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ECON 352 Inflation

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Alexander Carvalho

on 1 February 2016

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Transcript of ECON 352 Inflation

What is Inflation?
Sustained increase in the general level of prices for goods and services.
Consumer Price Index (CPI)
Fixed-basket method

Measures the changes in prices of a basket of goods

Filled with diverse items - Housing 40%, Transportation 17%, Food & Beverages 15%, Medical 6%, etc.

Most commonly cited measure of prices
How Inflation is Measured
Calculated by looking at the change between two CPIs (Discrete Compounding)

CPI₁= P₁ₓX₁ + P₁ᵧY₁

CPI₂= P₂ₓX₁ + P₂ᵧY₁

Inflation Rate = ((CPItoday- CPIbase)/ CPItoday) x 100

Example: CPI (December 2015) = 237.847 CPI (December 2008) = 211.398

((237.847-211.398)/(211.398)) x 100 = 12.5% in 7 years

Cost (2008) = $100 Cost (2015) = $112.50
Countries with the Highest Inflation
History Of Inflation in the US
Causes of Inflation
When the price of a grocery item like milk goes up overnight, it affects your household spending. The result of price changes, that cause your household spending to rise over time, is called inflation.
March 2003
March 2004
Demand-Pull Inflation
Most common, occurs when demand for a good or services increases so drastically that supply cannot keep up, giving sellers the ability to raise prices, caused by a growing economy, discretionary fiscal policy, and new technology
Cost Push Inflation
Less common, occurs when a shortage of supply yet enough demand allows the producers to raise prices, caused by wage inflation, monopolies, natural disasters, depletion of natural resources, and government regulation/taxation
Expansion of the Money Supply
Occurs when loans are cheap; there is too much money available to purchase too few goods, neither supply nor demand changes, yet prices will increase, caused by expansionary fiscal and monetary policy
History of Inflation in Venezuela
From the 1950s to the early 1980s, Venezuela had the strongest economy in South America

Currently the Country with the highest inflation rate at 57.30%

Exceeded 100% inflation rate in June of 1980, and again from July 1996 to January 1997, seven months

Since the mid 1980s, the inflation rate has been above 20% more often than not

March 2004
History of Inflation in Iran
Has a weak private sector due to government policy, which is detrimental because a strong private sector is necessary for a good economy

Has a current inflation rate of 19.70%, the secondest highest in the world

Peak rate of 59.02% in May of 1995

Remained above 50% from April 1995 to January 1996, except in October 1995 when the inflation rate dropped to 46.17%

During the American Revolution, the Massachusetts Legislature developed a rudimentary price index used to adjust soldiers’ wages as the dollar declined in value. The index comprised an average of the prices of four staple commodities: Indian corn, beef, sheep wool and finished leather.
History of Inflation in Argentina
The federal Bureau of Labor published a monthly index of retail food prices taken from 800 merchants in large industrial centers. The index, covering the past 13 years, priced 30 principal food items and weighted them according to average consumption. Within a few years, the food price index reflected data gathered from over 1,000 retail establishments in 40 states.
Argentina’s inflation rate of 10.90% seems low compared to Venezuela and Iran

However it peaked at a massive 20,262% in the 12 month period ended April 1990, considered hyperinflation

Recently, Argentina’s officially recorded inflation rates have seemed to be a lie, as independent economists record rates of almost double

Effort to avoid bad headlines lead to debasement of INDEC, one of South America’s premier statistical offices

Currently no progress being made to improve Argentina’s credibility in reporting the true numbers, independent sources are much more useful

The National War Labor Board called upon the BLS to produce nationwide data on the “cost of living”; changes over time in this index would indicate how much household income would have to change to maintain roughly the same standard of living. President Wilson allocates $300,000 to survey about 12,000 working class families in 42 states.
1. Venezuela
2. Iran
3. Argentina
Inflation and CPI
The Present and Future
Measures of inflation have come a long way, but they still have flaws

New products still take time to be recorded by CPI

The ever-increasing quality of technology is hard to account for

CPI continues to change and adapt to stay as accurate as possible

Overall, the CPI is not a perfect tool, but it has helped the government track the economy and determine when intervention is needed when the inflation rate becomes problematic

Question 1) When were the first price indexes created to measure how prices were changing?

A. 1000 years ago
B. 500 years ago
C. 200 years ago
D. 50 years ago
Question 2) Which of the following are flaws that price indexes have historically had?
A. Not accounting for new products entering the market
B. Not capturing changes in product quality
C. Not accounting for consumer substitutions of goods as prices change
D. All the above
Question 3) In the U.S. in the 1970s, “stagflation” led to various changes from policymakers. What macroeconomic conditions describe stagflation?
A. High deflation and low economic growth
B. High inflation and low economic growth
C. High deflation and high economic growth
D. High inflation and high economic growth
Question 5) If an inflation rate is calculated to be 4.13%, a box of cereal that costs $2.99 in year 1, would cost $_______ in year 2?
Question 4) Which of the following is NOT traditionally a cause of inflation?
A. Expansion of the money supply
B. Supply cannot keep up with the rapid increase in demand
C. Increase in prices of inputs like labor, raw materials, etc
D. Increase in interest rates
A. $2.90
B. $3.11
C. $3.42
D. $0.05

Widespread financial hardship prompted revisions to the BLS’s cost-of-living index, which was still based on consumer purchases during the First World War. The BLS updated and enlarged the index’s basket of goods to better reflect spending by wage-earning households and conducted a new family expenditure survey from 1934 to 1936.

Price controls and rationing during World War II brought more changes to the cost-of-living index and provoked heated opposition by trade union leaders who distrusted the BLS’s methodology. Prices rose as factories switched from the production of consumer goods to the manufacture of ships, tanks, munitions and other war material. After the War Labor Board tied wage increases to the cost-of-living index, labor unions attacked the index, charging that it failed to capture the full rise in living costs for industrial workers.

The BLS changed the name of the index to the Consumer Price Index—an acknowledgment that the measure was not a true cost-of-living index because it didn’t fully capture changes in product quality or consumer substitution of items when one becomes cheaper (or its price rises less) than another.

The BLS split the CPI into two measures, each representing the buying habits of distinct populations. A new CPI for all urban consumers (CPI-U) expanded the index’s geographic reach beyond large cities to smaller urban areas and added previously excluded groups of consumers such as salaried employees, part-time workers, the unemployed and retirees.

The BLS switched to the rental equivalence method of measuring homeowner costs: CPI price gatherers consider how much a house would rent for if the owner rented it to someone else.

The Boskin Commission, an advisory group, found that the CPI overestimated the rise in living costs by just over 1% per year. The implications of this provoked intense interest in the Boskin Report from economists, politicians and journalists around the world. If the CPI overstated inflation then economic output and productivity had grown more than previously believed. Real median income had risen more than the official CPI indicated and Social Security cost-of-living adjustments were too high
the CPI was still considered to be subject to bias from consumer trade-offs among broader item categories such as rice and pasta. To address this, the bureau added yet another measure of price change to its family of indexes—the chained CPI for all urban consumers. Intended primarily a research tool, the C-CPI-U relies on a different price-change formula that better accounts for consumer substitution among all item classes.
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