Ch.16InflationandthePriceLevel.pdfVIP

Ch. 16: Inflation and the Price Level By the end of this chapter, you will be able to: ? Construct a CPI and calculate the inflation rate (covered in pre-class video). ? Name some examples of hyperinflation. ? Adjust nominal quantities for the effects of inflation. ? List some biases in the official measure of inflation. ? Distinguish real and nominal interest rates. Ch. 16: Inflation and the Price Level By the end of this chapter, you will be able to: ? Construct a CPI and calculate the inflation rate. ? Name some examples of hyperinflation. ? Adjust nominal quantities for the effects of inflation. ? List some biases in the official measure of inflation. ? Distinguish real and nominal interest rates. The Consumer Price Index (CPI) ? It is a way to measure the price level and to calculate the rate of inflation. ? It is also a useful gauge of the cost of living. Calculating the CPI for a simple example Suppose the typical household has the following monthly purchases Item Quantity Price per unit in Cost in 2010 2010 Hamburgers 60 $ 5 T-shirts 4 $ 15 Total Now let’s see the prices they have to pay in 2014 for the same basket of goods. Item Quantity Price per unit in Cost in 2014 2014 Hamburgers 60 T-shirts 4 Total Let’s make 2010 the base year. Then we calculate the CPI in 2014 as follows: Note the following difference When calculating real GDP, ? we use prices as weights, hold prices fixed, and compare quantities across different years. When calculating the CPI, ? we use quantities as weights (“the market basket”), hold quantities fixed, and compare prices across different years. Question Suppose that no