Lecture Introduction to economics: Social issues and economic thinking: Chapter 7 - Wendy A. Stock

Introduction to
Economics:
Social Issues
and Economic
Thinking
Wendy A. Stock

Chapter 7

Inflation and the
Measurement of Prices
Copyright © 2013 John Wiley & Sons, Inc. / Photo Credit: public domain image from
wikipedia: http:en.wikipedia.org/wiki/File: Mugabecloseup20008.jpg

PowerPoint
Prepared by
Z. Pan


After studying this chapter, you should be
able to:
Ø

Ø

Ø

Explain the difference between
the face value of money and the
purchasing power of money
Describe inflation and calculate

inflation across time periods

Ø

Ø

Distinguish the sources of
inflation
Illustrate the difference
between real and nominal
values

Describe the winners and losers
from inflation

Copyright © 2013 John Wiley & Sons, Inc.

2


Inflation
Ø

Ø

Inflation is the rise in the general level of prices
in an economy.
Zimbabwe’s hyperinflation
Ø

Inflation rate 11.2 million percent per year

Ø

prices doubled every 25 hours!

Copyright © 2013 John Wiley

3


THE VALUE AND USES OF MONEY

Ø

Ø

The Face Value of Money is determined by
governments and printed on currency.
The Purchasing Power of Money reflects the
amount of goods and services that a given unit
of money could be used to acquire.

Copyright © 2013 John Wiley

4


Definition of Money

Three Roles of Money:
Ø

Ø

Ø

Medium of Exchange – Money can be used as
a means of payment for goods and services or
repayment of debt.
Unit of Account – Money provides a common
measure of the worth of goods or services.
Store of Value – Money can be saved and used
to purchase goods and services at a future time.

Copyright © 2013 John Wiley

5


Evolution of money
Ø

Commodity Money has value for its own sake, in
addition to its value as money.
Ø

Ø

e.g. gold, silver, shells, stones, decorated belts,

cigarettes, and alcohol

Fiat Money has value because of government law or
regulation.
Ø

e.g. Federal Reserve Notes, most paper money

Copyright © 2013 John Wiley

6


MEASURING PRICES AND INFLATION
Ø

Ø

Ø

Price Index - A measure of the average prices of a
given set of goods or services across time.
Consumer Price Index (CPI) is the ratio of the cost
of the market basket in one year over the cost of the
market basket in the base year multiplied by 100.
A Market Basket is a fixed set of goods or services
whose prices are tracked across time.

Copyright © 2013 John Wiley

7


MEASURING PRICES AND INFLATION

Copyright © 2013 John Wiley

8


Calculating cpi: an example
Three Steps:
1)

2)

3)

Finding the prices in the market basket
Computing the cost of the market basket in each
year
Calculating CPI by taking the ratio

Copyright © 2013 John Wiley

9


Calculating cpi: an example

Copyright © 2013 John Wiley

10


U.S. Consumer price index

Copyright © 2013 John Wiley

11


Inflation rate

Copyright © 2013 John Wiley

12


Calculating inflation rate – an example

Copyright © 2013 John Wiley

13


U.S. inflation rate (1950-2010)

Copyright © 2013 John Wiley

14


Deflation and Disinflation

Disinflation is a period of positive but falling inflation.
Disinflation indicates a slowing of the rate of price
increase in the economy.
Deflation is negative inflation. Deflation indicates a
period of declining prices of goods and services.

Copyright © 2013 John Wiley

15


World inflation comparison

Copyright © 2013 John Wiley

16


Sources of INFLATION

Ø

Government printing too much money

Ø

Demand Pull Inflation

Ø

Cost Push Inflation

Copyright © 2013 John Wiley

17


Sources of INFLATION
Demand-pull Inflation arises from increases in
aggregate demand.

Copyright © 2013 John Wiley

18


Sources of INFLATION
Cost-push Inflation arises from decreases in
aggregate supply.

Copyright © 2013 John Wiley

19

MEASURING NOMINAL AND REAL
VALUES
Ø

Ø

Nominal Values are values that have not been
adjusted for inflation.
Real Values are values that have been adjusted for
inflation.

Copyright © 2013 John Wiley

20


MEASURING NOMINAL AND REAL
VALUES
An Example:
1960: CPI = 29.6
Your grandma's starting salary as a school teacher =
$6,500
2010: CPI = 220.2
Your starting salary as a school teacher = $45,000

Will you make more than she did in real
earnings?
Copyright © 2013 John Wiley

21

MEASURING NOMINAL AND REAL
VALUES

Ø First, convert all nominal values into real
values in base year (base year = 1982 – 84)
Real value in base year = (nominal value in
current year/CPI in current year) x 100

Ø Then, compare
Copyright © 2013 John Wiley

22


MEASURING NOMINAL AND REAL
VALUES
1960: CPI = 29.6
Your grandma's starting salary as school teacher =
$6,500
2010: CPI = 220.2
Your starting salary as a school teacher = $45,000

Grandma’s real salary = ($6,500/29.6) x 100 =
$21,959 in 1982–84 dollars.
Your real salary = ($45,000/220.2) x 100 =
$20,436 in 1982–84 dollars.
Copyright © 2013 John Wiley

23


Questions/Discussions

During 2011, many citizens in the Middle
East called for governmental reform. In some
countries, oil production was reduced in the
face of protests. Use an AD/AS diagram to
illustrate the potential impact of these
outcomes on inflation in the United States.

Copyright © 2013 John Wiley

24


Key Concepts

•
•
•
•
•
•
•
•
•
•

Inflation
Face value of money
Purchasing power of money
Medium of exchange
Unit of account
Store of value
Commodity money
Fiat money
Price index
Market basket

Copyright © 2013 John Wiley

25