&A) Explain how people respond to inflation, and how that affects its inflation, and how that affects its measurement.measurement.

4.4. Identify problems with price indexes and Identify problems with price indexes and efforts to improve them.efforts to improve them.

5.5. (E&A) Explain how people respond to (E&A) Explain how people respond to inflation, and how that affects its inflation, and how that affects its measurement.measurement.


7.17.1THE GOAL OF LOW INFLATIONTHE GOAL OF LOW INFLATION7.17.1THE GOAL OF LOW INFLATIONTHE GOAL OF LOW INFLATIONAlongAlong with economic growth and high with economic growth and high

employment, employment, low inflationlow inflation is the third is the third fundamental goal of the economy.fundamental goal of the economy.

InflationInflation is a persistent increase in the is a persistent increase in the price level.price level.

The The price levelprice level refers to the prices of refers to the prices of goods and services, when considered in goods and services, when considered in the aggregate.the aggregate.

AlongAlong with economic growth and high with economic growth and high employment, employment, low inflationlow inflation is the third is the third fundamental goal of the economy.fundamental goal of the economy.

InflationInflation is a persistent increase in the is a persistent increase in the price level.price level.

The The price levelprice level refers to the prices of refers to the prices of goods and services, when considered in goods and services, when considered in the aggregate.the aggregate.


• The The inflation rateinflation rate is the annual is the annual percentage increase in the price level.percentage increase in the price level.

• In the U.S., as long as the inflation rate In the U.S., as long as the inflation rate from year to year stays at around 3% per from year to year stays at around 3% per year, Americans are satisfied that the year, Americans are satisfied that the goal of low inflation has been goal of low inflation has been accomplished.accomplished.

• If the inflation rate is above 3%, people If the inflation rate is above 3%, people expect the government to take action to expect the government to take action to “fight” inflation.“fight” inflation.

• The The inflation rateinflation rate is the annual is the annual percentage increase in the price level.percentage increase in the price level.

• In the U.S., as long as the inflation rate In the U.S., as long as the inflation rate from year to year stays at around 3% per from year to year stays at around 3% per year, Americans are satisfied that the year, Americans are satisfied that the goal of low inflation has been goal of low inflation has been accomplished.accomplished.

• If the inflation rate is above 3%, people If the inflation rate is above 3%, people expect the government to take action to expect the government to take action to “fight” inflation.“fight” inflation.

The Goal of Low InflationThe Goal of Low InflationThe Goal of Low InflationThe Goal of Low Inflation


The U.S. Inflation RateThe U.S. Inflation RateSelected YearsSelected Years


YearYear Inflation RateInflation Rate

19451945 2.32.3

19461946 8.38.3

19471947 14.414.4

19481948 8.18.1

19491949 -1.2-1.2

19501950 1.31.3



19551955 -.4-.4

19601960 1.71.7

19651965 1.61.6

19701970 5.75.7

19751975 9.19.1

19801980 13.513.5





19851985 3.63.6

19901990 5.45.4

19911991 4.24.2

19921992 3.03.0

19931993 3.03.0

19941994 2.62.6




Inflation – A World-WideInflation – A World-WidePhenomenonPhenomenon

Inflation – A World-WideInflation – A World-WidePhenomenonPhenomenon

The CIA estimates that the average inflation in The CIA estimates that the average inflation in the world in 2000 was 25%.the world in 2000 was 25%.Most of these severely high rates occurred in Most of these severely high rates occurred in

developing countries.developing countries.The developing countries inflation rates ranged The developing countries inflation rates ranged

between 5% and 60% as compared to the range in between 5% and 60% as compared to the range in developed countries which was between 1% and developed countries which was between 1% and 3%.3%.

Political instability can result from severe Political instability can result from severe inflationinflation

The CIA estimates that the average inflation in The CIA estimates that the average inflation in the world in 2000 was 25%.the world in 2000 was 25%.Most of these severely high rates occurred in Most of these severely high rates occurred in

developing countries.developing countries.The developing countries inflation rates ranged The developing countries inflation rates ranged

between 5% and 60% as compared to the range in between 5% and 60% as compared to the range in developed countries which was between 1% and developed countries which was between 1% and 3%.3%.

Political instability can result from severe Political instability can result from severe inflationinflation


Country - Year 2000Country - Year 2000 Inflation RateInflation Rate

EcuadorEcuador 9696

ZimbabweZimbabwe 6060

YugoslaviaYugoslavia 4242

UkraineUkraine 25.825.8

RussiaRussia 20.620.6

VenezuelaVenezuela 1313

MexicoMexico 99

Inflation Rates in Selected Inflation Rates in Selected CountriesCountries



Country - Year 2000Country - Year 2000 Inflation RateInflation Rate

BrazilBrazil 66

BoliviaBolivia 4.44.4

U.S.U.S. 3.43.4

U.K.U.K. 2.42.4

GermanyGermany 2.02.0

ChinaChina 0.40.4

JapanJapan -0.7-0.7

ArgentinaArgentina -0.9-0.9




Deflation and DisinflationDeflation and DisinflationDeflation and DisinflationDeflation and Disinflation

When the inflation rate is negative, When the inflation rate is negative, deflationdeflation is is said to occur.said to occur. This would happen if the price level declined from This would happen if the price level declined from

one year to the next.one year to the next. Deflation is not an economic goal. Deflation is not an economic goal.

Historically, widespread falling prices and poor Historically, widespread falling prices and poor economic performance seem to go hand in hand.economic performance seem to go hand in hand.

Disinflation Disinflation means that the rate of inflation means that the rate of inflation declines, and is different than both inflation, declines, and is different than both inflation, and deflation.and deflation.

When the inflation rate is negative, When the inflation rate is negative, deflationdeflation is is said to occur.said to occur. This would happen if the price level declined from This would happen if the price level declined from

one year to the next.one year to the next. Deflation is not an economic goal. Deflation is not an economic goal.

Historically, widespread falling prices and poor Historically, widespread falling prices and poor economic performance seem to go hand in hand.economic performance seem to go hand in hand.

Disinflation Disinflation means that the rate of inflation means that the rate of inflation declines, and is different than both inflation, declines, and is different than both inflation, and deflation.and deflation.


7.27.2THE HARM FROM INFLATIONTHE HARM FROM INFLATION7.27.2THE HARM FROM INFLATIONTHE HARM FROM INFLATION

o Energy and food prices are subject to Energy and food prices are subject to wide fluctuations caused by temporary wide fluctuations caused by temporary shifts in their supply.shifts in their supply.

o Excluding food and energy prices from Excluding food and energy prices from the computation of the inflation rate the computation of the inflation rate reveals what is termed reveals what is termed core inflationcore inflation..


Inflation hurts those Inflation hurts those on fixed incomes.on fixed incomes.

Inflation hurts Inflation hurts lenders.lenders.

Inflation increases Inflation increases the opportunity cost the opportunity cost of search time for of search time for cheaper substitute cheaper substitute goods.goods.

Inflation hurts those Inflation hurts those on fixed incomes.on fixed incomes.

Inflation hurts Inflation hurts lenders.lenders.

Inflation increases Inflation increases the opportunity cost the opportunity cost of search time for of search time for cheaper substitute cheaper substitute goods.goods.

Inflation motivates Inflation motivates businesses to offer businesses to offer new products.new products.

Inflation might Inflation might motivate business to motivate business to trim the amount of trim the amount of product rather than product rather than raise its price.raise its price.

Inflation motivates Inflation motivates businesses to offer businesses to offer new products.new products.

Inflation might Inflation might motivate business to motivate business to trim the amount of trim the amount of product rather than product rather than raise its price.raise its price.

The Harm from InflationThe Harm from InflationThe Harm from InflationThe Harm from Inflation


Anticipated and Unanticipated Anticipated and Unanticipated InflationInflation

Anticipated and Unanticipated Anticipated and Unanticipated InflationInflation

Anticipated inflationAnticipated inflation is expected by the is expected by the public.public.

In theory, everyone is able to defend In theory, everyone is able to defend themselves against losses imposed by themselves against losses imposed by anticipated inflation.anticipated inflation.

Unanticipated inflationUnanticipated inflation is inflation that is inflation that catches the public by surprise.catches the public by surprise.

Borrower’s gain by unanticipated inflation, Borrower’s gain by unanticipated inflation, while lenders lose. while lenders lose.

Anticipated inflationAnticipated inflation is expected by the is expected by the public.public.

In theory, everyone is able to defend In theory, everyone is able to defend themselves against losses imposed by themselves against losses imposed by anticipated inflation.anticipated inflation.

Unanticipated inflationUnanticipated inflation is inflation that is inflation that catches the public by surprise.catches the public by surprise.

Borrower’s gain by unanticipated inflation, Borrower’s gain by unanticipated inflation, while lenders lose. while lenders lose.


Indexing to Offset Inflation’s Indexing to Offset Inflation’s EffectsEffects

Indexing to Offset Inflation’s Indexing to Offset Inflation’s EffectsEffects

Indexing is a solution to offset the Indexing is a solution to offset the problems created by unanticipated problems created by unanticipated inflation.inflation.

Automatically adjusting the terms of an Automatically adjusting the terms of an agreement to account for inflation is agreement to account for inflation is referred to as referred to as indexing.indexing.


7.37.3MEASURING INFLATIONMEASURING INFLATION7.37.3MEASURING INFLATIONMEASURING INFLATION

A A price indexprice index measures the average level measures the average level of prices in the economy.of prices in the economy.

There are several price indexes.There are several price indexes.The consumer price index.The consumer price index.The producer price index.The producer price index.The GDP chain-type price indexThe GDP chain-type price index The GDP deflator.The GDP deflator.

A A price indexprice index measures the average level measures the average level of prices in the economy.of prices in the economy.

There are several price indexes.There are several price indexes.The consumer price index.The consumer price index.The producer price index.The producer price index.The GDP chain-type price indexThe GDP chain-type price index The GDP deflator.The GDP deflator.


The CPI measures prices of typical The CPI measures prices of typical purchases made by consumers living in purchases made by consumers living in urban areas.urban areas.

The base period used in the CPI is an The base period used in the CPI is an arbitrary selected initial time period arbitrary selected initial time period against which other time periods are against which other time periods are compared.compared.

The base period index number always The base period index number always equals 100.equals 100.

The CPI measures prices of typical The CPI measures prices of typical purchases made by consumers living in purchases made by consumers living in urban areas.urban areas.

The base period used in the CPI is an The base period used in the CPI is an arbitrary selected initial time period arbitrary selected initial time period against which other time periods are against which other time periods are compared.compared.

The base period index number always The base period index number always equals 100.equals 100.

Measuring Inflation – Measuring Inflation – The Consumer Price IndexThe Consumer Price Index





Inflation Rate =Inflation Rate = [change in price index / initial price index][change in price index / initial price index]

multiplied by 100multiplied by 100

The Inflation rate is calculated by takingThe Inflation rate is calculated by takingthe percentage change in the CPI as follows:the percentage change in the CPI as follows:

The Inflation rate is calculated by takingThe Inflation rate is calculated by takingthe percentage change in the CPI as follows:the percentage change in the CPI as follows:


The collection of goods and services used in the The collection of goods and services used in the calculation of the CPI is called the market calculation of the CPI is called the market basket.basket.The The market basketmarket basket represents a sampling of the represents a sampling of the items that consumers buy that make up a items that consumers buy that make up a significant portion of their budget.significant portion of their budget.There are 200 specific items that make up the There are 200 specific items that make up the CPI.CPI.Each item is assigned a weight that reflects its Each item is assigned a weight that reflects its importance in the consumers’ budgets.importance in the consumers’ budgets.

The collection of goods and services used in the The collection of goods and services used in the calculation of the CPI is called the market calculation of the CPI is called the market basket.basket.The The market basketmarket basket represents a sampling of the represents a sampling of the items that consumers buy that make up a items that consumers buy that make up a significant portion of their budget.significant portion of their budget.There are 200 specific items that make up the There are 200 specific items that make up the CPI.CPI.Each item is assigned a weight that reflects its Each item is assigned a weight that reflects its importance in the consumers’ budgets.importance in the consumers’ budgets.




CPI Market Basket CPI Market Basket Expenditure CategoriesExpenditure Categories

CPI Market Basket CPI Market Basket Expenditure CategoriesExpenditure Categories

Expenditure CategoryExpenditure Category Weight (in %)Weight (in %)

Food and beveragesFood and beverages 15.715.7

HousingHousing 40.940.9

ApparelApparel 4.44.4

TransportationTransportation 17.117.1

Medical careMedical care 5.85.8

RecreationRecreation 6.06.0

Education and communicationEducation and communication 5.85.8

Other goods and servicesOther goods and services 4.34.3

TotalTotal 100.0100.0


Computing a Price IndexComputing a Price IndexComputing a Price IndexComputing a Price Index

The CPI measure the increase in the price of the market The CPI measure the increase in the price of the market basket between the current year and the base period.basket between the current year and the base period.

The simplified formula for the CPI is:The simplified formula for the CPI is:

The CPI measure the increase in the price of the market The CPI measure the increase in the price of the market basket between the current year and the base period.basket between the current year and the base period.

The simplified formula for the CPI is:The simplified formula for the CPI is:

Cost of market basket at current pricesCost of market basket at current prices

Cost at market basket at base period pricesCost at market basket at base period pricesX 100


Nominal Versus Real ValuesNominal Versus Real ValuesNominal Versus Real ValuesNominal Versus Real Values

o A A nominal interest ratenominal interest rate is the payment is the payment from a borrower to a lender, expressed in from a borrower to a lender, expressed in percentage terms.percentage terms.

o A A real interest ratereal interest rate measure the percentage measure the percentage payment in terms of purchasing power.payment in terms of purchasing power.

o A A nominal interest ratenominal interest rate is the payment is the payment from a borrower to a lender, expressed in from a borrower to a lender, expressed in percentage terms.percentage terms.

o A A real interest ratereal interest rate measure the percentage measure the percentage payment in terms of purchasing power.payment in terms of purchasing power.

Real interest rate = nominal interest rate – inflation rateReal interest rate = nominal interest rate – inflation rate


Price Indexes for Other PurposesPrice Indexes for Other Purposes Price Indexes for Other PurposesPrice Indexes for Other Purposes

• The The Producer Price Index (PPI)Producer Price Index (PPI) focuses focuses on the prices received by U.S. producers, on the prices received by U.S. producers, as measured by the revenue they receive.as measured by the revenue they receive.

• The prices in the PPI are those received The prices in the PPI are those received by producers no matter who makes the by producers no matter who makes the initial purchase, whether it be another initial purchase, whether it be another firm or consumer.firm or consumer.

• The The Producer Price Index (PPI)Producer Price Index (PPI) focuses focuses on the prices received by U.S. producers, on the prices received by U.S. producers, as measured by the revenue they receive.as measured by the revenue they receive.

• The prices in the PPI are those received The prices in the PPI are those received by producers no matter who makes the by producers no matter who makes the initial purchase, whether it be another initial purchase, whether it be another firm or consumer.firm or consumer.



• The The GDP chain-type price index GDP chain-type price index is is computed in a manner similar to the computed in a manner similar to the GDP deflator.GDP deflator.

• The difference is that the real chained The difference is that the real chained GDP is used in the calculation.GDP is used in the calculation.

• The The GDP chain-type price index GDP chain-type price index is is computed in a manner similar to the computed in a manner similar to the GDP deflator.GDP deflator.

• The difference is that the real chained The difference is that the real chained GDP is used in the calculation.GDP is used in the calculation.

GDP chain-type = nominal GDP/real chained GDPGDP chain-type = nominal GDP/real chained GDP



• The term The term chain weightchain weight comes about comes about because the GDP chain-type price index because the GDP chain-type price index links quantities (weights) in two successive links quantities (weights) in two successive years.years.

• It then moves forward a year and does It then moves forward a year and does that link again, and so forth.that link again, and so forth.

• This continuous linking , for two years at This continuous linking , for two years at a time forms a chain, hence the name.a time forms a chain, hence the name.

• The term The term chain weightchain weight comes about comes about because the GDP chain-type price index because the GDP chain-type price index links quantities (weights) in two successive links quantities (weights) in two successive years.years.

• It then moves forward a year and does It then moves forward a year and does that link again, and so forth.that link again, and so forth.

• This continuous linking , for two years at This continuous linking , for two years at a time forms a chain, hence the name.a time forms a chain, hence the name.



The GDP deflator is a type of price index The GDP deflator is a type of price index called an called an implicit price deflatorimplicit price deflator..

An implicit price deflator takes current An implicit price deflator takes current quantities and calculates what they would quantities and calculates what they would have cost at prices prevailing during the have cost at prices prevailing during the base period.base period.

The GDP deflator is a type of price index The GDP deflator is a type of price index called an called an implicit price deflatorimplicit price deflator..

An implicit price deflator takes current An implicit price deflator takes current quantities and calculates what they would quantities and calculates what they would have cost at prices prevailing during the have cost at prices prevailing during the base period.base period.

GDP deflator = GDP deflator = Value of current quantities at current period pricesValue of current quantities at current period pricesValue of current quantities at base period pricesValue of current quantities at base period prices


Recent Changes to the CPIRecent Changes to the CPIRecent Changes to the CPIRecent Changes to the CPI

Prior to 1999, the CPI was calculated Prior to 1999, the CPI was calculated using using fixed-weightsfixed-weights throughout the throughout the market basket.market basket.

Fixed-weights do not take into account Fixed-weights do not take into account that people change their consumption that people change their consumption patterns when prices rise.patterns when prices rise. When the price level rises people substitute When the price level rises people substitute

relatively cheaper goods for goods that have relatively cheaper goods for goods that have become relatively more expensive.become relatively more expensive.

Prior to 1999, the CPI was calculated Prior to 1999, the CPI was calculated using using fixed-weightsfixed-weights throughout the throughout the market basket.market basket.

Fixed-weights do not take into account Fixed-weights do not take into account that people change their consumption that people change their consumption patterns when prices rise.patterns when prices rise. When the price level rises people substitute When the price level rises people substitute

relatively cheaper goods for goods that have relatively cheaper goods for goods that have become relatively more expensive.become relatively more expensive.


Recent Changes to the CPIRecent Changes to the CPIRecent Changes to the CPIRecent Changes to the CPI

The inaccuracy in the CPI cause by using The inaccuracy in the CPI cause by using fixed weights is termed the substitution fixed weights is termed the substitution bias.bias.

The The substitution biassubstitution bias causes inflation to causes inflation to be overstated.be overstated.

A new CPI was established in 2002 called A new CPI was established in 2002 called the the Chained weight CPI (C-CPI).Chained weight CPI (C-CPI).

The inaccuracy in the CPI cause by using The inaccuracy in the CPI cause by using fixed weights is termed the substitution fixed weights is termed the substitution bias.bias.

The The substitution biassubstitution bias causes inflation to causes inflation to be overstated.be overstated.

A new CPI was established in 2002 called A new CPI was established in 2002 called the the Chained weight CPI (C-CPI).Chained weight CPI (C-CPI).


7.4 EXPLORE & APPLY7.4 EXPLORE & APPLYLiving the Life of InflationLiving the Life of Inflation7.4 EXPLORE & APPLY7.4 EXPLORE & APPLYLiving the Life of InflationLiving the Life of Inflation

The CPI is used in three ways.The CPI is used in three ways.As an economic indicator.As an economic indicator.To convert nominal values to real To convert nominal values to real

values.values.To adjust selected monetary payments To adjust selected monetary payments

upward as prices increase.upward as prices increase.HyperinflationHyperinflation is inflation that is out of is inflation that is out of

control.control.

The CPI is used in three ways.The CPI is used in three ways.As an economic indicator.As an economic indicator.To convert nominal values to real To convert nominal values to real

values.values.To adjust selected monetary payments To adjust selected monetary payments

upward as prices increase.upward as prices increase.HyperinflationHyperinflation is inflation that is out of is inflation that is out of

control.control.


The rule of 72 is used to compute the The rule of 72 is used to compute the approximate time it takes for a rate to approximate time it takes for a rate to double.double.

To compute how long it would take for To compute how long it would take for an inflation rate to double the equation an inflation rate to double the equation would be…would be…

72/the inflation rate72/the inflation rate

The rule of 72 is used to compute the The rule of 72 is used to compute the approximate time it takes for a rate to approximate time it takes for a rate to double.double.

To compute how long it would take for To compute how long it would take for an inflation rate to double the equation an inflation rate to double the equation would be…would be…

72/the inflation rate72/the inflation rate

Living the Life of InflationLiving the Life of InflationLiving the Life of InflationLiving the Life of Inflation


Annual Inflation RateAnnual Inflation Rate Estimated # of Years for Estimated # of Years for Price Level to doublePrice Level to double

1%1% 7272

2%2% 3636

4%4% 1818

8%8% 99

10%10% 7.27.2

16%16% 4.54.5

Living the Life of InflationLiving the Life of InflationLiving the Life of InflationLiving the Life of Inflation


Key TermsKey TermsKey TermsKey Terms

inflationinflation

inflation rateinflation rate

indexingindexing

Consumer Price Consumer Price IndexIndex

Producer Price IndexProducer Price Index

inflationinflation

inflation rateinflation rate

indexingindexing

Consumer Price Consumer Price IndexIndex

Producer Price IndexProducer Price Index

GDP chain-type GDP chain-type indexindex

GDP deflatorGDP deflator

nominal valuenominal value

real valuereal value

GDP chain-type GDP chain-type indexindex

GDP deflatorGDP deflator

nominal valuenominal value

real valuereal value


Test YourselfTest YourselfTest YourselfTest Yourself

1.1. Which of the following best fits the Which of the following best fits the definition of inflation?definition of inflation?

a.a. A one-time increase in a few prices.A one-time increase in a few prices.

b.b. A one-time increase in many prices.A one-time increase in many prices.

c.c. A sustained increase in a few prices.A sustained increase in a few prices.

d.d. A sustained increase in many prices.A sustained increase in many prices.

1.1. Which of the following best fits the Which of the following best fits the definition of inflation?definition of inflation?

a.a. A one-time increase in a few prices.A one-time increase in a few prices.

b.b. A one-time increase in many prices.A one-time increase in many prices.

c.c. A sustained increase in a few prices.A sustained increase in a few prices.

d.d. A sustained increase in many prices.A sustained increase in many prices.



2.2. The core inflation rate excludesThe core inflation rate excludes

a.a. energy prices.energy prices.

b.b. the price of medical care.the price of medical care.

c.c. food prices.food prices.

d.d. both food and energy prices.both food and energy prices.

2.2. The core inflation rate excludesThe core inflation rate excludes

a.a. energy prices.energy prices.

b.b. the price of medical care.the price of medical care.

c.c. food prices.food prices.

d.d. both food and energy prices.both food and energy prices.



3.3. The goods and services included in the The goods and services included in the computation of the CPI are referred to computation of the CPI are referred to as the _____________________ .as the _____________________ .

a.a. base year.base year.

b.b. fixed weights.fixed weights.

c.c. market basket.market basket.

d.d. price level.price level.

3.3. The goods and services included in the The goods and services included in the computation of the CPI are referred to computation of the CPI are referred to as the _____________________ .as the _____________________ .

a.a. base year.base year.

b.b. fixed weights.fixed weights.

c.c. market basket.market basket.

d.d. price level.price level.



4.4. How is inflation computed?How is inflation computed?a.a. The inflation rate equals the value of a price The inflation rate equals the value of a price

index.index.b.b. The inflation rate equals the value of a price The inflation rate equals the value of a price

index.index.c.c. By the following computation: By the following computation:

(change in price index/initial value of price (change in price index/initial value of price index multiplied by 100).index multiplied by 100).

d.d. By the following computation:By the following computation:change in price index multiplied by the initial change in price index multiplied by the initial value of price index. value of price index.

4.4. How is inflation computed?How is inflation computed?a.a. The inflation rate equals the value of a price The inflation rate equals the value of a price

index.index.b.b. The inflation rate equals the value of a price The inflation rate equals the value of a price

index.index.c.c. By the following computation: By the following computation:

(change in price index/initial value of price (change in price index/initial value of price index multiplied by 100).index multiplied by 100).

d.d. By the following computation:By the following computation:change in price index multiplied by the initial change in price index multiplied by the initial value of price index. value of price index.



5.5. When the real value of GDP is computed by When the real value of GDP is computed by the governmentthe government

a.a. the CPI is used.the CPI is used.

b.b. the PPI is used.the PPI is used.

c.c. The GDP deflator or the chained-type price The GDP deflator or the chained-type price index is used.index is used.

d.d. no price index is necessary because the real no price index is necessary because the real and nominal values of GDP are always and nominal values of GDP are always identical.identical.

5.5. When the real value of GDP is computed by When the real value of GDP is computed by the governmentthe government

a.a. the CPI is used.the CPI is used.

b.b. the PPI is used.the PPI is used.

c.c. The GDP deflator or the chained-type price The GDP deflator or the chained-type price index is used.index is used.

d.d. no price index is necessary because the real no price index is necessary because the real and nominal values of GDP are always and nominal values of GDP are always identical.identical.



6.6. The substitution bias causes the CPI to?The substitution bias causes the CPI to?

a.a. overstate the effects of inflation.overstate the effects of inflation.

b.b. understate the effects of inflation.understate the effects of inflation.

c.c. more accurately reflect the effects of more accurately reflect the effects of inflation.inflation.

d.d. be nearly useless as a measure of be nearly useless as a measure of inflation.inflation.

6.6. The substitution bias causes the CPI to?The substitution bias causes the CPI to?

a.a. overstate the effects of inflation.overstate the effects of inflation.

b.b. understate the effects of inflation.understate the effects of inflation.

c.c. more accurately reflect the effects of more accurately reflect the effects of inflation.inflation.

d.d. be nearly useless as a measure of be nearly useless as a measure of inflation.inflation.


The End!The End!Next Chapter 8Next Chapter 8

““A Framework for A Framework for Macroeconomic Macroeconomic

Analysis"Analysis"

©2004 prentice hall publishing ayers/collinge, 1/e 1 chapter 7 “inflation”

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