Macro 2.4 & 2.5 Price Indices and Inflation & Costs of Inflation
Summary
TLDRIn this video, Jacob Reed from reviewecon.com discusses inflation, focusing on the Consumer Price Index (CPI) as the primary inflation metric. He explains the concept of inflation, the difference between nominal and real values, and how CPI measures price changes for a basket of goods. The video also covers the potential issues with CPI, such as substitution and quality change biases, and the impact of inflation on real wages, purchasing power, and different economic actors like borrowers and savers.
Takeaways
- 📈 Inflation is a general increase in average prices across an economy, with deflation being the opposite.
- 💼 Nominal values are not adjusted for inflation and tend to increase faster than real values, which are adjusted.
- 📊 The Consumer Price Index (CPI) measures inflation by tracking price changes in a basket of goods and services.
- 🧮 CPI is calculated by dividing the value of the market basket in the current year by the value in the base year, then multiplying by 100.
- 🛒 The market basket used for CPI includes a weighted average of goods reflecting typical household purchases.
- 📉 The base year's CPI is always set at 100, representing a benchmark for comparison.
- 📚 To find the inflation rate, subtract the old CPI from the new CPI, divide by the old CPI, and multiply by 100.
- 🛍️ CPI has limitations like substitution bias, quality change bias, and new products bias, which can affect its accuracy.
- 💼 Inflation impacts real wages by decreasing their purchasing power unless nominal wages increase at a higher rate than inflation.
- 💵 Inflation reduces the purchasing power of money, meaning each unit of currency buys fewer goods and services over time.
- 🏦 Unexpected inflation benefits borrowers as they repay loans with dollars worth less, but it hurts lenders and savers who receive less real value back.
Q & A
What is inflation?
-Inflation is a general increase in average prices throughout an entire economy, referring to the average prices of many goods and services over time.
How is deflation different from inflation?
-Deflation is a decrease in average prices for goods and services throughout an economy, as opposed to inflation which is an increase.
What is the difference between nominal and real values in economics?
-Nominal values are those that have not been adjusted for inflation and tend to increase over time. Real values, on the other hand, have been adjusted for inflation and are considered more important in economics as they reflect the actual purchasing power.
What is the Consumer Price Index (CPI) and how is it used to measure inflation?
-The CPI is the primary way to measure inflation by tracking price changes in a market basket of goods and services. It is calculated as the value of the market basket in the current year divided by the value of the market basket in the base year, multiplied by 100.
What is a market basket in the context of the CPI?
-A market basket is a selection of goods and services that a typical household might purchase. The CPI uses the changes in prices of this basket to measure inflation.
Why is the base year's CPI always set at 100?
-The base year's CPI is set at 100 because it serves as a reference point. The value of the market basket in the current year is compared to the value in the base year, and since they are the same in the base year, the CPI is 100.
How can the inflation rate between two years be calculated using CPI?
-The inflation rate between two years can be calculated using the formula: (New CPI - Old CPI) / Old CPI * 100. This gives the percentage change in prices over the period.
What are some problems with the CPI as a measure of inflation?
-Some problems with the CPI include substitution bias, quality change bias, and new products bias. These can cause the CPI to overestimate or underestimate the true impact of price increases on average households.
How does inflation impact real wages?
-Inflation can decrease the real value or purchasing power of wages. If wages increase at a slower rate than inflation, the real wage effectively decreases, meaning that the purchasing power of the wage earner is reduced.
Who benefits from unexpected inflation?
-Borrowers benefit from unexpected inflation because they end up repaying their loans with money that has less purchasing power. This means they effectively pay back fewer real dollars.
Who is hurt by unexpected inflation?
-Lenders and savers are hurt by unexpected inflation. Lenders receive fewer real dollars when loans are repaid, and savers find that their savings buy fewer goods and services over time due to decreased purchasing power.
Outlines
📈 Understanding Inflation and CPI
In this segment, Jacob Reed from reviewecon.com introduces the concept of inflation as a general increase in average prices across an economy. He explains the difference between inflation, deflation, and disinflation. The importance of distinguishing between nominal and real values is highlighted, with real values being adjusted for inflation. The Consumer Price Index (CPI) is presented as the primary measure of inflation, tracking changes in a market basket of goods and services. The video uses a simplified market basket to demonstrate how CPI is calculated by comparing the value of the basket in the current year to the base year, multiplied by 100. The script also covers how to calculate the inflation rate between two years using the CPI.
💸 The Impact of Inflation on Society
This paragraph discusses the real-world implications of inflation. It begins by addressing the limitations of the CPI, such as substitution bias, quality change bias, and new products bias, which can lead to overestimating or underestimating the impact of inflation. The paragraph then explores how inflation affects real wages, causing a decrease in purchasing power. It also touches on how inflation can benefit borrowers by reducing the real value of debt repayments, while it can hurt lenders and savers by decreasing the value of money over time. The video concludes by encouraging viewers to visit reviewecon.com for further resources on understanding inflation and preparing for economics exams.
Mindmap
Keywords
💡Inflation
💡CPI
💡Nominal Values
💡Real Values
💡Deflation
💡Disinflation
💡Market Basket
💡Substitution Bias
💡Quality Change Bias
💡New Products Bias
💡Real Wages
Highlights
Inflation is a general increase in average prices throughout an entire economy.
CPI is the primary way we measure inflation.
Deflation is a decrease in average prices for goods and services throughout an economy.
Disinflation occurs when the rate of inflation decreases.
Nominal values are values that have not been adjusted for inflation.
Real values have been adjusted for inflation and are more important in economics.
The difference between real values and nominal values is inflation.
CPI tracks price changes in a market basket of goods and services.
The U.S. market basket for CPI includes over 80,000 different goods.
CPI is calculated by dividing the value of the market basket in the current year by the value in the base year, then multiplying by 100.
The base year's CPI is always 100.
Inflation rate can be calculated using the formula: (New CPI - Old CPI) / Old CPI * 100.
CPI has some problems that can cause it to overestimate or underestimate the true impact of price increases on average households.
Substitution bias is a problem where consumers buy other goods when the price of one increases.
Quality change bias indicates that changes in product quality are not always reflected in the CPI.
New products bias means new products take time to show up in the market basket that tracks inflation rate.
Inflation impacts real wages by decreasing their purchasing power.
Unexpected inflation helps borrowers and hurts lenders or banks.
Inflation also hurts savers as their savings will be worth fewer real dollars over time.
Transcripts
hi everybody jacob reed here from
reviewecon.com today we're going to be
talking about inflation the cpi is the
primary way we measure inflation and
we're also going to talk about the cost
of inflation as well if after watching
this video you still need a little more
help head over to reviewecon.com and
pick up the total review booklet he has
everything you need to know to ace your
microeconomics or macroeconomics ap exam
let's get into the content
now the first thing we're going to do is
talk about a few different definitions
the first definition you need to know is
the definition of inflation inflation is
a general increase in average prices
throughout an entire economy we're
talking about average prices of lots of
goods and services not the average price
of one particular good or service and
since prices generally increase over
time inflation is what we're going to
see most often in the real world economy
of course sometimes prices decrease as
well and when that happens we call that
deflation that's a decrease in average
prices for goods and services throughout
an economy you could also see the term
disinflation that occurs when there is a
high level of inflation say eight
percent and then the rate of inflation
decreases to let's say five percent
prices are still increasing but they're
increasing at a slower rate and when it
comes to understanding inflation it's
all about understanding the difference
between nominal values and real values
nominal variables are values that have
not been adjusted for inflation they
tend to go up over time way faster than
if we had adjusted for inflation but in
economics real values are more important
real variables have been adjusted for
inflation and so of course that tells us
that the difference between real values
and nominal values is inflation and so
adjusting between nominal values and
real values is all about deleting the
price changes caused by inflation
when it comes to measuring inflation the
cpi or the consumer price index is the
primary way that we measure inflation
the cpi tracks price changes in a market
basket of goods and services in the
united states that market basket is
comprised of over 80 000 different goods
that a typical urban household purchases
urban household meaning people living in
and near cities in order to help us
understand how to calculate a cpi we're
going to have a market basket that is
comprised of just three items a gallon
of milk a chicken and a pair of shoes
and here we have different prices for
those items in 2012 and 2020. now just
like the real market basket this market
basket is weighted meaning that some
items are more heavily counted than
other items and they are more heavily
counted by the quantity that we see
within the market basket when it comes
to calculating the cpi we're going to
calculate the value of that entire
market basket twice because the formula
for consumer price index is the value of
the market basket in the current year
divided by the value of the market
basket for the base year times 100 so
we're going to take a look at all of
those prices and all of those quantities
first thing we're going to do is
calculate the cpi for 2012 using the
market basket we have here so the first
thing we're going to do is calculate the
value of the market basket in the
current year so for 2012 we're going to
use 2012's prices that's the 10 gallons
of milk times the three dollars those
cost the eight chickens times the five
dollars and the two pairs of shoes times
the 25 dollars that gives us 120 for the
market basket value in 2012 for those
quantities and those prices and then
we're going to calculate the value of
that market basket using base year
prices since the year we are focusing on
is the same year as the base year the
value is going to be the same so the
market basket value in the base year is
also 120 so that's going to be our
denominator here and then times that by
100 that gives us a consumer price index
of 100 for the year 2012 and that's
because the base year's cpi is always
going to be 100 and that's because the
value of the market basket in the
current year will be the same value as
the market basket in the base year next
we're going to calculate the value of
the cpi for 2022 for this market basket
so for the current year prices in the
market basket we're going to use the
same quantities but this time with the
2022 prices of five dollars for a gallon
of milk six dollars for a chicken and
twenty six dollars for that pair of
shoes ten times five eight times six and
two times twenty six added together
gives us a hundred and fifty dollars for
the market basket in 2022 and for the
market basket value in the base year we
have the same quantities and the base
year prices it's the same value we
already calculated and that was 120
take the 150 divided by the 120
times 100 that gives us a cpi of 125 for
2022. on your ap macroeconomics exam you
could be asked to calculate the
inflation rate between two years if they
give you two different cpi's here's the
formula for you you take the new cpi
minus the old cpi divided by the old cpi
then times 100 and that will give you
the amount of inflation between those
two years so if in 1997 we had a cpi of
160 and then two years later in 1999 we
had a cpi of 176 how much inflation was
there between those two years well
you're going to take the new cpi of 176
minus the old cpi of 160 divided by that
160 times 100 and that gives us 10
inflation over those two years between
1997 and 1999.
now the cpi is an attempt to capture the
impact on average households when prices
increase but it does have some problems
and it's not perfect and those problems
can cause an inflation rate to either
overestimate or underestimate the true
impact of price increases on average
households one of those problems is the
substitution bias when prices go up we
have the substitution effect that you
may have learned about in microeconomics
when this price of one thing increases
consumers tend to buy other things
instead so for example when i go to the
store to buy some carrots and i see that
the price has gone up i might buy
cucumbers instead if the price of
cucumbers hasn't increased next we have
the quality change bias and that tells
us that changes in quality for products
are not always reflected in the cpi
televisions have dramatically changed
over my lifetime and those quality
changes may not be fully reflected in
the consumer price index and lastly we
have the new products bias new products
may be introduced into the market but it
will take some time for them to show up
in the market basket that tracks our
inflation rate so when cellular phones
came out they were not immediately
included in the cpi market basket even
though they were part of typical
consumer purchases
so why do we care why does it matter
that prices are going up well inflation
has some real costs in our society the
first big impact is the impact on real
wages when we have inflation the real
value or the purchasing power of wages
decreases and sometimes wages aren't
increasing nearly as fast let's say i
get a nominal increase in my wage of
five percent but we have a seven percent
inflation rate as a result in order to
find out the impact on my real wages
we're going to have to subtract that
inflation rate so the five percent
nominal increase in my wages minus the
seven percent inflation rate that means
that the approximate impact on my real
wages is actually a two percent decrease
and so the real impact of the nominal
wage increasing slower than prices means
in this example i'm actually two percent
worse off and that's what inflation does
it changes the purchasing power of our
money purchasing power is the ability of
your money to buy goods and services and
inflation decreases the purchasing power
of your money in other words it
decreases the real value of that money
now inflation isn't bad for everyone
some people are actually helped by
inflation in fact unexpected inflation
actually helps borrowers and that's
because they're going to pay back fewer
real dollars and that means that
unexpected inflation is going to hurt
lenders or banks and that's because
they're going to be paid back fewer real
dollars you can learn more about the
impact of the inflation rate on
borrowers and lenders when you learn
about the fisher formula in a future
unit and that unexpected inflation is
also going to hurt savers because they
have set aside money and as time goes on
their savings will be worth fewer real
dollars and that's because those dollars
have less purchasing power and buy fewer
goods and services and there you have it
that's everything you need to know about
the cpi and the cost of inflation if
after watching this video you still need
a little more help head over to
reviewecon.com and pick up the total
review booklet it has everything you
need to know to ace your microeconomics
and macroeconomics ap exam that's all
for now i'll see you all next time
Weitere ähnliche Videos ansehen
5.0 / 5 (0 votes)