INFLATION
SSEMA1 Illustrate the means by which economic activity is measured.
c. Define unemployment rate, Consumer Price Index (CPI), inflation, real GDP, aggregate supply and aggregate demand and explain how each is used to evaluate the macroeconomic goals from SSEMA1a
c. Define unemployment rate, Consumer Price Index (CPI), inflation, real GDP, aggregate supply and aggregate demand and explain how each is used to evaluate the macroeconomic goals from SSEMA1a
The Consumer Price Index (CPI) is a statistic reported monthly by the BLS. The statistic measures the change in value of a basket of goods and services purchased by the average urban consumer. To calculate CPI, take the current value of the market basket, divide it by the value of the market basket in the base year, and multiply the quotient by 100 to get the index number. The base year is simply the year the BLS has chosen to be the year of comparison. As of the writing of this document, the BLS uses the value of the basket in 1982-1984. Statisticians use the resulting CPI number to calculate the inflation rate in the country.
Inflation is a sustained increase in the price level in an economy over time. One way to measure whether there is inflation in the economy is to calculate the inflation rate. The inflation rate is equal to the percent change in a price index number such as the CPI. Percent change in CPI is equal to the new CPI minus the old CPI divided by the old CPI times 100. If the result of this calculation is positive then the price level is rising. Most economists do not want the inflation rate to be zero percent and agree that some inflation will occur when an economy is growing. Increases in the price level become a concern when they happen too quickly, when they make it difficult for households and firms to plan for the future, when they occur because of shocks in markets for productive resources, or when they are a result of inappropriate public policy decisions.
Inflation is a sustained increase in the price level in an economy over time. One way to measure whether there is inflation in the economy is to calculate the inflation rate. The inflation rate is equal to the percent change in a price index number such as the CPI. Percent change in CPI is equal to the new CPI minus the old CPI divided by the old CPI times 100. If the result of this calculation is positive then the price level is rising. Most economists do not want the inflation rate to be zero percent and agree that some inflation will occur when an economy is growing. Increases in the price level become a concern when they happen too quickly, when they make it difficult for households and firms to plan for the future, when they occur because of shocks in markets for productive resources, or when they are a result of inappropriate public policy decisions.
d. Give examples of who benefits and who loses from unanticipated inflation.
One of the reasons price stability is good for an economy is that it allows households, firms, governments, and the financial sector to make decisions in the present with confidence about the price level in the future. Two groups with an eye on changes in the price level are borrowers and lenders. Households, firms, governments, and financial institutions act as borrowers in the economy. Households take loans for major purchases like cars, college, and homes. Firms borrow to cover expenses in difficult times and to expand operations when the future looks bright. Governments borrow to fund shortfalls in tax revenue needed to provide public goods and services to citizens. Even financial institutions borrow overnight funds to cover their reserve requirements and take longer-term loans to fund expansion projects. All of the sectors act as lenders too. Anyone who holds a bond has lent funds to one of these sectors. Households, businesses, and banks lend to government when they buy Treasury or Municipal bonds. They lend to businesses when they buy corporate bonds. The price of borrowing money is the interest charged over the life of the loan. When lenders make a loan, they agree to a price for the loan. When making loans at fixed rates, an unanticipated rise in price level by more than the lender anticipated hurts the lender since the money repaid will have less purchasing power. Unanticipated inflation hurts lenders who lend at fixed rates. Borrowers who borrow at fixed rates will benefit from unanticipated inflation. Their interest rates remain stable as price rise and they pay back their loan with money that has less purchasing power than the money they borrowed.
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