Principles of Macroeconomics for AP® Courses 2e Chapter 9 The International Trade and Capital Flows

Inflation , I ' ONE HUNDRED . BILLION DOLLARS on 91 Debra 31 st 2008 ' Issue date July 2008 . a of BILLION . FIGURE Big Bucks in Zimbabwe This bill was worth 100 billion dollars when issued in 2008 . There were even bills issued with a face value of 100 trillion dollars . The bills had written on them . Unfortunately , they were almost worthless . At one point , dollars were equal to one dollar . Eventually , the country abandoned its own currency and allowed people to use foreign currency for purchases . Credit of 100 Billion Dollars by Peat , BY ) HI ' as as CHAPTER OBJECTIVES In this chapter , you will learn about Tracking How to Measure Changes in the Cost of Living How the US . and Other Countries Experience The Confusion Over Indexing and Its Limitations Introduction to Inflation BRING IT HOME A 550 Million Loaf of Bread ?

If you were born within the last three decades in the United States , Canada , or many other countries in the developed world , you probably have no real experience with a high rate of inflation . Inflation is when most prices in an entire economy are rising . However , there is an extreme form of inflation called hyperinflation . This occurred in Germany between 1921 and 1928 , and more recently in Zimbabwe between 2008 and 2009 . In November 2008 , Zimbabwe had an inflation rate of billion percent . In contrast , in 2014 , the United States had an average annual rate of inflation of .

220 Inflation Zimbabwe inflation rate was so high it is to comprehend , so let put it into context . It is equivalent to price increases of 98 per day . This means that , from one day to the next , prices essentially double . What is life like in an economy afflicted with hyperinflation ?

Most of you will have never experienced this phenomenon . The government adjusted prices for commodities in dollars several times each day . There was no desire to hold on to currency since it lost value by the minute . The people there spent a great deal of time getting rid of any cash they acquired by purchasing whatever food or other commodities they could find . At one point , a loaf of bread cost 550 million dollars . Teachers salaries were in the trillions a month however , this was equivalent to only one dollar a day . At its height , it took dollars to purchase one dollar . Government agencies had no money to pay their workers so they started printing money to pay their bills rather than raising taxes . Rising prices caused the government to enact price controls on private businesses , which led to shortages and the emergence of black markets . In 2009 , the country abandoned its currency and allowed people to use foreign currencies for purchases . How does this happen ?

How can both government and the economy fail to function at the most basic level ?

Before we consider these extreme cases of hyperinflation , let first look at inflation itself . is a general and ongoing rise in the level of prices in an entire economy . does not refer to a change in relative prices . A relative price change occurs when you see that the price of tuition has risen , but the price of laptops has fallen . on the other hand , means that there is pressure for prices to rise in most markets in the economy . In addition , price increases in the model were events , representing a shift from a previous equilibrium to a new one . implies an ongoing rise in prices . If happened for one year and then stopped , then it would not be any more . This chapter begins by showing how to combine prices of individual goods and services to create a measure of overall . It discusses the historical and recent experience of , both in the United States and in other countries around the world . Other chapters have sometimes included a note under an exhibit or a parenthetical reminder in the text saying that the numbers have been adjusted for . In this chapter , it is time to show how to use statistics to adjust other economic variables , so that you can tell how much of , for example , we can attribute the rise in over different periods of time to an actual increase in the production of goods and services and how much we should attribute to the fact that prices for most items have risen . has consequences for people and throughout the economy , in their roles as lenders and borrowers , taxpayers , and consumers . The chapter concludes with a discussion of some imperfections and biases in the statistics , and a preview of policies for that we will discuss in other chapters . Tracking Inflation LEARNING OBJECTIVES By the end of this section , you will be able to Calculate the annual rate of Explain and use index numbers and base years when simplifying the total quantity spent over a year for products Calculate rates using index numbers Dinner table conversations where you might have heard about usually entail reminiscing about when everything seemed to cost so much less . You used to be able to buy three gallons of gasoline for a dollar and then go see an afternoon movie for another dollar . Table compares some prices of common goods in 1970 and 2017 . Of course , the average prices in this table may not the prices where you live . The cost of living in New York City is much higher than in Houston , Texas , for example . In addition , certain products have evolved over recent decades . A new car in 2021 , loaded with antipollution equipment , safety gear , Access for free at

Tracking Inflation 221 computerized engine controls , and many other technological advances , is a more advanced machine ( and more fuel ) than your typical car . However , put details like these to one side for the moment , and look at the overall pattern . The primary reason behind the price rises in Table all the price increases for the other products in the not to the market for housing or cars or gasoline or movie tickets . Instead , it is part of a general rise in the level of all prices . At the beginning of 2021 , had about the same purchasing power in overall terms of goods and services as 15 cents did in 1972 , because of the amount of that has occurred over that time period . Items 1970 2021 Pound of ground beef Pound of butter Movie ticket Sales price of new home ( median ) New car Gallon of gasoline Average hourly wage for a manufacturing worker Per capita TABLE Price Comparisons , 1970 and 2021 ( Sources See chapter References at end of book . Moreover , the power of does not goods and services , but wages and income levels , too . The row of Table shows that the average hourly wage for a manufacturing worker increased nearly from 1970 to 2021 . The average worker in 2021 is better educated and more productive than the average worker in not six times more productive . Per capita increased substantially from 1970 to 2021 , but is the average person in the economy really more than twelve times better off injust 51 years ?

Not likely . A modern economy has millions of goods and services whose prices are continually quivering in the breezes of supply and demand . How can all of these shifts in price attribute to a single rate ?

As with many problems in economic measurement , the conceptual answer is reasonably straightforward Economists combine prices ofa variety of goods and services into a single price level . The rate is simply the percentage change in the price level . Applying the concept , however , involves some practical . The Price of a Basket of Goods To calculate the price level , economists begin with the concept ofa basket of goods and services , consisting of the different items individuals , businesses , or organizations typically buy . The next step is to look at how the prices of those items change over time . In thinking about how to combine individual prices into an overall price level , many people that their impulse is to calculate the average of the prices . Such a calculation , however , could easily be misleading because some products matter more than others . Changes in the prices of goods for which people spend a larger share of their incomes will matter more than changes in the prices of goods for which people spend a smaller share of their incomes . For example , an increase of 10 in the rental rate on housing matters more to most people than whether the price of carrots rises by 10 . To construct an overall measure of the price level , economists compute a weighted average of the

222 Inflation prices of the items in the basket , where the weights are based on the actual quantities of goods and services people buy . The following Work It Out feature walks you through the steps of calculating the annual rate of based on a few products . Calculating an Annual Rate of Inflation Consider the simple basket of goods with only three items , represented in Table . Say that in any given month , a college student spends money on 20 hamburgers , one bottle of aspirin , and five movies . The table provides prices for these items over four years through each time period ( Prices of some goods in the basket may rise while others fall . In this example , the price of aspirin does not change over the four years , while movies increase in price and hamburgers bounce up and down . The table shows the cost of buying the given basket of goods at the prices prevailing at that time . Items Hamburger Aspirin Movies Total Inflation Rate 20 bottle ( Price ( Amount Spent ( Price ( Amount Spent ( Price ( Amount Spent ( Price ( Amount Spent TABLE A College Student Basket of Goods To calculate the annual rate of inflation in this example Step . Find the percentage change in the cost of purchasing the overall basket of goods between the time periods . The general equation for percentage changes between two years , whether in the context of inflation or in any other calculation , is ( Level in new year Level in previous year ) Level in previous year 100 Percentage change Step . From period to period , the total cost of purchasing the basket of goods in Table rises from 100 to . Therefore , the percentage change over this inflation ( 100 ) 1000 Step . From period to period , the overall change in the cost of purchasing the basket rises from to 107 . Thus , the inflation rate over this time , again calculated by the percentage change , is approximately ( 107 ) 10650 Access for free at

Tracking Inflation 223 Step . From period to period , the overall cost rises from 107 to . The inflation rate is thus ( 107 ) This calculation of the change in the total cost of purchasing a basket of goods accounts for how much a student spends on each good . Hamburgers are the good in this example , and aspirin is the . If an individual buys a greater quantity of a good , then it makes sense that changes in the price of that good should have a larger impact on the buying power of that person money . The larger impact of hamburgers shows up in the amount spent row , where , in all time periods , hamburgers are the largest item within the amount spent row . Index Numbers The numerical results ofa calculation based on a basket of goods can get a little messy . The example in Table has only three goods and the prices are in even dollars , not numbers like 79 cents or . If the list of products were much longer , and we used more realistic prices , the total quantity spent over a year might be some number like or . To simplify the task of interpreting the price levels for more realistic and complex baskets of goods , economists typically report the price level in each period as an index number , rather than as the dollar amount for buying the basket of goods . Economists create price indices to calculate an overall average change in relative prices over time . To convert the money spent on the basket to an index number , economists arbitrarily choose one year to be the base year , or starting point from which we measure changes in prices . The base year , by , has an index number equal to 100 . This sounds complicated , but it is really a simple math trick . In the example above , say that we choose time period as the base year . Since the total amount of spending in that year is 107 , we divide that amount by itself ( 107 ) and multiply by 100 . Again , this is because the index number in the base year always has to have a value of 100 . Then , to out the values of the index number for the other years , we divide the dollar amounts for the other years by as well . Note also that the dollar signs cancel out so that index numbers have no units . Table shows calculations for the other values of the index number , based on the example in Table . Because we calculate the index numbers so that they are in exactly the same proportion as the total dollar cost the basket of goods , we can calculate the rate based on the index numbers , using the percentage change formula . Thus , the rate from period to period would be ( 934 This is the same answer that we derived when measuring based on the dollar cost of the basket of goods for the same time period . Total Spending Index Number Inflation Rate Since Previous Period Period 100 , 107 11 TABLE Calculating Index Numbers When Period is the Base Year

224 Inflation If the rate is the same whether it is based on dollar values or index numbers , then why bother with the index numbers ?

The advantage is that indexing allows easier eyeballing of the numbers . If you glance at two index numbers like 107 and 110 , you know automatically that the rate of between the two years is about , but not quite exactly equal to , By contrast , imagine that we express the price levels in absolute dollars ofa large basket of goods , so that when you looked at the data , the numbers were and . Most people it difficult to eyeball those kinds of numbers and say that it is a change of about . However , the two numbers expressed in absolute dollars are exactly in the same proportion of 107 to 110 as the previous example . If you re wondering why simple subtraction of the index numbers would work , read the following Clear It Up feature . CLEAR IT UP Why do you notjust subtract index numbers ?

A word of warning When a price index moves from , say , 107 to 110 , the rate of inflation is not . Remember , the inflation rate is not derived by subtracting the index numbers , but rather through the change calculation . We calculate the precise inflation rate as the price index moves from 107 to 110 as 100 ( 110 107 ) 100 . When the base year is fairly close to 100 , a quick subtraction is not a terrible shortcut to calculating the inflation when precision matters down to tenths of a percent , subtracting will not give the right answer . Two final points about index numbers are worth remembering . First , index numbers have no dollar signs or other units attached to them . Although we can use index numbers to calculate a percentage rate , the index numbers themselves do not have percentage signs . Index numbers just mirror the proportions that we in other data . They transform the other data so that it is easier to work with the data . Second , the choice of a base year for the index is , the year that is automatically set equal to arbitrary . We choose it as a starting point from which we can track changes in prices . In the statistics , it is common to use one base year for a few years , and then to update it , so that the base year of 100 is relatively close to the present . However , any base year that we choose for the index numbers will result in exactly the same rate . To see this in the previous example , imagine that period is the base year when total spending was 100 , and we assign it an index number of 100 . At a glance , you can see that the index numbers would now exactly match the dollar figures , and the rate in the period would be . Now that we see how indexes work to track , the next module will show us how economists measure the cost of living . LINK IT UP Watch this video Duck Tales from the cartoon Duck Tales to view a on . How to Measure Changes in the Cost of Living LEARNING OBJECTIVES By the end of this section , you will be able to Use the Consumer Price Index ( to calculate rates Identify several ways the Bureau of Labor Statistics avoids biases in the Consumer Price Index ( Differentiate among the Consumer Price Index ( the Producer Price Index ( the International Price Index , the Employment Cost Index , and the . The most commonly cited measure of in the United States is the Consumer Price Index ( Access for free at

How to Measure Changes in the Cost of Living 225 Government statisticians at the Bureau of Labor Statistics calculate the based on the prices in a basket of goods and services that represents the purchases of the average family of four . In recent years , the statisticians have paid considerable attention to a subtle problem that the change in the total cost a basket of goods and services over time is conceptually not quite the same as the change in the cost of living , because the cost of living represents how much it costs for a person to feel that their consumption provides an equal level of satisfaction or utility . To understand the distinction , imagine that over the past 10 years , the cost a basket of goods increased by 25 and your salary also increased by 25 . Has your personal standard of living held constant ?

Ifyou do not necessarily purchase an identical basket of goods every year , then an calculation based on the cost of a basket of goods may be a misleading measure of how your cost of living has changed . Two problems arise here substitution bias and goods bias . When the price of a good rises , consumers tend to purchase less of it and to seek out substitutes instead . Conversely , as the price ofa good falls , people will tend to purchase more of it . This pattern implies that goods with generally rising prices should tend over time to become less important in the overall basket of goods used to calculate , while goods with falling prices should tend to become more important . Consider , as an example , a rise in the price by 100 per pound . If consumers were utterly in their demand for peaches , this would lead to a big rise in the price of food for consumers . Alternatively , imagine that people are utterly indifferent to whether they have peaches or other types of fruit . Now , prices rise , people completely switch to other fruit choices and the average price of food does not change at all . A and unchanging basket of goods assumes that consumers are locked into buying exactly the same goods , regardless of price a very likely assumption . Thus , substitution rise in the price ofa basket of goods over to overstate the rise in a consumer true cost of living , because it does not take into account that the person can substitute away from goods whose relative prices have risen . The other major problem in using a basket of goods as the basis for calculating is how to deal with the arrival of improved versions of older goods or altogether new goods . Consider the problem that arises ifa cereal is improved by adding 12 essential vitamins and also if a box of the cereal costs more . It would clearly be misleading to count the entire resulting higher price as , because the new price a higher quality ( or at least different ) product . Ideally , one would like to know how much of the higher price is due to the quality change , and how much of it is just a higher price . The Bureau of Labor Statistics , which is responsible for computing the Consumer Price Index , must deal with these in adjusting for quality changes . LINK IT UP Visit this website to view a list of Ford car prices between 1909 and 1927 . Consider how these prices compare to today models . Is the product today of a different quality ?

We can think of a new product as an extreme improvement in something that did not exist to something that does . However , the basket of goods that was in the past obviously does not include new goods created since then . The basket of goods and services in the Consumer Price Index ( is revised and updated over time , and so new products are gradually included . However , the process takes some time . For example , room air conditioners were widely sold in the early , but were not introduced into the basket of goods behind the Consumer Price Index until 1964 . The and personal computer were available in the late and widely sold by the early , but did not enter the basket of goods until 1987 . By 1996 , there were more than 40 million cellular phone subscribers in the United cell phones were not yet part of the basket of goods . The parade of inventions has continued , with the inevitably lagging a few years behind . The arrival of new goods creates problems with respect to the accuracy of measuring . The reason

226 Inflation people buy new goods , presumably , is that the new goods offer better value for money than existing goods . Thus , if the price index leaves out new goods , it overlooks one of the ways in which the cost of living is improving . In addition , the price of a new good is often higher when it is introduced and then declines over time . Ifthe new good is not included in the for some years , until its price is already lower , the may miss counting this price decline altogether . Taking these arguments together , the goods bias means that the rise in the price ofa basket of goods over time tends to overstate the rise in a consumer true cost of living , because it does not account for how improvements in the quality of existing goods or the invention of new goods improves the standard of living . The following Clear It Up feature is a on how statisticians comprise and calculate the . CLEAR IT UP How do government statisticians measure the Consumer Price Index ?

When the Bureau of Labor Statistics ( calculates the Consumer Price Index , the first task is to decide on a basket of goods that is representative of the purchases of the average household . We do this by using the Consumer Expenditure Survey , a national survey of about households , which provides detailed information on spending habits . Statisticians divide consumer expenditures into eight major groups ( seen below ) which in turn they divide into more than 200 individual item categories . The currently uses as the base period . For each of the 200 individual expenditure items , the chooses several hundred very examples of that item and looks at the prices of those examples . In out the breakfast cereal item under the overall category of foods and beverages , the picks several hundred examples of breakfast cereal . One example might be the price of a box of a particular brand of cereal sold at a particular store . The statistically selects products and sizes and stores to reflect what people buy and where they shop . The basket of goods in the Consumer Price Index thus consists of about products that is , several hundred products in over 200 item categories . Statisticians rotate about of these products of the sample each year , and replace them with a different set of products . The next step is to collect data on prices . Data collectors visit or call about stores in 87 urban areas all over the United States every month to collect prices on these products . The also conducts a survey of landlords or tenants to collect information about rents . Statisticians then calculate the Consumer Price Index by prices of individual products and , using weights ( see Figure ) determined by the quantities of these products that people buy and allowing for factors like substitution between goods and quality improvements , into price indices for the 200 or so overall items . Then , the statisticians combine the price indices for the 200 items into an overall Consumer Price Index . According the Consumer Price Index website , there are eight categories that data collectors use The Eight Major Categories in the Consumer Price Index . Food and beverages ( breakfast cereal , milk , coffee , chicken , wine , meals , and snacks ) Housing ( renter cost of housing , homeowner cost of housing , fuel oil , bedroom furniture ) Apparel ( men shirts and sweaters , women dresses , jewelry ) Transportation ( new vehicles , airline fares , gasoline , motor vehicle insurance ) Medical care ( prescription drugs and medical supplies , physicians services , eyeglasses and eye care , hospital services ) Recreation ( televisions , cable television , pets and pet products , sports equipment , admissions ) Education and communication ( college tuition , postage , telephone services , computer software and accessories ) Other goods and services ( tobacco and smoking products , haircuts and other personal services , funeral expenses ) Access for free at

How to Measure Changes in the Cost of Living 227 Other goods and ) air ! be ares ( lu and ! I Recreation ' Apparel 13 ) ni FIGURE The Weighting of Components Of the eight categories used to generate the Consumer Price Index , housing is the highest at . The next highest category , food and beverage at , is less than half the size of housing . Other goods and services , and apparel , are the lowest at and , respectively . Source ) The and Core Inflation Index Imagine if you were driving a company truck across the country you probably would care about things like the prices of available roadside food and motel rooms as well as the trucks operating condition . However , the manager of the might have different priorities . He would care mostly about the trucks performance and much less so about the food you were eating and the places you were staying . In other words , the company manager would be paying attention to the firm production , while ignoring transitory elements that impacted you , but did not affect the bottom line . In a sense , a similar situation occurs with regard to measures of . As we ve learned , measures prices as they affect everyday household spending . Economists typically calculate a core index by taking the and excluding volatile economic variables . In this way , economists have a better sense of the underlying trends in prices that affect the cost of living . Examples of excluded variables include energy and food prices , which can jump around from month to month because of the weather . According to an article by Kent , during Hurricane Katrina in 2005 , a key supply point for the nation gasoline was nearly knocked out . Gas prices quickly shot up across the nation , in some places by up to 40 cents a gallon in one day . This was not the cause of an economic policy but rather a event until the pumps were restored in the region . In this case , the that month would register the change as a cost of living event to households , but the core index would remain unchanged . As a result , the Federal Reserve decisions on interest rates would not be . Similarly , droughts can cause spikes in food prices that , if temporary , do not affect the nation economic capability . As former Chairman of the Federal Reserve Ben noted in 1999 about the core index , It provide ( a better guide to monetary policy than the other indices , since it measures the more persistent underlying rather than transitory on the price also noted that it helps communicate that the Federal Reserve does not need to respond to every shock since some price changes are transitory and not part ofa structural change in the economy . In sum , both the and the core index are important , but serve different audiences . The helps households understand their overall cost of living from month to month , while the core index is a preferred gauge from which to make important government policy changes .

228 Inflation Practical Solutions for the Substitution and the Goods Biases By the early , the Bureau of Labor Statistics was using alternative mathematical methods for calculating the Consumer Price Index , more complicated adding up the cost ofa basket of goods , to allow for some substitution between goods . It was also updating the basket of goods behind the more frequently , so that it could include new and improved goods more rapidly . For certain products , the was carrying out studies to try to measure the quality improvement . For example , with computers , an economic study can try to adjust for changes in speed , memory , screen size , and other product characteristics , and then calculate the change in price after accounting for these product changes . However , these adjustments are inevitably imperfect , and exactly how to make these adjustments is often a source of controversy among professional economists . By the early , the substitution bias and goods bias had been somewhat reduced , so that since then the rise in the probably overstates the true rise in by only about per year . Over one or a few years , this is not much . Over a period of a decade or two , even half of a percent per year compounds to a more amount . In addition , the tracks prices from physical locations , and not at online sites like Amazon , where prices can be lower . When measuring ( and other economic statistics , too ) a tradeoff arises between simplicity and interpretation . If we calculate the rate with a basket of goods that is and unchanging , then the calculation of an rate is straightforward , but the problems of substitution bias and goods bias will arise . However , when the basket of goods is allowed to shift and evolve to reflect substitution toward lower relative prices , quality improvements , and new goods , the technical details of calculating the rate grow more complex . Additional Price , Deflator , and More The basket of goods behind the Consumer Price Index represents an average hypothetical consumption , which is to say that it does not exactly capture anyone personal experience . When the task is to calculate an average level of , this approach works . What if , however , you are concerned about experienced by a certain group , like the elderly , or the poor , or families with children , or ?

In situations , a price index based on the buying power of the average consumer may not feel quite right . This problem has a straightforward solution . If the Consumer Price Index does not serve the desired purpose , then invent another index , based on a basket of goods appropriate for the group of interest . The Bureau of Labor Statistics publishes a number of experimental price indices some for particular groups like the elderly or the poor , some for different geographic areas , and some for certain broad categories of goods like food or housing . The also calculates several price indices that are not based on baskets of consumer goods . For example , the Producer Price Index ( is based on prices paid for supplies and inputs by producers of goods and services . We can break it down into price indices for different industries , commodities , and stages of processing ( like goods , intermediate goods , or crude materials for further processing ) There is an International Price Index based on the prices of merchandise that is exported or imported . An Employment Cost Index measures wage in the labor market . The , which the Bureau of Economic Analysis measures , is a price index that includes all the components ( that is , consumption plus investment plus government plus exports minus imports ) Unlike the , its baskets are not but calculate what that year would have been worth using the prices . MIT Billion Prices Project is a more recent alternative attempt to measure prices economists collect data online from retailers and then put them into an index that they compare to the ( Source ) What the best measure of ?

If one is concerned with the most accurate measure of , one should use the as it picks up the prices of goods and services produced . However , it is not a good Access for free at How the and Other Countries Experience Inflation 229 measure of the cost of living as it includes prices of many products not purchased by households ( for example , aircraft , engines , factory buildings , complexes , and bulldozers ) If one wants the most accurate measure of as it impacts households , one should use the , as it only picks up prices of products purchased by households . That is why economists sometimes refer to the as the index . As the Bureau of Labor Statistics states on its website The best measure of for a given application depends on the intended use of the How the and Other Countries Experience Inflation LEARNING OBJECTIVES By the end of this section , you will be able to Identify patterns of for the United States using data from the Consumer Price Index Identify patterns of on an international level In the last three decades , has been relatively low in the US . economy , with the Consumer Price Index typically rising to per year . Looking back over the twentieth century , there have been several periods where caused the price level to rise at rates , but nothing has come close to . Historical Inflation in the Economy Figure ( a ) shows the level in the Consumer Price Index stretching back to 1913 . In this case , the base years ( when the is defined as 100 ) are set for the average level of prices that existed from 1982 to 1984 . Figure ( shows the annual percentage changes in the over time , which is the rate . 300 250 Price Level Year III ma ( II ?

Rate ) mi . in rate 1946 me FIGURE Price Level and Inflation Rates since 1947 Graph a shows the trends in the price level from the year 1947 to 2020 . In 1947 , the graph starts out close to 22 . It gradually increases until about 1973 , then increases more rapidly through the remainder of the and beyond , with periodic dips , until 2020 , when it reached around 260 . Graph shows the trends in inflation rates from the year 1948 to 2020 . In 1948 , the graph starts out with inflation at almost , goes up and down periodically , with peaks in the and the , until settling to around in 2020 . Click to view content ( books paces

230 Inflation as measured by the consumer price index the annual percentage change in the cost to the average consumer of acquiring a basket of goods and services that may be or changed at intervals , such as yearly . The two waves of are easy to characterize in historical terms they are right after World War I and World War II . However , there are also two periods of severe negative the early decades of the twentieth century one following the deep recession and the other during the Great Depression of the 19305 . Since is a time when the buying power of money in terms of goods and services is reduced , will be a time when the buying power of money in terms of goods and services increases . For the period from 1900 to about 1960 , the major and nearly balanced each other out , so the average annual rate of over these years was only about per year . A third wave of more severe arrived in the 19705 and departed in the early . LINK up Visit this website ( calculator ) to use an calculator and discover how prices have changed in the last 100 years . Times of recession or depression often seem to be times when the rate is lower , as in the recession of , the Great Depression , the recession of , and the Great Recession in . There were a few months in 2009 that were , but not at an annual rate . High levels of unemployment typically accompany , and the total demand for goods falls , pulling the price level down . Conversely , the rate of often , but not always , seems to start moving up when the economy is growing very strongly , like right after wartime or during the . The for analysis , that we developed in other chapters , will explain why recession often accompanies higher unemployment and lower , while rapid economic growth often brings lower unemployment but higher . Inflation around the World Around the rest of the world , the pattern of has been very mixed Figure shows rates over the last several decades . Many industrialized countries , notjust the United States , had relatively high rates in the 19705 . For example , in 1975 , Japan rate was over and the rate for the United Kingdom was almost 25 . In the 19805 , rates came down in the United States and in Europe and have largely stayed down . Access for free at

How the and Other Countries Experience Inflation 231 30 25 20 ( 10 Year FIGURE Countries with Relatively Low Inflation Rates , This chart shows the annual percentage change in consumer prices compared with the previous year consumer prices in the United States , the United Kingdom , Japan , and Germany . Countries with controlled economies in the , like the Soviet Union and China , historically had very low rates of measured prices were forbidden to rise by law , except for the cases where the government deemed a price increase to be due to quality improvements . However , these countries also had perpetual shortages of goods , since forbidding prices to rise acts like a price ceiling and creates a situation where quantity demanded often exceeds quantity supplied . As Russia and China made a transition toward more economies , they also experienced outbursts of , although we should regard the statistics for these economies as somewhat . in China averaged about 10 per year for much of the and early , although it has dropped off since then . Russia experienced outburst of high per year in the early , although by 2006 Russia consumer price had dipped below 10 per year , as Figure shows . The closest the United States has ever reached was during the Civil War , in the Confederate states .

232 3500 us ! 1500 1000 ' co In 53 ) Year ( 100 80 60 50 China 40 Russia 30 20 , Year ( bi VENUS FIGURE Countries with Relatively High Inflation Rates , These charts show the percentage change in consumer prices compared with the previous year consumer prices in Brazil , China , and Russia . a ) Of these , Brazil and Russia experienced very high inflation at some point between the and . Though not as high , China also had high inflation rates in the . Even though their inflation rates have come down over the last two decades , several of these countries continue to see inflation rates . Sources ) Access for free at

The Confusion Over Inflation 233 Many countries in Latin America experienced raging during the and early , with rates often well above 100 per year . In 1990 , for example , both Brazil and Argentina saw climb above 2000 . Certain countries in Africa experienced extremely high rates of , sometimes bordering on , in the . the most populous country in Africa , had an rate of 75 in 1995 . In the early , the problem of appears to have diminished for most countries , at least in comparison to the worst times of recent decades . As we noted in this earlier Bring it Home feature , in recent years , the worlds worst example of was in Zimbabwe , where at one point the government was issuing bills with a face value of 100 trillion ( in dollars ) is , the bills had written on the front , but were almost worthless . In many countries , the memory of , and even is not very far in the past . The Confusion Over Inflation LEARNING OBJECTIVES By the end of this section , you will be able to Explain how can cause of purchasing power Identify ways can blur the perception of supply and demand Explain the economic benefits and challenges of Economists usually oppose high , but they oppose it in a milder way than many . Robert , one of Nobel Prize winners in economics , carried out several surveys during the about attitudes toward . One of his questions asked , Do you agree that preventing high is an important national priority , as important as preventing drug use or preventing deterioration in the quality of our schools ?

Answers were on a scale of , where meant Fully agree and meant Completely For the population as a whole , 52 answered Fully agree that preventing high was a highly important national priority and just said Completely disagree . However , among professional economists , only 18 answered Fully agree , while the same percentage of 18 answered Completely The Land of Funny Money What are the economic problems caused by , and why do economists often regard them with less concern than the general public ?

Consider a very short story The Land of Funny One morning , everyone in the Land of Funny Money awakened to find that everything in money had increased by 20 . The change was completely unexpected . Every price in every store was 20 higher . Paychecks were 20 higher . Interest rates were 20 higher . The amount of money , everywhere from wallets to savings accounts , was 20 larger . This overnight of prices made newspaper headlines everywhere in the Land of Funny Money . However , the headlines quickly disappeared , as people realized that in terms of what they could actually buy with their incomes , this had no economic impact . Everyone pay could still buy exactly the same set of goods as it did before . Everyone savings were still to buy exactly the same car , vacation , or retirement that they could have bought before . Equal levels of in all wages and prices ended up not mattering much at all . When the people in Robert surveys explained their concern about , one typical reason was that they feared that as prices rose , they would not be able to afford to buy as much . In other words , people were worried because they did not live in a place like the Land of Funny Money , where all prices and wages rose simultaneously . Instead , people live here on Planet Earth , where prices might rise while wages do not rise at all , or where wages rise more slowly than prices . Economists note that over most periods , the level in prices is roughly similar to the level in wages , and so they reason that , on average , over time , people economic status is not greatly changed by

234 Inflation . If all prices , wages , and interest rates adjusted automatically and immediately with , as in the Land of Funny Money , then no one purchasing power , or real loan payments would change . However , if other economic variables do not move exactly in sync with , or if they adjust for only after a time lag , then can cause three types unintended power , blurred price signals , and in planning . Unintended of Purchasing Power can cause of purchasing power that hurt some and help others . People who are hurt by include those who are holding considerable cash , whether it is in a safe deposit box or in a cardboard box under the bed . When happens , the buying power of cash diminishes . However , cash is only an example ofa more general problem anyone who has assets invested in a way that the nominal return does not keep up with will tend to be affected by . For example , if a person has money in a bank account that pays interest , but rises to , then the real rate of return for the money invested in that bank account is negative . The problem ofa nominal interest rate transforming into an real interest rate can be worsened by taxes . The income tax is charged on the nominal interest received in dollar terms , without an adjustment for . Thus , the government taxes a person who invests and receives a nominal rate of interest on the 500 matter whether the rate is , or 10 . If is , then the real interest rate is and all 500 is a gain in buying power . However , if is , then the real interest rate is zero and the person had no real owes income tax on the nominal gain anyway . If is 10 , then the real interest rate is negative and the person is actually falling behind in buying power , but would still owe taxes on the 500 in nominal gains . can cause unintended for wage earners , too . Wages do typically creep up with over time , eventually . The last row of Table at the start of this chapter showed that the average hourly wage in manufacturing in the economy increased from in 1970 to in 2021 , which is an increase by a factor of close to ten . Over that time period , the Consumer Price Index increased by about a factor of eight . However , increases in wages may lag behind for a year or two , since wage adjustments are often somewhat sticky and occur only once or twice a year . Moreover , the extent to which wages keep up with creates insecurity for workers and may involve painful , prolonged between employers and employees . Ifthe government adjusts minimum wage for only infrequently , minimum wage workers are losing purchasing power from their nominal wages , as Figure shows . Access for free at

The Confusion Over Inflation 16 14 12 Ga Real ( 2010 dollars ) 61 41 21 LO LO in Lo LO oo oo ) co ) co Year FIGURE . Minimum Wage and Inflation After adjusting for inflation , the federal minimum wage dropped about 30 percent from , even though the nominal climbed from to per hour . Increases in the minimum wage in between 2008 and 2010 kept the decline from being it would have been if the wage had remained the same as it did from 1997 through 2007 . Since 2010 , the real minimum wage has continued to decline . Sources and ?

cu ) One sizable group of people has often received a large share of their income in a form that does not increase over time retirees who receive a private company pension . Most pensions have traditionally been set as a nominal dollar amount per year at retirement . For this reason , economists call pensions plans . Even if is low , the combination of and a income can create a substantial problem over time . A person who retires on a income at age 65 will that to of buying power per year to compounds to a considerable loss of buying power after a decade or two . Fortunately , pensions and other retirement plans are increasingly rare , replaced instead by contribution plans , such as 401 ( and 403 ( In these plans , the employer contributes a amount to the worker retirement account on a regular basis ( usually every pay check ) The employee often contributes as well . The worker invests these funds in a wide range of investment vehicles . These plans are tax deferred , and they are portable so that if the individual takes a job with a different employer , their 401 ( comes with them . To the extent that the investments made generate real rates of return , retirees are not burdened by the costs of traditional pensioners . However , ordinary people can sometimes from the unintended of . Consider someone who borrows to buy a car at a interest rate of . If is at the time the loan is made , then the borrower must repay the loan at a real interest rate of . However , if rises to , then the real interest rate on the loan is zero . In this case , the borrower from is the loss . A borrower paying a interest rate , who from , is just the side of an investor receiving a interest rate , who suffers from . The lesson is that when interest rates are , rises in the rate of tend to penalize suppliers of capital , who receive repayment in dollars that are 235

236 Inflation worth less because of , while of capital end up better off , because they can repay their loans in dollars that are worth less than originally expected . The unintended power that causes may have a broader effect on society . America widespread acceptance of market forces rests on a perception that people actions have a reasonable connection to market outcomes . When causes a retiree who built up a pension or invested at a interest rate to suffer , however , while someone who borrowed at a interest rate from , it is hard to believe that this outcome was deserved in any way . Similarly , when homeowners from because the price of their homes rises , while renters suffer because they are paying higher rent , it is hard to see any useful incentive effects . One of the reasons that the general public dislikes is a sense that it makes economic rewards and penalties more therefore likely to be perceived as unfair even dangerous , as the next Clear It Up feature shows . CLEAR IT UP Is there a connection between German hyperinflation and Hitler rise to power ?

Germany suffered an intense hyperinflation of its currency , the Mark , in the years after World War I , when the Republic in Germany resorted to printing money to pay its bills and the onset of the Great Depression created the social turmoil that Adolf Hitler was able to take advantage of in his rise to power . described the connection this way in a National Bureau of Economic Research 1996 Working Paper A fact that is probably little known to young people today , even in Germany , is that the collapse of the Mark in 1923 , the time when the Marks inflation reached astronomical levels ( inflation of in November 1923 alone , for an annual rate that month of ) came in the same month as did Hitler Beer Hall Putsch , his Nazi Party armed attempt to overthrow the German government . This failed putsch resulted in Hitler imprisonment , at which time he wrote his book Mein , setting forth an inspirational plan for Germany future , suggesting plans for world domination . Most people in Germany today probably do not clearly remember these events this lack of attention to it may be because its memory is blurred by the more dramatic events that succeeded it ( the Nazi seizure of power and World War II ) However , to someone these historical events in sequence . the putsch may have been remembered as vivid evidence of the potential effects of inflation . Blurred Price Signals Prices are the messengers in a market economy , conveying information about conditions and supply . blurs those price messages . means that we perceive price signals more vaguely , like a radio program received with considerable static . If the static becomes severe , it is hard to tell what is happening . In Israel , when accelerated to an annual rate of 500 in 1985 , some stores stopped posting prices directly on items , since they would have had to put new labels on the items or shelves every few days to . Instead , a took items from a shelf and went up to the checkout register to out the price for that day . Obviously , this situation makes comparing prices and shopping for the best deal rather . When the levels and changes become uncertain , businesses and individuals it harder to react to economic signals . In a world where is at a high rate , but bouncing up and down to some extent , does a higher price of a good mean that has risen , or that supply of that good has decreased , or that demand for that good has increased ?

Should a buyer of the good take the higher prices as an economic hint to start substituting other have the prices of the substitutes risen by an equal amount ?

Should a seller of the good take a higher price as a reason to increase is the higher price only a sign of a general in which the prices of all inputs to production are rising as well ?

The true story will presumably become clear over time , but at a given moment , who can say ?

Access for free at The Confusion Over Inflation 237 High and variable means that the incentives in the economy to adjust in response to changes in prices are weaker . Markets will adjust toward their equilibrium prices and quantities more erratically and slowly , and many individual markets will experience a greater chance of surpluses and shortages . Problems of Planning can make planning . In discussing unintended , we considered the case of someone trying to plan for retirement with a pension that is in nominal terms and a high rate of . Similar problems arise for all people trying to save for retirement , because they must consider what their money will really buy several decades in the future when we can not know the rate of future . especially at moderate or high levels , will pose substantial planning problems for businesses , too . A can make money from example , by paying bills and wages as late as possible so that it can pay in dollars , while collecting revenues as soon as possible . A can also suffer losses from , as in the case of a retail business that gets stuck holding too much cash , only to see eroding the value of that cash . However , when a business spends its time focusing on how to by , or at least how to avoid suffering from it , an inevitable tradeoff strikes less time is spent on improving products and services or on out how to make existing products and services more cheaply . An economy with high rewards businesses that have found clever ways of from , which are not necessarily the businesses that excel at productivity , innovation , or quality of service . In the short term , low or moderate levels of may not pose an overwhelming for business planning , because costs business and sales revenues may rise at similar rates . If , however , varies substantially over the short or medium term , then it may make sense for businesses to stick to term strategies . The evidence as to whether relatively low rates of reduce productivity is controversial among economists . There is some evidence that if can be held to moderate levels of less than per year , it need not prevent a nation real economy from growing at a healthy pace . For some countries that have experienced of several thousand percent per year , an annual rate of may feel basically the same as zero . However , several economists have pointed to the suggestive fact that when US . heated up in the early 10 . growth in productivity slowed down , and when slowed down in the 19805 , productivity edged up again not long thereafter , as Figure shows . inflation rate to 35 It a or pro 38 ' a , ma go ( Year FIGURE Inflation Rate and Labor Productivity , Over the last several decades in the United States , there have been times when rising inflation rates have been closely followed by lower productivity rates and lower inflation rates have corresponded to increasing productivity rates . As the graph shows , however , this correlation does not always exist .

238 Inflation Any Benefits of Inflation ?

Although the economic effects of are primarily negative , two points are worth noting . First , the impact of will differ considerably according to whether it is creeping up slowly at to per year , galloping along at 10 to 20 per year , or racing to the point of at , say , 40 per month . can rip an economy and a society apart . An annual rate of , or , however , is a long way from a national crisis . Low is also better than which occurs with severe . Second , economists sometimes argue that moderate may help the economy by making wages in labor markets more . The discussion in Unemployment pointed out that wages tend to be sticky in their downward movements and that unemployment can result . A little could nibble away at real wages , and thus help real wages to decline if necessary . In this way , even ifa moderate or high rate of may act as sand in the gears of the economy , perhaps a low rate of serves as oil for the gears of the labor market . This argument is controversial . A full analysis would have to account for all the effects of . It does , however , offer another reason to believe that , all things considered , very low rates of may not be especially harmful . Indexing and Its Limitations LEARNING OBJECTIVES By the end of this section , you will be able to Explain the relationship between indexing and Identify three ways the government can control through policy When a price , wage , or interest rate is adjusted automatically with , economists use the term indexed . An indexed payment increases according to the index number that measures . Those in private markets and government programs observe a wide range of indexing arrangements . Since the negative effects of depend in large part on having unexpectedly affect one part of the economy but not , increasing the prices that people pay but not the wages that workers will take some of the sting out of . Indexing in Private Markets In the and , labor unions commonly negotiated wage contracts that had adjustments ( COLAS ) which guaranteed that their wages would keep up with . These contracts were sometimes written as , for example , COLA plus . Thus , if was , the wage increase would automatically be , but if rose to , the wage increase would automatically be 12 . COLAs are a form of indexing applied to wages . Loans often have adjustments , too , so that if the rate rises by two percentage points , then the interest rate that a institution charges on the loan rises by two percentage points as well . An mortgage ( ARM ) is a type of loan that one can use to purchase a home in which the interest rate varies with the rate of . Often , a borrower will be able to receive a lower interest rate if borrowing with an ARM , compared to a loan . The reason is that with an ARM , the lender is protected against the risk that higher will reduce the real loan payments , and so the risk premium part of the interest rate can be correspondingly lower . A number of ongoing or business contracts also have provisions that prices will adjust automatically according to . Sellers like such contracts because they are not locked into a low nominal selling price if turns out higher than expected . Buyers like such contracts because they are not locked into a high buying price if turns out to be lower than expected . A contract with automatic adjustments for in effect agrees on a real price for the borrower to pay , rather than a nominal price . Access for free at

Indexing and its Limitations 239 Indexing in Government Programs Many government programs are indexed to . The income tax code is designed so that as a income rises above certain levels , the tax rate on the marginal income earned rises as well . That is what the expression move into a higher tax bracket means . For example , according to the basic tax tables from the Internal Revenue Service , in 2020 , a married person owed 10 of all taxable income from to 12 ofall income from to 22 ofall taxable income from to 24 of all taxable income from to 32 ofall taxable income from to 35 of all taxable income from to and 37 of all income from and above . Because of the many complex provisions in the rest of the tax code , it is to determine exactly the taxes an individual owes the government based on these numbers , but the numbers illustrate the basic theme that tax rates rise as the marginal dollar of income rises . Until the late 19705 , if nominal wages increased along with , people were moved into higher tax brackets and owed a higher proportion of their income in taxes , even though their real income had not risen . In 1981 , the government eliminated this bracket creep . Now , the income levels where higher tax rates kick in are indexed to rise automatically with . The Social Security program offers two examples of indexing . Since the passage of the Social Security Indexing Act of 1972 , the level of Social Security increases each year along with the Consumer Price Index . Also , Social Security is funded by payroll taxes , which the government imposes on the income earned up to a certain in 2020 . The government adjusts this level of income upward each year according to the rate of , so that an indexed increase in the Social Security tax base accompanies the indexed rise in the level . As yet another example of a government program affected by indexing , in 1996 the , government began offering indexed bonds . Bonds are means by which the government ( and many companies as well ) borrows money that is , investors buy the bonds , and then the government repays the money with interest . Traditionally , government bonds have paid a rate of interest . This policy gave a government that had borrowed an incentive to encourage , because it could then repay its past borrowing in do lars at a lower real interest rate . However , indexed bonds promise to pay a certain real rate of interest above whatever rate occurs . In the case of a retiree trying to plan for the long term and worried about the of , for example , indexed bonds that guarantee a rate of return higher than matter the level of be a very comforting investment . Might Indexing Reduce Concern over Inflation ?

Inc may seem like an obviously useful step . After all , when individuals , and government programs are indexed against , then people can worry less about arbitrary and other effects of ation . However , some of the opponents of express grave concern about indexing . They point out that inc is always partial . Not every employer will provide COLAS for workers . Not all companies can assume that costs and revenues will rise in lockstep with the general rates of . Not all interest rates for borrowers and savers will change to match exactly . However , as partial indexing spreads , the po opposition to may diminish . After all , older people whose Social Security are protected against , or banks that have loaned their money with loans , no longer have as much reason to care whether heats up . In a world where some people are indexed against and some are not , savvy businesses and investors may seek out ways to be protected against ation , while the unsophisticated and small businesses may feel it the most . A Preview of Policy Discussions of Inflation This chapter has focused on how economists measure , historical experience with , how to ad ust nominal variables into real ones , how affects the economy , and how indexing works . We have

240 Inflation barely hinted at the causes of , and we have not addressed government policies to deal with . We will examine these issues in depth in other chapters . However , it is useful to offer a preview here . We can sum up the cause of in one phrase Too many dollars chasing too few goods . The great surges of early in the twentieth century came after wars , which are a time when government spending is very high , but consumers have little to buy , because production is going to the war effort . Governments also commonly impose price controls during wartime . After the war , the price controls end and buying power surges forth , driving up . Otherwise , if too few dollars are chasing too many goods , then will decline or even turn into . Therefore , we typically associate in economic activity , as in major and the Great Depression , with a reduction in or even outright . The policy implications are clear . Ifwe are to avoid , the amount of purchasing power in the economy must grow at roughly the same rate as the production of goods . policies that the government can use to affect the amount of purchasing taxes , spending , and regulation of interest rates and thus cause to rise or reduce to lower levels . BRING IT HOME Inflation in a Return to the 19703 , or Adjustment ?

The recession caused all sorts of disruptions to our economy , including inflation . During the pandemic , the prices for goods like gas and cars fell as people shifted to remote work and canceled travel plans . But as the economy started to recover from the pandemic in early 2021 , we started to see large increases in these prices . Higher prices were also fueled by the injections of cash into the economy through stimulus checks and unemployment . The pandemic also caused shortages throughout the global supply chain , further pushing prices up ( you learn more about this idea in a few chapters when we talk about aggregate supply and demand ) With headline inflation rates in 2021 exceeding , the question in the next few years is whether see permanently high inflation rates , 10 , or more , like we did in the 19705 and . Some economists believe the inflation is just a transitory , used car and gasoline prices rose dramatically in 2010 and 2011 as well , as we were recovering from the Great Recession . Others are more concerned that the inflation is permanent . Shortages continue to exist throughout the economy as of early 2022 , and if consumers expect higher inflation , it can be a prophecy , as they start buying things now in order to avoid future bouts of inflation . As you learned about earlier , inflation is a major concern of consumers , if less of an issue among economists . But inflation should be matched by increases in living standards , otherwise there could be major implications for the economy . Access for free at

Key Terms 241 Key Terms mortgage ( ARM ) a loan a borrower uses to purchase a home in which the interest rate varies with market interest rates base year arbitrary year whose value as an index number economists as 100 from the base year to other years can easily be seen by comparing the index number in the other year to the index number in the base example , 100 so , if the index number for a year is 105 , then there has been exactly between that year and the base year basket of goods and services a hypothetical group of different items , with quantities of each one meant to represent a typical set of consumer purchases , used as a basis for calculating how the price level changes over time Consumer Price Index ( a measure of that US . government statisticians calculate based on the price level from a basket of goods and services that represents the average consumer purchases core index a measure of typically calculated by taking the and excluding volatile economic variables such as food and energy prices to better measure the underlying and persistent trend in prices adjustments ( COLAs ) a contractual provision that wage increases will keep up with negative most prices in the economy are falling Employment Cost measure of based on wages paid in the labor market measure of based on the prices of all the components an outburst of high that often occurs ( although not exclusively ) when economies shift from a controlled economy to a economy index number derived from the price level over a number of years , which makes computing rates easier , since the index number has values around 100 indexed a price , wage , or interest rate is adjusted automatically for a general and ongoing rise in price levels in an economy International Price measure of based on the prices of merchandise that is exported or imported Producer Price Index ( a measure of based on prices paid for supplies and inputs by producers of goods and services goods bias calculated using a basket of goods over time tends to overstate the true rise in cost of living , because it does not account for improvements in the quality of existing goods or the invention of new goods substitution bias an rate calculated using a basket of goods over time tends to overstate the true rise in the cost of living , because it does not take into account that the person can substitute away from goods whose prices rise considerably Key Concepts and Summary Tracking Inflation Economists measure the price level by using a basket of goods and services and calculating how the total cost of buying that basket of goods will increase over time . Economists often express the price level in terms of index numbers , which transform the cost of buying the basket of goods and services into a series of numbers in the same proportion to each other , but with an arbitrary base year of 100 . We measure the rate as the percentage change between price levels or index numbers over time . How to Measure Changes in the Cost of Living Measuring price levels with a basket of goods will always have two problems the substitution bias , by which a basket of goods does not allow for buying more of what becomes relatively less expensive and less ofwhat becomes relatively more expensive and the goods bias , by which a basket can not account for improvements in quality and the advent of new goods . These problems can be reduced in

242 Questions example , by allowing the basket of goods to evolve over we can not totally eliminate them . The most commonly cited measure of is the Consumer Price Index ( which is based on a basket of goods representing what the typical consumer buys . The Core Index further breaks down the by excluding volatile economic commodities . Several price indices are not based on baskets of consumer goods . The is based on all components . The Producer Price Index is based on prices of supplies and inputs bought by producers of goods and services . An Employment Cost Index measures wage in the labor market . An International Price Index is based on the prices of merchandise that is exported or imported . How the and Other Countries Experience Inflation In the economy , the annual rate in the last two decades has typically been around to . The periods of highest in the United States in the twentieth century occurred during the years after World Wars I and II , and in the . The period of lowest , with the 19305 Great Depression . The Confusion Over Inflation Unexpected will tend to hurt those whose money received , in terms of wages and interest payments , does not rise with . In contrast , can help those who owe money that they can pay in less valuable , dollars . Low rates of have relatively little economic impact over the short term . Over the medium and the long term , even low rates of can complicate future planning . High rates of can muddle price signals in the short term and prevent market forces from operating , and can vastly complicate savings and investment decisions . Indexing and Its Limitations A payment is indexed if it is automatically adjusted for . Examples of indexing in the private sector include wage contracts with adjustments ( COLAS ) and loan agreements like mortgages ( ARMS ) Examples of indexing in the public sector include tax brackets and Social Security payments . Questions . Table shows the fruit prices that the typical college student purchased from 2001 to 2004 . What is the amount spent each year on the basket of fruit with the quantities shown in column ?

2001 ) 2002 ) 2003 ) 2004 ) 2001 ) 2002 ) 2003 ) 2004 ) Items Amount , Amount Amount Amount Price Price Price Price Spent Spent Spent Spent Apples 10 Bananas 12 Grapes Raspberries Total . Construct the price index for a fruit basket in each year using 2003 as the base year . Compute the rate for fruit prices from 2001 to 2004 . Access for free at

. 10 . Review Questions 243 Edna is living in a retirement home where most of her needs are taken care of , but she has some discretionary spending . Based on the basket of goods in Table , by what percentage does Edna cost of living increase between time and time ?

Items Quantity ( Time ) Price ( Time ) Price Gifts for grandchildren 12 50 60 Pizza delivery 24 15 16 Blouses 60 50 Vacation trips 400 420 TABLE How to Measure Changes in the Cost of introduced a number of different price indices . Which price index would be best to use to adjust your paycheck for ?

The Consumer Price Index is subject to the substitution bias and the goods bias . Are the Producer Price Index and the also subject to these biases ?

Why or why not ?

Go to this website ( for the Purchasing Power Calculator at . How much money would it take today to purchase what one dollar would have bought in the year ofyour birth ?

If rises unexpectedly by , would a state government that had recently borrowed money to pay for a new highway or lose ?

How should an increase in affect the interest rate on an mortgage ?

A mortgage has the same interest rate over the life of the loan , whether the mortgage is for 15 or 30 years . By contrast , an mortgage changes with market interest rates over the life of the mortgage . If falls unexpectedly by , what would likely happen to a homeowner with an mortgage ?

Review Questions 11 . 12 . 13 . 14 . 15 . 16 . 17 . 18 . 19 . 20 . How do economists use a basket of goods and services to measure the price level ?

Why do economists use index numbers to measure the price level rather than dollar value of goods ?

What is the difference between the price level and the rate of ?

Why does substitution bias arise if we calculate the rate based on a basket of goods ?

Why does the goods bias arise if we calculate the rate based on a basket of goods ?

What has been a typical range of in the economy in the last decade or so ?

Over the last century , during what periods was the rate highest and lowest ?

What is ?

Identify several parties likely to be helped and hurt by . What is indexing ?

244 Critical Thinking Questions 21 . Name several forms of indexing in the private and public sector . Critical Thinking Questions 22 . 23 . 24 . 25 . 26 . 27 . 28 . 29 . 30 . 31 . 32 . rates , like most statistics , are imperfect measures . Can you identify some ways that the rate for fruit does not perfectly capture the rising price of fruit ?

Given the federal budget in recent years , some economists have argued that by adjusting Social Security payments for using the , Social Security is overpaying recipients . What is their argument , and do you agree or disagree with it ?

Why is the not an accurate measure of as it impacts a household ?

Imagine that the government statisticians who calculate the rate have been updating the basic basket of goods once every 10 years , but now they decide to update it every years . How will this change affect the amount of substitution bias and goods bias ?

Describe a situation , either a government policy situation , an economic problem , or a private sector situation , where using the to convert from nominal to real would be more appropriate than using the . Describe a situation , either a government policy situation , an economic problem , or a private sector situation , where using the to convert from nominal to real would be more appropriate than using the . Why do you think the experience with over the last 50 years has been so much milder than in many other countries ?

If , over time , wages and salaries on average rise at least as fast as , why do people worry about how affects incomes ?

Who in an economy is the big winner from ?

Ifa government gains from unexpected when it borrows , why would it choose to offer indexed bonds ?

Do you think perfect indexing is possible ?

Why or why not ?

Problems 33 . 34 . 35 . The index number representing the price level changes from 110 to 115 in one year , and then from 115 to 120 the next year . Since the index number increases by each year , is the rate each year ?

Is the rate the same each year ?

Explain your answer . The total price of purchasing a basket of goods in the United Kingdom over four years is year , year , year , and year . Calculate two price indices , one using year as the base year ( set equal to 100 ) and the other using year as the base year ( set equal to 100 ) Then , calculate the rate based on the price index . Ifyou had used the other price index , would you get a different rate ?

If you are unsure , do the calculation and out . Within or percentage points , what has the rate been during the last 20 years ?

Draw a graph to show the data . Access for free at Problems 245 36 . If rises unexpectedly by , indicate for each of the following whether the economic actor is helped , hurt , or unaffected a . A union member with a COLA wage contract . Someone with a large stash of cash in a safe deposit box A bank lending money at a rate of interest A person who is not due to receive a pay raise for another 11 months 37 . Rosalie the Retiree knows that when she retires in 16 years , her company will give her a payment of . However , if the rate is per year , how much buying power will that have when measured in today dollars ?

Hint Start by calculating the rise in the price level over the 16 years .