Chapter 5- Inflation and the Price Level

Chapter 5- Inflation and the Price Level

·      Consumer price index (CPI)- for any period, a measure of the cost in that period of a standard basket of goods and services relative to the cost of the same basket of goods and services in a fixed year, called the base year

·      Price index- a measure of the average price of given quality of goods or services relative to the price of the same goods or services in a base year

·      Rate of inflation- the annual percentage rate of change in the price level, as measured, for example, by the CPI

·      Deflation- a situation in which the prices of most goods and services are falling over time so that inflation is negative

·      Core rate of inflation- the rate of increase of all prices except energy and food, the two items most frequently responsible for short run fluctuations in the inflation rate

·      Deflating- using CPI to convert quantities measured at current dollar values into real terms

·      Indexing- the process of using the CPI to convert real quantities into current-dollar terms

·      Nominal quantity- a quantity that is measured in terms of its current dollar value

·      Real quantity- a quantity that is measured in physical terms- for example, in terms of quantities of goods and services

·      Deflating (a nominal quantity)- the process of dividing a nominal quantity by a price index (such as the CPI) to express the quantity in real terms

·      Real wage- the wage paid to workers measured in terms of purchasing power; the real wage for any given period is calculated by dividing the nominal (dollar) wage by the CPI for that period

·      Indexing- the practice of increasing a nominal quantity each period by an amount equal to the percentage increase in a specified price index. Indexing prevents the purchasing power of the nominal quantity from being eroded by inflation

·      Price level- a measure of the overall level of prices at a particular point in time as measured by a price index such as the CPI

·      Relative price- the price of a specific good or service in comparison to the prices of other goods and services  

·      Hyperinflation- a situation in which the inflation rate is extremely high

·      Real interest rate- the annual percentage increase in the purchasing power of a financial asset; the real interest rate on any asset equals the nominal interest rate on that asset minus the inflation rate

·      Nominal interest rate (or market interest rate)- the annual percentage increase in the nominal value of a financial asset

·      Inflation protected bonds- bonds that pay a nominal interest rate each year equal to a fixed real rate plus the actual rate of inflation during that year

·      Fisher effect- the tendency for nominal interest rates to be high when inflation is high and low when inflation is low

r = the real interest rate

i = the nominal, or market, interest rate

 = the current inflation rate

·      When calculating nominal and real GDP, fix the price

·      When calculating CPI in Year X and in Base Year, fix the quantity

·      Instead of using (Nominal / CPI) = Real, the following can be used