Macroeconomics
Inflation
The economy can be in one of three phases at any one time:
- Recession with falling GDP and employment
- Expansion with increasing GDP and full employment
- Inflationary gap with an increase in real GDP, which increases consumption, causing prices to rise in the long term
When there is inflation, each dollar of income buys fewer goods and services. Therefore, it takes more money to buy items in the marketplace. Disinflation is a decrease in the rate of inflation. In this situation, inflation has been occurring for some time, but it has slowed down. Deflation is a decrease in the price of goods and services.
There are two types of wages:
- Nominal wage is measured by dollars rather than by purchasing power.
- Real wage is adjusted for inflation.
If a worker gets a 6 percent raise but there is 12 percent inflation, the worker has not gotten a raise. The workerās nominal wage increased by 6 percent, but the real wage declined by 6 percent.
The nominal interest rate is the stated interest rate and the actual monetary price that borrowers pay to lenders. If a loan has a 3 percent interest rate, borrowers will pay $3 of interest for every $100 loaned to them.
The real interest rate is calculated by subtracting the inflation rate from the nominal interest rate (Nominal interest rate ā Inflation = Real interest rate). If a loan has a 10 percent interest rate and the inflation rate is 8 percent, then the real interest rate is 2 percent.
- The nominal interest rate is the percentage increase in money that a borrower pays, not adjusting for inflation.
- The real interest rate is the percentage increase in purchasing power that a borrower pays. If inflation goes up, the real interest rate decreases. Unexpected inflation hurts lenders and helps borrowers.
KEEP IN MIND . . .
The CPI is not a dollar value like GDP. The CPI is an index number or a percentage change from the base year.
The Consumer Price Index (CPI) is one of the principal ways to measure price changes and inflation over a period of time. A conceptual market basket is analyzed. The base year is given an index of 100. To compare, each year is also given an index number.
- CPI = Price of Market Basket/Price of Market Basket in Base Year Ć 100
There are three causes of inflation:
- The government prints too much money.
- Demand pulls up prices.
- Higher production costs increase prices.
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