Unit 6 Macroeconomics: GDP and Economic Challenges

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Unit 6 Macroeconomics:

GDP and Economic Challenges

Chapters 13.2

Economics

Mr. Biggs

The Effects of Rising Prices

Inflation

-

A general increase in prices.

In the American economy, prices have
mostly risen since World War II.

Purchasing power
-

The ability to
purchase goods and services.

Inflation can shrink the purchasing
power of money.

For example, in 1954 a Mercedes
Benz 300SL cost $11,000.

In 2011 a Mercedes Benz SLS AMG
cost $183,000.

Inflation

Price Indexes

Economists do not compare individual
prices, they compare price levels.

Price Index
-

A measurement that
shows how the average price of a
standard group of goods changes

over time.

For example, a home price index.


Using Price Indexes

Price indexes help consumers and
businesses make economic decisions.

For example, increased savings in

time of inflation.


G
overnments also use indexes
to

make
policy decisions.

For example, increasing minimum
wage if purchasing power has been
decreased.

The Consumer Price Index

There are several price indexes, the best
-
known index focuses on consumers.

The Consumer Price Index (CPI)
-

A
measurement that shows how the

average price of a

standard group

of goods changes over time.

They measure

the price of a standard

group of goods that represent the


market basket
” of an urban consumer.

Market basket
-

A representative

collection of goods and services.


Price Indexes and the Inflation Rate

Economists also calculate the inflation

rate but the CPI is the index you

will most often hear about.

Inflation rate
-

The percentage rate of
change in price level over time.

Determining the CPI

To determine CPI,

the BLS establishes a
base period to which it can compare
current prices.

Currently,

the base period is 1982


1984.

The cost of the market basket for that
period is assigned the index number 100.

The BLS determines the CPI for a given
year using the following formula:




Calculating the Inflation Rate

The BLS determines the inflation rate
using the following formula:

Types of Inflation

Inflation rates between 1%
-

3%

do not typically cause problems

for an economy.

When the

rate exceeds 5%, the

inflation rate itself becomes

unstable and unpredictable.

In order to study long
-
term trends

in inflation rate, economists

calculate the core inflation rate.

Core inflation rate

-

The rate of inflation
excluding the effects of food and energy
prices.

Hyperinflation

-

Inflation that is out of
control.

For example, inflation of 100% causes
your money to lose much of its value
and can lead to an economic collapse.

Causes of Inflation



Economists incorporate the quantity
theory, demand
-
pull theory, and cost
-
push theory when they try to understand
the inflation

process.


The Quantity Theory

Q
uantity theory
-

Theory that too much
money in the economy causes inflation.


Demand
-
Pull Theory

Demand
-
pull
theory
-

Theory that
inflation occurs when demand for goods
and services exceeds existing supplies.

The Cost
-
Push Theory

Cost
-
push theory

-

Theory that
inflation occurs when producers raise
prices in order to meet increased
costs.

Wage increases are usually the
reason for the increased costs.

Wage
-
price spiral
-

The process by
which rising wages cause higher
prices, and higher prices cause higher
wages.


Effects of Inflation

The effects of inflation can be seen
mainly in purchasing power, income,
and interest rates.

Purchasing Power

Inflation can erode purchasing power.

In

an inflationary economy, a dollar will
not buy the same number of goods that
it did in years past.


Income

Inflation will erode income if wage
increases do not

keep up with inflation.

People on a fixed income will see the
real value of their paycheck steadily
decrease.

Fixed income
-

Income that does not
increase even when prices go up.


Interest Rates

Savers may

lose money if the inflation
rate is higher than their interest rate.

Recent Trends

In the late 1990s and early 2000s, unemployment levels were
low and inflation began to increase (wage
-
price spiral).

In 2009, prices seemed to be falling and some experts
predicted a period of deflation.

Deflation
-

A sustained

drop in price level.

In the late 2000s, the

unemployment rate

rose to 10% with less

than 2% inflation.

The
End