1

Warm UpWarm Up

How are real & nominal GDP different?

What equation connects them?

22

Chapter 24: Measuring the Cost of Living

Chapter 24: Measuring the Cost of Living

It sure adds up quickly!

It sure adds up quickly!

3

OverviewOverview

CPI COLAS Real vs nominal interest rates

Vocab is the same list

15 slides

4

Backwards firstBackwards first

Last chapter we introduced GDPReal vs nominalGNP, NDP, PI, NI, DI, NEWIncome & expenditure approach

It’s great to know the total, but what does it cost us?

5

Rising SunRising Sun

Prices increasing is almost as consistent as the sun

Some more than othersSometimes it’s DEFLATIONDISINFLATION & HYPERINFLATIONAlso galloping & moderateBottom line is that prices increase

6

Making sense of cents

Making sense of cents

It’s a mess to keep straightMost rise, a few fallWhat’s it mean overall?Analyze everything together

7

CPICPI

Take a big “market basket” Add up the cost Do it every month forever Use tallies to evaluate inflation

Tells us overall how much prices are changing for the average consumer

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3 step Process3 step Process

1. Set the “MARKET BASKET” 2. Find the prices 3. Compute cost for basket 4. Set a base year

Analyze inflation over that period

5. Calculate CPI Equation?

9

Others care tooOthers care too

It’s not the only one…It is the most commonly usedPPIWhole purpose is to track prices

10

Wha’t it used for?Wha’t it used for?

It’s great to knowServe a real purpose?Who uses it?Best tool gov’t has for checking burden on “average” consumer

Often times COLA based on it

11

Now & LaterNow & Later

Inflation affects your money now

Also reduces value later$5 used to buy a lot$.49 cheeseburgers at McDees$.39 tacos on Sunday

12

Banks aren’t losers

Banks aren’t losers

Banks must consider thisMoney loaned out is worth less when repaid

Add expected inflation onto price charged for loan (interest rate)

The rate you pay now (nominal) = expected inflation +real IR

13

Can’t expect the unexpected

Can’t expect the unexpected

Banks consider “EXPECTED INFLATION”

What if it’s not expected?Who suffers?

Who benefits?

14

Use in moderationUse in moderation

So far it sounds like inflation is all bad

No really, but can be when not controlled

Moderate is ok (ideally 2-3%)When we have time to adjust it’s all good (gas of late)

15

SummarySummary

Prices go up…it’s inevitable Price indices used to estimate burden to consumers

CPI most popular (relevant) Directly affects interest rates (nominal = real + inflation)

HW: Questions for Review (p 532): 1, 4 Problems & Aps (p 532): 2, 3, 5, 6, 11